Posted by Jeff Ball ● Oct 18, 2018 9:00:00 AM

Financing Challenges for Vacation or Short-Term Rentals (STRs)

STR Financing Challenges by Jeff Ball

Whether you call it a short-term rental or a vacation rental, people often start with a second home.  Financing a second home is straightforward and simple; lenders generally look at your income and see if you qualify for a mortgage.  What we see happen, though, is people start renting out their second homes and quickly uncover that it works well, and they want to replicate this model. Lenders like us come in when consumers run out of income to qualify for additional mortgages and need to find another way to finance their next rental investment. Here are some of the key nuances of financing an STR or vacation rental:

Residential properties need residential appraisals

Traditionally, for rental properties, appraisers fill out a 1007 report on comparable rents for long-term leases; think a year or more. Appraisers primarily appraise homes for consumers.  Every once in a while they are asked to appraise a home as a long-term rental.  In most markets, they rarely are hired to appraise an STR or vacation rental.  Getting an accurate appraisal of an STR or vacation rentals potential gross rents, therefore, can be difficult because most appraisers are unsure how to calculate short-term rents. Our solution is to direct appraisers to build an STR comparison. For instance, let’s say the buyer is purchasing a condo in a 50-unit building in Destin, and of the 50 units, 10 are short-term rentals. The appraisers could use the 10 short-term rentals for their comparable information. Another fool-proof method is to purchase a house with an existing rent-roll; it’s always better to buy a property with existing records for an appraiser to use.

Turnover Costs

Let’s say you generate $3,000 per month on an STR and only $2,000 a month on a long-term lease for the same property. While it might look like the STR is far more lucrative, in reality the turnover and maintenance costs associated with an STR are higher so you need to make some adjustments before drawing a conclusion. At Visio, we adjust our pricing model for STRs by adjusting the gross rents used in our DSCR calculations.  Our goal is to do as much as we can to STRs to make comparing them to long-term rentals apples to apples, instead of apples and oranges.

Regulatory Risks

Owning a vacation rental in Orlando by Disney World is a different ballgame than owning one in the heart of an elite neighborhood in Boston. While a large part of Orlando’s economy relies on tourists, in a more suburban neighborhood, the city might not be as open to short-term renters and might pass regulations restricting them. This can be tricky for a lender, particularly in cases where the owner designed or modified the house for short-term rentals. A 9 bed, 9 bath house might be fantastic for vacationers, but not for many consumers. So what happens if the short-term use becomes outlawed? This is an issue any lender needs to consider when underwriting a loan.

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Related: Financing a Short-term Rental (Vacation) Property, Visio & Short-Term Rentals

Topics: Real Estate Investing, Vacation Rentals