long-term rental/vacation rental niche

[clarkfan1979]

I was thinking this post might be helpful for those who are work from home and wish to purchase a vacation rental.

I have a furnished long-term rental on the island of Kauai. The main house is on the first level (3 bed/2 bath/2 car garage). It's 1850 sq. ft. with another 550 sq. ft. of covered deck space. Downstairs is a separate lock-out mother in law suite that is around 650 sq. ft.

Due to local zoning laws, I rent both with a 6 month lease minimum and then month to month. As a long-term rental, market rent for the upstairs is around $4000/month and downstairs is around $2500/month. Leases less than 6 months are not allowed. The fine is $10,000/night.

There are a small number of houses within a 1-2 mile radius of my rental house that received a vacation rental permit years ago and they are still grandfathered in to operate. The listing below is a very good comp for my rental house because the listing is for the upstairs only and most likely the owner lives in the lower unit. As a vacation rental, after taxes and fees, it goes for $16,000-$18,000/month (upstairs only).

For the 3rd summer in a row I got lucky and I'm able to occupy my rental when I'm in between tenants. In summer 2021, we occupied the upstairs for 6 weeks, in summer 2022 we occupied the basement unit for 2 months and for summer 2023 we are going to occupy the upstairs for one month. As an owner, I am legally allowed to occupy my rental on a short-term basis. I'm also allowed to invite family and friends, as long as I don't charge them rent, which I don't. There is no way I could afford to rent a comparable vacation rental at 16K to 18K for one month. However, I can stay in my own place for one month and just pay the opportunity cost of lost rent. 

Most tenants stay 6-12 months. The biggest downside is that we typically only get about 45 days notice to try to pull it off. In the future, I'm going to offer a discount for signing a 9 to 11 month terminal lease. That would give us more time to plan if we know the exact move out date in advance. The short notice doesn't really bother us. However, friends and family are more likely to join us with more notice.

https://www.airbnb.com/book/stays/29011887?numberOfAdults=2&checkin=2023-10-01&numberOfGuests=1&checkout=2023-10-31&guestCurrency=USD&productId=29011887&isWorkTrip=false&numberOfChildren=0&numberOfInfants=0&numberOfPets=0

[GilesMM]

Short term rental is a higher rate but often a much higher vacancy. Over the course of a year it could be 30-60%. It can also be a lot more wear and tear since a lot more visitors move through. Chances of a bad one increase. It just takes one to wreak havoc.

[PMJL34]

The listing you shared appears to have about 50% occupancy for the peak summer months and not one single night of booking after August of 2023 through 2025.

Edit: On second thought, what are you trying to share here? That short term rentals in Kauai charges more per night than long term leases? But that airbnbs are not allowed anyway so it's a moot point? But that it's great for you because you can vacation there? Or that it sucks because you don't get to choose when you vacation  + short notice.

lol I am very confused Clark. What is actionable here?

[clarkfan1979]

The listing you shared appears to have about 50% occupancy for the peak summer months and not one single night of booking after August of 2023 through 2025.

Edit: On second thought, what are you trying to share here? That short term rentals in Kauai charges more per night than long term leases? But that airbnbs are not allowed anyway so it's a moot point? But that it's great for you because you can vacation there? Or that it sucks because you don't get to choose when you vacation  + short notice.

lol I am very confused Clark. What is actionable here?

It seems as though the actionable advice is not clear. I apologize for that. I will attempt to get straight to the point.

If you have a favorite vacation spot, consider buying a long-term rental in an area that does not allow short-term rentals. Rent it out furnished and "long-term" consistent with local laws and stay there yourself on a short-term basis when in between tenants. All things being equal, the neighborhood that does not allow short-term rentals is going to be cheaper.

We have spent significant time over the past 3 years at our long-term rental on Kauai when we are in between tenants. Based on our income, we could never afford to do this by renting a comparable house or condo.

Under the right conditions, a short-term rental could be financially possible for us. However, I think it might be worth it to compare the long-term rental option that I proposed with the typical short-term rental option when deciding.

Talk to your lender, but if you plan to be at the house for 14 days or more each year, you can qualify for a second home mortgage with a lower rate and only 10% down. Immediately after closing spend at least 14 days at the property to make sure you fulfill the requirement and then rent it out long-term until your next vacation.

Every location and situation is different. Fort Collins, CO considers a short-term rental anything less than 30 days. Kauai County considers a short-term rental anything less than 6 months. We have had success and I thought it was worth sharing.

 

[GilesMM]

What is your annual cash flow like?

[maginvizIZ]

This is an awesome idea!  I've been thinking of doing something like this... Mixing an investment with personal use like this.  I've never thought about this strategy of getting long term renters, then staying in it in-between...

Have you thought about it with short term rentals?  I live in Salt Lake, and would love to vacation in St George / Mesquite / Las Vegas.  I've thought about purchasing a property for airbnb, then using it when it is not rented...

[clarkfan1979]

This is an awesome idea!  I've been thinking of doing something like this... Mixing an investment with personal use like this.  I've never thought about this strategy of getting long term renters, then staying in it in-between...

Have you thought about it with short term rentals?  I live in Salt Lake, and would love to vacation in St George / Mesquite / Las Vegas.  I've thought about purchasing a property for airbnb, then using it when it is not rented...

I think the short-term rental strategy is pretty well known and talked about on this forum. Short-term rentals typically cost more. If you can buy a long-term rental in an area that does not allow short-term rentals, the price point is typically less. As an owner, you are legally allowed to stay at your long-term rental, on a short term basis. A smaller price point gets you a lower down payment and lower mortgage for a similar (but not the same) experience. To pull this off, you need to be flexible with your travel schedule. Work from home would be a good fit. 

My Kauai example, might be on the extreme end, but I think the principle is still the same. My Kauai house that is not zoned for short-term rentals is probably worth around 1.15-1.2 million. If my house was in an area that allows short-term rentals, it would probably be worth around 3 - 3.5 million because you can get 5X the rent for short-term.

[maginvizIZ]

I agree in certain cities, short term rental allowed houses sell at a premium.  That doesn't seem to be the case in Mesquite (NV).  I definitely think St George (UT) homes with STR zoning has 2x the value.

Mesquite currently has new construction 3 bed 1455 sq ft houses selling for $385k that allow STR.  Nerding out too much, I'm guessing $200 x 30 days @ 65% occupancy = $3900.  Maybe I can get better returns elsewhere, but this is kind of a blend of investment and last-minute vacation getaways...


Cool to hear about you doing these vacations with a long-term rental house in Hawaii!  Definitely something I didn't think of. 

[SeattleCPA]

This tax planning observation to add to the discussion. And it may be an esoteric point.

Short-term rentals provide a way for investors to get really gigantic tax savings onto a tax return.

Extreme Example: Your tax return shows $300K of income from jobs. But the short-term rental loses $200K so you pay taxes on just the net $100K.

The two rules of short-term-rentals gambit: One, your average rent interval needs to be 7 days or less. Two, you need to materially participate. (This lets you sidestep the Section 469 passive loss limitation law and regulations.)

Practical reality: You probably can't use personally the rental the first couple of years of ownership. (The problem with personal use is, another chunk of tax law, Section 280A, makes it really tricky to get deductions to work right if you have personal use.)

P.S. There are other ways to get giant real estate tax deductions onto a tax return. But short-term rentals are probably the easiest.

P.P.S. Because short-term rentals and vacations rentals are a popular tax planning gambit for our CPA's clients, there are several articles on how technique works and when it breaks at my blog. Link to blog in signature below.

[maginvizIZ]

Extreme Example: Your tax return shows $300K of income from jobs. But the short-term rental loses $200K so you pay taxes on just the net $100K.

The two rules of short-term-rentals gambit: One, your average rent interval needs to be 7 days or less. Two, you need to materially participate. (This lets you sidestep the Section 469 passive loss limitation law and regulations.)

Practical reality: You probably can't use personally the rental the first couple of years of ownership. (The problem with personal use is, another chunk of tax law, Section 280A, makes it really tricky to get deductions to work right if you have personal use.)

This is interesting!  I need to research more on this.  Won't reducing my W2 income, hurt me in getting future home loans?

I'm 99% sure I'm going in on this 3 bed new construction in Mesquite Nevada.  I do plan/hope it is successful and that I scoop up a new vacation home the following year...

[SeattleCPA]

Extreme Example: Your tax return shows $300K of income from jobs. But the short-term rental loses $200K so you pay taxes on just the net $100K.

The two rules of short-term-rentals gambit: One, your average rent interval needs to be 7 days or less. Two, you need to materially participate. (This lets you sidestep the Section 469 passive loss limitation law and regulations.)

Practical reality: You probably can't use personally the rental the first couple of years of ownership. (The problem with personal use is, another chunk of tax law, Section 280A, makes it really tricky to get deductions to work right if you have personal use.)

This is interesting!  I need to research more on this.  Won't reducing my W2 income, hurt me in getting future home loans?

I'm 99% sure I'm going in on this 3 bed new construction in Mesquite Nevada.  I do plan/hope it is successful and that I scoop up a new vacation home the following year...

I've got a bunch of stuff at my blog. But here's an article to start your research: https://evergreensmallbusiness.com/tax-strategy-tuesday-vacation-rental-property/

This blog post is probably also a good one to read carefully: https://evergreensmallbusiness.com/irs-short-term-rental-audits/

I think the way to think about this: Short-term rental investing can be a way to save a lot more pretax money. The twin drawbacks to this: First, you have an active investment you need to manage. And second, these investments (unlike an IRA loaded with index funds) may not work well in the final chapters of your life.