The owner has a cash cow. Her second unit is bringing in $3,300 per month as an Airbnb rental, and it’s paying her mortgage. Since these types of rentals are all the rage right now, let’s talk about some important details to keep in mind from a value perspective. This isn’t meant to be exhaustive, but I wanted to share some things on my mind. I’d love to hear your take in the comments.
1) Airbnb rent vs. market rent: Having an Airbnb rental is really more like a hotel since the guest is only there for a short period of time. In the owner’s case above she was getting $3,300 per month for Airbnb rent, but market rent with a tenant would have been $1,900. In other words, Airbnb was renting 73% higher in this case. Granted, there are expenses and taxes to consider, so the owner is not actually netting 73% more.
2) Lenders and market rent: Typically lenders are going to ask residential appraisers to use market rent in appraisal reports instead of a short-term transient rent (“hotel” rent). Thus when appraisers do The Income Approach for a 2-4 unit residential property, you can expect the appraiser to use market rent instead of a short-term rent that might be much higher. We can also expect for the real estate community to keep thinking through how to value properties like this because it’s an emerging market. For appraiser colleagues, which rent do you use and why? How do you deal with highest and best use?
3) Investors & seller expectations: In some cases investors can make more money with a residential property by doing a short-term rental. They can buy at fair market value based on fair market rents, but then attract higher-than-market rents through a short-term rental setup. Many savvy investors have been doing this by targeting properties near Downtown. Yet sellers trying to sell a property with a short-term rental would be wise to recognize that not everyone wants to run a short-term rental business. This means buyers are going to be looking at market rents instead of just “hotel rent” when assessing whether a deal works or not. So if you’re broadcasting the unit can rent for $3,300 as a short-term rental, but it’s market rent is $1,900, buyers can’t ignore the $1,900 (and the lenders probably won’t ignore that number either). Let’s not forget to look at similar sales too. It’s easy to say, “I have an accessory dwelling and it’s a cash cow because of Airbnb.” I get that, but what have other properties with accessory dwellings been selling for? Let’s look to the market for the proof of value.
4) The fine print and a 12% tax: Owners need to know the fine print. In the City of Sacramento a rental is deemed “short term” if an owner is going to rent to someone for less than 30 consecutive days, and a short-term rental permit is needed (cost is $125 per year). If you’re going to rent a house or room for longer than 90 days during a calendar year, you’ll need a conditional use permit. But if you live in part of the property as your primary residence you only need a short-term rental permit. Oh, and there’s a 12% transient occupancy tax that Airbnb (or sometimes the owner if not using a third party) will pay to the city. Lastly, the city will require the owner to have a business operation tax account because the residential property is being used like a hotel.
I hope that was interesting or helpful.
Questions: Anything else to add to the conversation? Did I miss something? I’d love to hear your take.
If you liked this post, subscribe by email (or RSS). Thanks for being here.
Thanks for opening this topic up Ryan. I think a big point is that revenue generated by an Air BnB rental is business income. Unlike a 2- to 4-unit real property, where you could manage directly or have someone else handle for a 10% or 12% or whatever line item, the Air BnB requires the owner to be on-site reservation agent, host, manager and cleaning person. We rarely appraise SFRs using an income approach…even when they are income properties, so an Air BnB unit is a non-issue as far as real property. If it is an issue, then you’re looking at a different buyer profile, different comps, etc. I’ve appraised B&B properties before but not the business…just the real property (adjusting if needed for functionality to return to traditional residential use). Similarly, If a buyer is willing to pay a premium for a SFR due to Air BnB potential, he’s paying for that business opportunity. First and foremost the SFR buyer is buying their own home (and maybe they don’t want people staying in their pool house every day or every week). If we’re talking Air BnB with multiple units then we’re talking an income property to start with, but, as you said, income property buyers (and lenders) want stable, long-term tenancy, not baby-sitting of an inn. I think the takeaway is that if an Air BnB premium is present it’s attributable to business value (aka going-concern value) not the real property.
Great commentary John. Thank you. I always appreciate comments like this because they make the post better.
This reminds us there can be a difference between market value and investment value. It sort of reminds me how sometimes investors use cap rates to come up with a value that really isn’t in sync with the definition of market value, but the numbers work for their holding period. I think it’s similar here too. It really is a mini “hotel-like” business. I’m looking forward to hearing what other appraisers are doing though. This is absolutely an emerging market and a trend to watch.
Love John’s distinction between business value and real property value.
There is also a key element of how well a short-term rental is marketing. A current owner may do an amazing job of marketing their rental and keeping the cash flowing in, whereas a new owner may not have the same level of commitment and marketing moxie. (and vice-versa: sleepy rental wakes up with new owner)
I recently met with a seller who had an extremely inflated sense of value due to how popular his AirBNB is. I declined the listing.
Thank you Corey. This is stellar. That’s so true about different business owners. Someone might inherit or buy a business, but that doesn’t mean it’s going to be run the same way, be profitable, etc… I imagine the Airbnb market is very review-oriented, and it takes a special person with a gift for detail and hospitality to make it work.
How does one determine the best place to buy a house and set up an Airbnb?
Hi Gilbert. I don’t know that there is just one way to do this, but here’s my take (others please pitch in). I would probably ask myself where people want to stay in a given area. In many places I’m guessing the areas for tourists and traveling business people are going to be hotbeds for Airbnb. There may also be some destination / vacation type places where it can be very successful. In other words, where are the people? That’s a huge question in my mind. I would probably seek to understand rent dynamics in various locations too as that might be a clue into opportunities or even places to avoid if rents are flat or declining. Local zoning is also a big deal because not every location will allow short-term rentals. For instance, a colleague emailed me this morning and told me the City of Anaheim at one point was trying to ban third-party rentals. Yikes. It would be tragic to have an investment plan only to buy in a location where zoning does not allow short-term rentals. Lastly, I would search third-party websites to see if others are already there and/or having success. To me it would be a concern if there weren’t any rentals listed on Airbnb, VRBO, and other sites like that. In the backdrop of all of this I suppose I would research the health of the economy and tourism industry too. More people = better opportunity probably.
Any thoughts?
And be aware of the local political climate regarding short term rentals. For instance – El Dorado County is considering not allowing ANY vacation rentals countywide, that will be a big hit to property owners that count on that income and may affect their inventory and therefore property values.
Solid point. Thank you so much Deniece. I really appreciate you mentioning this. It just goes to show how zoning can impact value. It reminds me of counties with reciprocal tax agreements where residents can move and keep their tax base. A rule like that can incentivize buying, selling, and choosing to do life in some areas as opposed to others. Thus code and zoning make a difference. Anyway, I’ll watch this trend in El Dorado County. I hadn’t heard about that, so I appreciate the heads-up.
I’m not sure the county could get that through because SO much of Tahoe (and Truckee) SFR market is daily and weekly vacation rentals, and El Dorado County covers part of W Shore and the S Shore. But those vacation rentals are handled by property mgmt companies. Maybe they’ll try to do away with the little guys by requiring them to be licensed property managers (which I think is real estate activity requiring a broker at the helm?). Ultimately its probably pressure from hospitality industry just like pushback on Uber from taxi industry, etc.
John,
I wish you were correct, but Deniece has a very valid point. If you think of who is actually registered to vote (long time residents that don’t like having rotating occupants next door) v.s. out of area property owners, the impact is quite a bit different. No one wants to see private property rights impaired, but I hope the County, it’s residents and the tourism economy can all agree on a plan with mutual benefit.
I am wondering if a lender is asking to see the business license in order to include the rental income on these? Just curious…maybe a lender can chime in.
Thanks for the comments everyone. I read an article in the SacBee a while back about the council in South Lake Tahoe making rules more strict. I have heard of other cities trying to ban STRs (Short Term Rentals). It could be about supporting the hotel business of course, but it could also be about complaints from residents. On Facebook a friend shared my post (thanks Heather) and it was interesting to see a comment with the following link. Here is a Realtor in New Orleans who talks about the issue of STRs (Short Term Rentals). She actually has chosen not to do business with people who are looking to buy a property and use it as an STR. Her sense is they disrupt neighborhood life with noise, parties, parking, etc… But she also states workers who serve the city are being forced out to other parts because of how many homes are being used this way. Anyway, I wanted to share because I thought it was on topic yet a different layer to consider. https://beneworleans.com/aint-dere-no/
Great discussion on Airbnb rentals and where business and real estate often mix. Love reading the comments.
Thanks Gary. I’ve really enjoyed this too. I’ve had some stellar private emails too.
I’m not sure that AirBnB income must be treated as ordinary income. What if the AirBnB “landlord” couldn’t form an LLC, which would collect the rent, keep the place spotless, etc. Would ownership by a business entity reduce the tax in some way. Only one thing is sure: one day, they’ll get you! It helps to think of the development of AirBnBs as timeshares, which is what they really are, simply not pooled for distribution. An opinion from a timeshare realtor might be in order. After all, tax evasion is a crime, but tax avoidance is a personal civic responsibility!
Thank you Barry. I appreciate you bringing a different angle to the conversation.
Great post! Interesting topic. We have not come across too many properties that have a Airbnb rental but it is an emerging market.
Thanks Shannon. By the way, speaking of Texas, I see that Chip & Jo house is still listed at $950,000. I wrote about that one in July of 2017 (http://sacramentoappraisalblog.com/2017/07/05/smoking-pricing-crack-era-charm-blaming-appraisers/). This is a perfect conversation piece for this article today because the owner of that house looks to be expecting a huge price premium on the open market because the property generates a very lofty short-term rental income. Let’s keep watching….
True! I was thinking about that listing last week as we made a quick little visit to the Magnolia Market and Silos in Waco. Nice place to visit. It was astonishing to see all of the visitors and tours that were there as well as tour buses and people from other states and countries. That listing has been on the market for 287 days now at that price which is $904 per sq ft. The current median price per sq ft in Waco is $93. The listing notes that it is Airbnb rented 90% of the time. Can we say “aspirational”?
Very cool. I love the local perspective. One of these days I want to visit Magnolia. I’m not sure if Clint Harp’s shop is open, but I’d love to check out some of his woodworking too. Though I imagine he sells stuff at Magnolia.
Anyway, that’s wild to hear it’s rented 90% of the time. Being that it has been on the market that long it just goes to show buyers still look at the comps and they won’t pay prices that are disconnected from the market just because a house has a ridiculously high rental income. I recall last year looking at million dollar listings in Waco and you can get some extraordinary properties at that price point.
You will love Magnolia Market if you get a chance to go. I did. You can shop and hang out at the Silos. There are several fantastic food trucks there. A great taste of Texas! It’s right by Baylor University- a beautiful campus. Yes, with all of the traffic and visitors to Magnolia Market I can imagine the rental does stay rented but it would be difficult to get conventional financing as it is such a unique property that profits off of Magnolia Market fame. So far it doesn’t appear any cash buyers are interested at that price point.