Rental Arbitrage

Posted by Hannah Lapin on Mar 25, 2024 3:12:20 PM

rental arbitrageIf you want to become a real estate investor without having to buy property yourself, then there is a strategy that could be perfect for you — rental arbitrage. This unique method of earning income from real estate, specifically short-term rentals, has a high potential for profitability and could help you achieve your financial goals or fund the next big investment.

What Is Rental Arbitrage?

Rental arbitrage is a method of running a short-term rental business using a long-term rental. Essentially, a tenant signs a lease for a long-term rental and then rents it out on a short-term basis to other tenants to make a profit. This allows the tenant to take advantage of vacation rental rates without having to look for investment property loans and own the property themselves, simply renting it instead.

Usually, a long-term tenant will use vacation rental platforms like Airbnb to advertise the unit they are renting to short-term tenants. Vacation rental fees are normally much higher on a per-night basis than a long-term lease would be, so the long-term tenant can earn a decent profit as long as they secure enough short-term tenants per month.

Is Rental Arbitrage Legal?

On the surface, this practice may sound a little suspicious, and possibly even illegal. The key to becoming successful with rental arbitrage is ensuring it is allowed in the first place, which often comes down to state and local laws and the property owner.

Some cities or states may require you to have a hospitality license to rent out a unit to other tenants. If that is the case, the property owner already has this license, but you would have to acquire your own to participate in this strategy. There may also be laws regarding short-term rentals that you have to know about.

Additionally, you will need permission from the property owner and landlord to conduct this type of business. Your lease agreement may state whether or not it is allowed, but if it isn’t clear, you should ask the landlord directly to ensure you do not run into any issues.

The Earning Potential of Rental Arbitrage

Earning potential for rental arbitrage depends on many factors, so there's no way to determine an average amount to expect. An example could give you the best insight into what kind of money you can make.

Let’s say a long-term rental costs $2,000 a month to a tenant. In this particular area, a typical vacation rental fee may cost $200 a night. If you book the unit to short-term renters for ten nights in a month, you will break even when paying your rent to the landlord. Any additional booked nights will result in a profit that goes right to you. 

The Pros and Cons of Rental Arbitrage for Tenants

Tenants are the ones who would sign the original lease with the landlord and then turn around to rent the unit out to other short-term tenants, and there are several pros and cons:

Pros

  • No startup costs for buying a property
  • Quick method of investing
  • High earning potential with rental income
  • Can fund other investments

Cons

And here are a few cons:

  • Must be able to book tenants
  • Must cover utilities
  • Responsible for maintenance and guest screening
  • The landlord can order you to stop, cutting into profitability

     

    The Pros and Cons of Rental Arbitrage for Landlords

    Landlords also have a stake when rental arbitrage occurs on their property, and it's crucial for them to understand the benefits and risks of allowing it.

    Pros

    • A long-term tenant is secured
    • The tenant is incentivized to cover maintenance, upkeep, and cleaning
    • An increase in rent can be charged for this special circumstance

    Cons

    And here are a few cons:

    • More landlord liability insurance may be necessary to protect the property from unforeseen events or wear and tear
    • Tenants in the unit will be vetted by your long-term tenant, not you
    • Rental payments may be inconsistent or late based on the number of short-term tenants

 

How to Start a Successful Rental Arbitrage Business

Turning long-term rental units into vacation rentals is not incredibly complex to start, but there are important considerations to take into account. Failing to follow the necessary steps could land you in legal trouble or result in a net loss if you run the rental business poorly.

Research the Market

Research is always the key to running a successful vacation rental business, and rental arbitrage is no exception. You need to know if short-term rental laws allow for your strategy in this location, if you need a hospitality license, and if the area is a travel hotspot.

If there is not enough demand or too much supply in that specific rental market, this will affect bookings, and you may struggle to attract paying tenants who will cover your monthly rent. Consider working with a real estate agent for help.

Get Permission From the Property Owner

Allowing rental arbitrage can be a little risky for a landlord, and you will need their permission to enact this strategy for steady rental income for yourself. There are a few strategies you could employ to convince the landlord to get on board with the idea:

  • Offer a larger security deposit that is more than the first month’s rent
  • Offer to cover additional insurance since there is increased risk for them
  • Pre-pay some of your rent
  • Offer to extend your lease for a longer period

Plan Your Finances

Managing short-term rentals is not the same as managing long-term rentals. Planning your finances is crucial if you want rental arbitrage to be successful because you may need more money than you think to get started with short-term rental arbitrage. 

  • Do you have enough money to cover a security deposit or a pre-payment of rent?
  • How will you turn the unit into an attractive space for vacationers with decorations and layout?
  • What equipment will be needed to properly care for the property so it is ready for travelers?
  • Will you speak to an insurance provider about extra liability protection to ease the landlord's mind so they give their permission?
  • What rate will you charge to earn enough income to cover all your rent payments, utilities, and other expenses while still earning a profit? 

Arrange Rental Management

As the tenant renting the unit out to other tenants, you are responsible for maintaining the property. That means you will have to clean the property, address property damage, screen tenants, collect payments, manage checking in and out of the property, and do other necessary tasks that would normally fall to the landlord.

Creating a property management plan will be an essential step as you prepare to enact your rental arbitrage strategy. It might be wise to consider hiring a cleaning service or using property management software to make your job easier — but be sure to calculate these costs into your budget.

Market Your Listing

The final step in making rental arbitrage work is securing tenants for your short-term rental strategy. This is not as easy as it sounds. You will need to market your listing effectively through various channels to ensure you get enough bookings to cover all your expenses.

A vacation rental platform, social media channels, and even a website can be effective ways to advertise a short-term rental property to travelers when combined with professional images and attention-grabbing copy. Some helpful platforms for marketing include Airbnb, Vrbo, Booking.com, Facebook, Instagram, TikTok, X, and LinkedIn. 

Consider Owning the Vacation Rental Property

Although rental arbitrage is one way to become a vacation rental host, the alternative is buying a property yourself. Owning a short-term rental property can be very profitable, even if the initial process is a bit more complicated. However, you will have more control over the business model and a more secure asset to rent out.

Overcoming the startup costs for buying a vacation rental is easier with the right financing options, and if you have enough for a down payment, then it is a better long-term solution for short-term rentals. Plus, you could secure the property with a DSCR loan, which calculates risk based on rental income projections rather than the property owner’s income.

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Rental Arbitrage FAQs

Q: Do you need an LLC to run a rental arbitrage business?

A: The short answer is no, but that doesn’t mean it would not be helpful to form an LLC for this strategy. It will provide better protection for your personal assets from the business expenses of managing the property.

Q: What are the best cities for rental arbitrage?

A: Popular tourist destinations are usually the best places for a tenant’s business to operate in. Some of the best major cities for rental arbitrage include Nashville, TN; Boston, MA; Charleston, SC; and San Diego, CA [1]. However, you should research the rental market to determine the best spot for making money this way.

Q: How profitable is rental arbitrage?

A: Again, it is hard to determine the exact numbers for how profitable this business can be. It all depends on the amount of due diligence, your skills as a marketer, and the average occupancy rate of the unit. With just one unit, if you have decent occupancy rates, you could generate $1,000 or more of profit each month, with a high ceiling for even greater earnings.

 

Resources: [1] Ippei Blog

Topics: Real Estate Investing

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The information in this blog has been prepared solely for informational purposes. The contents are based upon or derived form information generally believed to be reliable although Visio accepts no liability with regard to the user's reliance on it. For legal advice, please contact your counsel.