#218 Investing in Rental Real Estate: Short-Term vs. Long-Term Rentals ft. Peter Kim, MD - Passive Income MD
#218 Investing in Rental Real Estate Short-Term vs. Long-Term Rentals ft. Peter Kim, MD
Episode #218

#218 Investing in Rental Real Estate: Short-Term vs. Long-Term Rentals ft. Peter Kim, MD

In this episode, Peter dives into the world of rental real estate investment. He’ll compare the two main popular options: short-term and long-term rentals. We’ll explore the differences in time commitment, management responsibilities, tenant considerations, and many more for each type.  Tune in and gain insights that help you decide which investment approach best fits your goals!

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13.41 Min • July 1

Episode Highlights

Now, let’s look at what we discussed in this episode:

  • What are Short-term and Long-term Rentals?
  • Difference in Returns
  • Property Management Fees
  • Risk Management
  • Tax Repercussions and Management
  • Time Commitment & Hassle

Here’s a breakdown of how this episode unfolds.

Episode Breakdown

[00:36]

What are Short-term and Long-term Rentals?

Peter begins by explaining what short-term and long-term rentals are, and comparing them to active and passive approaches. He explained active investing as buying and managing properties directly, while passive investing involves putting your money into someone else’s deals.

He shared his own experience with both owning properties and passive investing, highlighting the increasing popularity of short-term rentals within the real estate market.

Peter mentions that short-term rentals typically last from one to 30 days and are often associated with vacation rentals like those on Airbnb. They offer flexibility and options for vacationers, creating opportunities for property owners. Long-term rentals on the other hand usually last a year or more, and cater to stable tenants seeking regular housing.

[03:37]

Difference in Returns

Peter weighed the pros and cons of short-term rentals versus traditional long-term rentals. He acknowledged that short-term rentals can bring in more money per night, potentially leading to a higher overall cash flow.

However, he also recognized the downsides: higher vacancy periods between guests and the added costs associated with managing a hospitality-like environment, such as cleaning and guest turnover.

On the other hand, long-term rentals offer a predictable, steady income stream. While the nightly rate might be lower, the stability of a single tenant throughout the year averages out to be a reliable income source. Peter then considered the cash-on-cash yield, a metric used to compare investment returns.

He noted that with proper optimization, short-term rentals might generate a higher yield due to the nature of the asset class. However, this comes with the added risks and responsibilities of managing a vacation rental property.

[04:36]

Property Management Fees

Peter continued his analysis by diving into property management fees.

Short-term rentals, he explained, typically incur steeper fees due to the frequent guest turnover and hospitality-like services involved. These fees can range anywhere from 20 to 30% of the property’s gross income.

This stands in contrast to long-term rentals, where management fees are much lower, averaging around 5 to 10% of gross income. The reason? Long-term rentals require less day-to-day oversight compared to the constant guest flow of short-term rentals. Moreover, Peter noted that these long-term management fees also tend to decrease as the number of managed units increases.

[06:42]

Risk Management

Peter then talked about the risk management side of things. While short-term rentals might offer higher returns, they also come with a unique set of risks. Seasonal fluctuations in demand, sudden changes in regulations, and overall economic sensitivity could all negatively impact his income. The biggest risk, Peter highlighted, was the possibility of regulatory changes that could restrict or even ban short-term rentals altogether.

Long-term rentals, on the other hand, presented a different set of challenges. Tenant defaults, where renters stop paying rent, could disrupt income flow. Market shifts, like sudden drops in rental prices, could also affect profits. Additionally, regulations around evictions and rent caps could add another layer of complexity to managing long-term tenants.

Peter concluded by emphasizing the importance of carefully assessing the risks associated with each type of property before making any investment decisions. By understanding these risks upfront, you could make a more informed choice about which approach best suits your goals and risk tolerance.

[08:23]

Tax Repercussions and Management

Peter next explored the tax implications of each rental strategy.

Short-term rentals, he explained, are treated as ordinary income on tax returns. This means the income is taxed at the regular income tax rate. However, there are some tax advantages. Short-term rentals allow a deduction to a wider range of expenses, such as cleaning fees and maintenance costs, from rental income, potentially lowering your tax bill.

Additionally, there’s a potential tax loophole for short-term rentals: paper losses. By strategically managing expenses and depreciation, you might be able to offset some income from your regular job with these paper losses on the rental property.

Long-term rentals, on the other hand, are considered passive income. This means they are taxed differently than ordinary income, potentially at a lower rate. Long-term rentals also offer tax benefits like depreciation, which allows you to deduct a portion of the property’s value from his taxes each year.

While you couldn’t use paper losses from long-term rentals to offset day job income like with short-term rentals, you could qualify for a special tax status called “real estate professional” if you met certain criteria. This status would allow you to offset some of your day job income with losses from long-term rentals. However, achieving this status can be challenging.

Peter emphasized that while tax benefits are significant for both short-term and long-term rentals, basing investment decisions solely on taxes wouldn’t be wise. It’s crucial to consider the overall picture, including factors like risk tolerance, management workload, and desired income stability, before making a final decision.

[10:21]

Time Commitment & Hassle

Peter wrapped up the podcast by considering the time commitment and hassle involved with each type of rental.

Short-term rentals, he acknowledged, require significantly more hands-on management. Even with a property management company, there’s a high daily demand for tasks like communicating with guests, scheduling cleanings, handling turnovers between guests, and constantly marketing the property.

Long-term rentals, on the other hand, demanded less immediate attention on a day-to-day basis. However, that didn’t mean they were hassle-free. Tenant turnover, while less frequent, still required effort to find new renters and fill vacancies. Additionally, long-term rentals could involve major costs for repairs or unexpected issues. Selecting responsible tenants and keeping the property well-maintained were also ongoing considerations.

Peter emphasized that regardless of whether you choose short-term or long-term rentals, some level of responsibility would always fall on you as the property owner. The ability to fully outsource everything wasn’t an option.

He concluded by reiterating the importance of considering your investment goals, available capital, and personal preferences before making a decision. Finally, Peter stressed the importance of thorough due diligence and self-education on the pros and cons of each option to ensure you make an informed investment choice.

Kinds of 1031 Exchanges_Improvement Exchange_Reverse Exchange_1031 Tax Implications & Rules_Lazy Man's 1031 ExchangeWe talk in depth about all of this and more in our course–Passive Real Estate Academy. Want to learn everything about investing in real estate with confidence? You can grab your seat right here!   

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