Over the past several years, the vacation rental market has skyrocketed in popularity — not just for travelers, but also for the owners and investors who own the properties. As of March 2019, an estimated 31.9 million people were projected to use short-term rentals (STRs) in the U.S. last year, generating a whopping $14.5 billion in rental revenue for the year. Coming off 6.4% growth in 2019, the upswing was expected to continue into 2020.
But then came COVID-19.
How the coronavirus sent travel into a tailspin
When the pandemic struck in mid-March of this year, many STR owners saw their rental revenues slow to a trickle or grind to a halt in the face of travel restrictions, consumers’ shrinking incomes, and government regulations. Based on a survey of more than 1,400 short-term rental owners, hosts and managers around the U.S., 55% of them had temporarily shut down operations as of May.
Although the economy has started its long and slow recovery, the financial strain has led many owners to consider selling their vacation rental properties.
“Many Airbnb operators got a wake-up call during the onset of the pandemic, as they were hit with a wave of cancellations and saw their revenues collapse,” says Caleb Liu, a property investor and owner of House Simply Sold. “Based on the latest data published at AirDNA, guest bookings have nearly recovered in many markets to pre-COVID levels, but many operators may decide that this business model is no longer for them.”
If you’re one of them, you may be wondering where to start and how to navigate the process of selling your rental unit. We talked with a top real estate agent, along with some experienced investors who have sold their own properties, to gather all of the information you need.
What qualifies as a vacation rental?
A vacation rental property, also known as a short-term rental, is defined as “a rental of a residential dwelling unit or accessory building for periods of less than 31 consecutive days.”
There are two main types of short-term rental properties:
- Owner-occupied: With this type of property, the owner has occupancy more than half the time and rents out the home throughout the rest of the year for up to 30 days per rental.
- Non-owner-occupied: In this scenario, the owner does not live in the property and rents it out at least once a year for up to 30 days per rental.
Out of the nearly 8 million vacation rental homes in the U.S., roughly 2 million are listed on online travel agency (OTA) sites like Airbnb, VRBO, and HomeAway.
Connor Griffiths, listing manager with Lifty Life, an Airbnb property management service, points out that the ideal locations for short-term rentals are major cities, oceanfront, or lakefront homes, or skiing destinations — but STRs are also growing in other areas across the country.
Signs that it’s time to sell your vacation rental
Owning and operating a vacation rental can be a lucrative and enjoyable pursuit — until it’s not. If any of these factors applies to your situation, it might make sense to reach out to an agent to explore selling your short-term rental:
You’ve reached the end of the property’s life cycle.
This is one of the main reasons that vacation rental owners decide to sell, says Grant Fritschle, a top agent who also owns a vacation rental company in Ocean City, Maryland. In his market, he typically sees this happen between 5 and 10 years into ownership of an STR.
“Most have reached that lifestyle or life choice point where it makes sense to sell,” Fritschle explains.
“Maybe their kids are grown, they’re not using the property as much, or they’re traveling more. In essence, the reason they purchased the home is no longer as prevalent or demanding.”
Your rental income isn’t covering your expenses.
Cash flow should be the primary driver of the selling decision, says Kathy Fettke, a real estate investor with Real Wealth Network. “If the income doesn’t cover your expenses, then it is a negative income property. That means you are feeding it, rather than it feeding you.”
The capitalization rate (cap rate) ties into this. The cap rate is calculated with the following formula: income minuses expenses, divided by purchase price. “If your cap rate is weak or failing, you may want to focus on other investment opportunities that will generate a higher return,” says Griffiths.
For example, if you receive $120,000 in rental income each year and pay out about $50,000 for maintenance, repairs, and taxes, and the property was purchased for $1.5 million, the cap rate formula would look like this:
$120,000-$50,000 = $70,000
$70,000/$1,500,000 = 4.67% cap rate
The market is favorable for sellers.
In Fritschle’s Ocean City market, prices have rebounded and vacation rental sellers are in a strong position. “Post-COVID, our market has been as high in the last three weeks as it’s ever been,” he says. “Inventory is low or lower than it’s ever been. We’re seeing bidding wars and price escalations like we haven’t seen since 2005 or 2006.”
If you’ve been waiting for the opportunity to get a better price for your short-term rental to pay off a mortgage or liquidate built-up equity, this type of favorable market could be a signal that it’s time to sell.
Big-ticket repairs are on the horizon.
“It’s wise to sell before you expect capital expenditures to come due,” he says. “These are the larger expenses that are required to maintain a home, such as replacing a roof, furnace, fence, or windows.”
Samuel suggests also evaluating the home’s appeal in terms of upgrades. As an example, one of his Illinois properties was renovated with new kitchens and bathrooms in 2015. While the upgrades are still in line with today’s trends, he expects that might not be the case in another five years, at which point he probably won’t be able to sell at the higher end of the neighborhood’s range.
You don’t have the time, capability, or interest to manage the property.
If you’ve been managing the property yourself but are in a position where you can’t or don’t want to continue doing so — and if you don’t want to enlist a third-party property management company to take over the duties — it might be time to start looking for a buyer. Liu sometimes sees this happen when owners relocate to a different area and don’t want the hassle of renting and maintaining the home from afar.
Regulations are limiting your rental income.
Griffiths points out that new government or HOA regulations can hamper some property owners’ ability to legally operate, and could nudge them in the direction of selling.
Liu has seen the same thing happen in his market. “As local regulators are continuing to restrict the growth of short-term rentals, the increased regulation can reduce the profitability of operating under this business model for some property owners,” he notes.
Checklist for successfully selling your vacation rental
So, you’ve decided to list your vacation rental and move on to investing in other properties, enjoying the ones you already have, or maybe getting out of the STR business altogether. As with any real estate transaction, the first key to success is to start with a plan. By following this step-by-step checklist, you’ll be in a much better position to land the right kind of offer.
Pick the right time to list.
While there is no single, universal rule as to the best time to put a vacation rental on the market, there may be a more favorable season depending on where your property is located.
In a “normal” (pre-COVID) year, Fritschle recommends listing early in the year in his Ocean City market. In January and February, he typically sees an influx of buyers in town trying to buy for the summer season, although that has leveled out over the past couple of years. November and December are usually the slowest months.
Lucas Machado, property investor and owner of House Heroes, agrees with Fritschle’s strategy to list as early in the season as possible, as long as the property is ready to rent. “Buyers will see this as a benefit because they can start making money right away,” he points out. “Also, if the seller can show that lots of bookings are already locked in, that makes it an even stronger offering.”
If your property needs some work before it can operate at peak efficiency, Machado recommends selling before the season begins. This will give the new owner time to make any necessary improvements without missing out on opportunities during the peak time of year.
Spell out the income potential.
It’s undisputed that the vacation rental market has been hard-hit by the economic impact of COVID-19. The same concerns motivating you to sell could also hamper your ability to attract buyers, who may be worried about their ability to earn as much income on the property due to the slowdown in travel.
Liu points out that every investor in the short-term rental space is aware of the recent severe downturn in guest bookings. He suggests providing potential buyers with hard data on why the Airbnb model is likely to recover and remain viable in the future.
“Buyers will want to know the historical returns of the property on Airbnb versus the standard cap rates under the traditional long-term rental model,” he says. “If the spread is wide enough, you can explain that even with major economic disruptions due to a future pandemic or restrictions due to city ordinances, the buyer can still come out ahead with superior returns.”
Fritschle stresses the importance of setting realistic expectations for buyers in terms of cash flow. “Make sure they understand what they’re purchasing, what their preferences are, and that they might not make money right away,” he says.
Partner with an agent who knows the STR market.
Just as with any type of property sale, Fritschle highlights the advantage of using an experienced local real estate agent who has a strong familiarity with vacation rentals. Not only will they know more about any existing rules and restrictions, they will also have greater expertise in some of the finer details, such as HOA requirements, nearby attractions, and the lifestyle of specific neighborhoods.
“The ideal scenario is to work with a real estate agent who owns and operates an Airbnb themselves, or at least has transacted the sale of an Airbnb property to an investor,” says Liu. “They will be able to provide accurate feedback on how to position your property for a successful sale. They may even know of an investor who is actively searching for an Airbnb property in your market.”
Another key benefit of using an investor-friendly Realtor is their access to an extensive local network of reputable cleaners, inspectors, contractors, and remodelers, he adds.
Factor market shifts into your price.
To set an appropriate price for your vacation rental property, the experts recommend looking at a combination of these valuation methods:
- The sales comparison approach (SCA), which looks at recent comparable sales in the area
- The capital asset pricing model (CAPM), which takes into account the level of risk and how that will impact the return on investment
- The annual capitalization rate (the expected annual rental income divided by value of the property)
- The cost approach, which prices a vacation rental based on what it would cost to construct a new similar property
There is no hard-and-fast rule for pricing a vacation rental, as each property is different. Particularly in unstable economic times, it’s more important than ever to consult with an agent who has a good understanding of the local market and can help you calculate a price that reflects the property’s value and is in line with comparable sales.
Know your audience when marketing your vacation rental.
In a “normal” market, buyers of vacation properties are typically investors seeking a cash-flowing asset. In that case, Liu notes that you’ll need to provide evidence for your profit-and-loss statements, including bank statements, tax returns, vendor contracts, and any financial models and projections you’ve put together. He recommends calculating three separate financial statements: one as a traditional long-term rental, one as a short-term rental while self-managing, and one as a short-term rental while hiring a property manager.
Buyers will want to know about any unique features of the house that may represent untapped income potential, such as a separate mother-in-law suite on the same lot or a sealed-off basement with a separate entrance, says Liu. “Location, curb appeal, amenities and interior finishes are also major selling points,” he adds.
With the travel industry still bruised from the pandemic’s impact, sellers of vacation rentals may also want to expand their target to include regular buyers and families who are seeking a place to live.
“These days, buyers aren’t saying ‘I might rent a little,’” notes Fritschle. “Either they want to rent the property out or they want to live there. We’re seeing a pretty even mix right now.”
Manage active bookings during the sale.
If you’re selling an actively operating vacation rental, the new owner will need to honor any bookings that have already been made, as well as any existing contract with a lease management company. “Guests who have already booked and are already occupying the unit have the right to enjoy their stay as previously agreed upon,” says Liu.
When it comes to showings, there’s no need to halt bookings while a property is for sale, says Fritschle. He shows his properties either while they are vacant or between the time when a renter checks out and the next one checks in. You can also choose to block out certain days or weeks with the purpose of scheduling showings.
Most sellers pass along any existing systems and processes — for details like reservations, marketing, cleaning, and maintenance — to the buyer. If you’ve been using a vacation rental management company, the buyer can opt to continue that relationship.
“Besides the property itself, one of the key selling points of a vacation rental is that you are passing along a turnkey business, including all the backend office systems,” says Liu. “The relationships with existing cleaning and maintenance crews can all be transferred as part of the sale if specified in the contract.”
And beyond the numbers, you should be prepared to explain the “secret sauce” that has led to any past success with the property. “These are the intangible factors that aren’t readily apparent from the financial statements or marketing materials,” Liu explains.
That might mean the near-hidden pathway that leads straight to the beach, the well-maintained pool and hot tub, the proximity to local dining and shopping spots, or the friendly, on-call maintenance man who takes care of any issues within minutes.
Take taxes into consideration.
Selling your vacation property could be lucrative in terms of freeing up equity, but you’ll also have to make sure to set aside some of the profits to cover the taxes.
When selling a home that was their primary residence, a seller can exclude any capital gains taxes up to $250,000 for single homeowners or $500,000 for married homeowners. But for investment properties, they are required to pay a capital gains tax on the profits from the sale.
If you’ve owned your rental property for 12 months or longer, you’ll have to pay a long-term capital gains tax. As of 2020, the IRS tax rate is 15% for incomes of at least $78,750 but less than $434,550 for single homeowners and less than $488,850 for married, filing jointly. If your income is higher than those max amounts, you’ll be on the hook for a 20% capital gains tax.
There are a couple of different ways to defer or reduce your tax liability when selling a vacation property:
- Tax-loss harvesting: If you’ve experienced a loss from another investment within the same tax year, you can subtract that amount from any capital gains earned in the sale of your rental property. For example, if you lost $25,000 in stocks in the same year that you earned $50,000 in the sale of your vacation rental, you can offset half of the amount of your capital gains.
- 1031 exchange: If you take the money earned from the sale of your vacation rental and invest it in a “like-kind” rental property, you can defer the capital gains tax, per the 1031 exchange rule. You’ll have to act quickly, though: The IRS requires that sellers choose prospective like-kind properties within 45 days of selling the original property and close on the new purchase within 180 days of the first sale. If you don’t do so within that time frame, you’ll have to pony up the full capital gains tax.
- Live in the property before you sell: You could be eligible to deduct up to $500,000 of capital gains tax by converting your vacation rental into your primary residence. In order for this to work, you must have owned your property for at least five years and used it as your primary residence for at least two years.
Selling a vacation rental property involves navigating many moving parts, managing countless details and decisions, and following frequently changing rules and regulations. Having a specialized real estate agent in your corner will greatly increase your chances of successfully closing and moving on to the next chapter in your journey, whether that’s purchasing a new STR or just enjoying the financial fruits of your investment.
Header Image Source: (Sandra Seitamaa / Unsplash)