Thursday, December 22, 2022
There’s no doubt that real estate can be an excellent way to create long-term wealth. However, it is important to take caution when investing in real estate, as not all investment opportunities are going to be suitable for everyone.
Short-term rentals are one such option, often involving the renting of property for a stay of less than seven days (e.g. AirBnB-type models). It is important to be aware that existing investors and enthusiasts have been able to benefit from low interest rates and rising property values. Furthermore, they may live in states where property prices and taxes are lower than those in other states.
Additionally, some individuals may have a spouse who is able to put in all the required hours to gain Real Estate Professional Status (REPS), thus allowing them to offset their W2 income with deductions such as depreciation. Note that physicians who work full-time clinical jobs often cannot meet the IRS two-test requirements for material participation (750 hours of work/year) and that their working hours need to exceed those of any other job in order to qualify for this status.
My wife and I are both physicians who work full-time, and last year we decided to buy a short-term rental property. We chose a location close to the beach at the Jersey Shore, just 70 miles from our home. We thought that the property was close enough to visit and enjoy with our children, and we were confident that managing it wouldn’t be too difficult. However, an investment in short-term rental properties carries a number of risks that you need to be aware of.
In particular, the switch days in the summertime can be especially stressful, as there is a five-hour window which needs to be filled between check-out of existing guests and check-in of new ones. I am entirely reliant on my cleaners to get the place ready for the new occupants, but their availability is never certain, and in the event of any emergency or illness, I would be in a difficult position as it would be impossible to clean and turn over the property ourselves with three young children in tow.
Therefore, when considering any sort of real estate investment, it is important to take into account all potential risks, as well as any relevant Internal Revenue Service (IRS) regulations, before committing to anything. It is also worth remembering that, although the rewards can be great, there is always the possibility that the investment will not be successful.
In our case, we have encountered a number of challenges during the past two summers of running our short-term rental property:
1. Renters bringing pets to the property
Our rental agreement and Airbnb rules clearly stated no pets, but we had an incident where a renter brought a large animal into our property. We had to contact the renters and notify them of the violation, which wasn't a pleasant experience (the renter’s boyfriend even flipped me off on our Ring front door camera as he took the dog away).
2. HVAC system issues
We encountered an issue where one floor had no heat. I spent three hours trying to contact different HVAC companies and luckily we had portable heaters in the house that the guests were able to take up and use in two bedrooms. The repair costed us $500, including labor and parts.
3. Water Heater Issues
We had a physician and her family stay with us for only two nights in the offseason and, of course, the water heater didn’t work. I was able to contact a local company to come out and take care of the problem (which had something to do with the pilot going out and corrosion on one specific part) for a total repair cost of $750, including labor and parts.
4. Renters causing damage and Airbnb only paying a portion
We had renters who contacted us and said that the wind had blown a window in. Inspection revealed that the vinyl frame was broken, window off its rail, and glass had a small crack. When I called window repair companies out for quotes, all of them told me that it couldn’t have been the wind; something or someone must have hit it with force. The total replacement cost was $1500, and Airbnb only paid us back $600 due to their determination that a window should only cost that much.
5. Unauthorized party
Our cleaners reported a discharged fire extinguisher on the kitchen level and living room, with no evidence of fire. In addition, there were cans and bottles littered over the backyard and a broken yard chair. We had to make an extra cleaning fee of $350, which the renters thankfully agreed to pay.
6. Not generating a lot of cash flow
Buying property in a beach town on the northeast was a good investment, despite the limited four-month high season. Operating expenses add up, including cleaning fees, utilities, property insurance, maintenance, repairs, etc. These should be factored into a proforma when considering taking the plunge, along with property taxes and debt costs. We have seen an appreciation of the property in the past two years, and have generated some tax-free income due to the ability to legally deduct all operating costs and depreciation, as well as being able to spend some weekends with our family at the house.
Despite the above challenges overall having a short term rental has been a good investment so far - albeit a somewhat stressful one. Despite the limited cash flow - we have seen appreciation of the property the last two years, been able to generate some tax free income due to the ability to legally deduct all operating costs and depreciation, and created countless memories by being able to spend a number of weekends with our family at the house (within IRS rules).
[Note: If you are considering investing in real estate, including a short-term rental, it is important to research the local market, familiarize yourself with all potential risks associated with such an investment, and consult a tax expert well-versed in IRS regulations in order to ensure that you are in full compliance.]