September 16, 2024 | 3 Minute Read
Last week, Carl from NYC reached out to ask about his vacant long-term rental property in Birmingham. He wondered if switching it to a short-term rental (STR) would be a profitable choice.
We’ve all seen the success stories from short term rental evangelists, sharing their impressive profits and promising that you can do the same if you follow their strategy (usually for a fee). But what they don’t often highlight is that most STRs aren’t luxury vacation homes or unique experiences in hot tourist destinations. Many are found in mid-sized cities, owned by relatively small investors, or people simply trying to supplement their monthly income. And these properties are not delivering the massive returns the talking heads
Take a look at the market data: In mid-sized cities, suburban, and urban metro areas, the average daily rate (ADR) for STRs is around $251. That’s 32% lower than the rates for coastal properties and 42% lower than those in mountain or lakeside regions.
Now, while an ADR of $251 seems promising, it can be misleading. These figures are averages and don’t take into account critical factors like region, property size, or amenities. For example, a three-bedroom house in the suburbs may only pull in an ADR of less than $200, and its occupancy rate could be much lower than properties in high-demand vacation spots skewing the actual numbers for your property. This makes it crucial to analyze your financials carefully before deciding to convert your long-term rental into a short-term one.
Let’s dive into Carl’s case. He owns a three-bedroom, one-bathroom home in a C-class neighborhood, with a mortgage of $725 per month.
Long-Term Rental (LTR)
Previous rent: $1,100 per month
10% property management fee
Tenant covered all utilities and landscaping
Deduct 5% for maintenance
Carl’s net income from the previous tenant was roughly $210 per month. While this is predictable, stable income with minimal management effort, it comes with the typical challenges of long-term rentals: tenant issues, rent collection, and the cap on monthly income.
To prepare the property for a new tenant, Carl might have to spend between $3,000 and $5,000 on cleaning, painting, and minor repairs.
Short-Term Rental (STR)
I researched comparable STRs in Carl’s area using Airbnb, PriceLabs, and AirDNA. Based on this, I estimate an ADR of $155 and an occupancy rate of around 55%. This gives Carl a potential gross monthly income of $2,635 (17 booked nights x $155). At first glance, this looks appealing – nearly double the income of a long-term rental. However, we need to look much more closely because Carl is now absorbing all the costs of maintaining the STR.
15% booking fees: $324
25% management fee (minus booking fees): $459
$100 per stay for housekeeping (4 stays avg/month): $400
Landscaping: $120
Electric: $150
Water: $75
Internet: $75
Gas: $40
Supplies: $50
Mortgage: $725
Total monthly expenses: $2,418
Net income: $217/month
While Carl could see higher demand during peak months, there will also be times of low occupancy, making it harder to cover his mortgage and expenses if he’s relying solely on STR income. Based on this analysis, Carl’s net income is almost the same whether he stays with his long-term rental or switches to a short-term strategy.
And one crucial detail we haven’t covered yet: the upfront cost of upgrading, furnishing, designing and setting up the property as an STR. That could run anywhere from $20,000 to $40,000.
Is converting Carl’s property to an STR Worth It?
In Carl’s case, the answer is no. The returns just don’t justify the effort or the upfront costs.
So, what’s a good rule of thumb when deciding whether to convert over to an STR? I recommend your gross monthly income from the STR be at least 3.5X to 4X your monthly LTR projected rent. If Carl were making $4,400 a month, his net income would be about $1,005 – nearly five times what he’s earning from his long-term rental. This may justify the reason and cost to convert the property.
Remember, the numbers need to make sense. Without the right financial analysis, converting to a short-term rental could be more trouble than it’s worth.