The Short Term Rental Trap

On today’s show we’re talking about one of the traps that the market might be luring investors with.

When you make an investment in real property, this is often majority funded by permanent financing, usually amortized over a long time like 20-30 years. But if the market window for your demand is short term, then you’re at risk of making a bad investment.

I’m hearing reports that cottages and other similar vacation properties are already fully booked for next summer. Some investors I’ve spoken with have indicated a desire to purchase a vacation property and rent it out when not in use. They point to the strong demand as the rationale for the investment.

The fact is we don’t know what the demand will look like in a year or two, or five.

We know that global travel is down 90% due to the pandemic. People who are desperate for a getaway are booking accommodations within driving distance of home that allow for them to remain socially isolated.

In a pandemic environment, this all makes perfect sense. Even our own short term rental portfolio has continued to experience strong demand well into the coming year.

But we expect that the pandemic will eventually come to an end. It won’t be in the next few months. It will take much of 2021 before enough of the population is immunized for these restrictions on social activities to eliminated.

Israel stands alone in the world as having the most aggressive roll-out of vaccination of any nation. They have already immunized 20% of the population and expect to complete the entire population over 16 years of age before the end of March.

The roll-out in the US, Canada, Europe, is looking like it will be well into the 4th quarter before the majority of the population is immunized. It could be even longer. I’m expecting 2021 to look an awful lot like 2020 in terms of travel and leisure.

Cruise ships probably won’t be sailing anytime in 2021. If they do, it will be later in the year. In 2019, the cruise industry had nearly 30 million passengers, the majority of them from North America. There are all these tourists who are looking for a different vacation this year.

But eventually, many will return to cruise ships, to beach resorts in the islands, to the bus tour through Asia, to the luxury cottages in the middle of a game reserve in Africa or Australia. All of these experiences are off-limits for many because of the higher risk of infection that comes with international travel.

So what happens to all those cottages that are fully booked this year when people return to traveling? What will bookings look like in 2022 and 2023 and beyond?

I think back to the lean years at resorts that built excess capacity. Many of those condo units sat empty for much of the year.  In retrospect turned out to be very poor investments. Yes, they look great again in 2020 and perhaps in 2021. But if it took a black swan event like a global pandemic to make your investment viable, is that really a good strategy?

If you currently own a vacation property and you want to make a small incremental investment in maximize the revenue for that property, I say go for it. Maybe you want to upgrade the furniture and the interior finishes so you can command a higher price in the market. That’s a good move.

But if you’re an investor looking to make a major investment with a 25 or 30 year commitment, how do you know if the demand for your product is going to be there in a year from now, or five? After all, just as quickly as conditions changed this year, they could change again next year.

I would go back to the market conditions of 2017 and 2018 as a better indicator of what the market demand might look like in the post covid environment. You want to use market analysis tools like Alltherooms or AirDNA to determine both demand and pricing for your local market before you make an investment.