One of the most common ways to earn passive income as a real estate investor is through building a portfolio of rental properties. Once you’ve identified you’d like to take this route, it’s time to determine whether you’ll focus on short-term or long term-rentals.
What is a Short-Term Rental?
A short-term rental is a real estate property that is rented out for a brief period of time, such as a few days or a few weeks. Airbnbs are an example of short-term rentals. A guest pays for temporary lodging and the owner earns income for that guest’s stay in the process. Think of it as an alternative to a traditional hotel or resort.
What is a Long-Term Rental?
A long-term rental is likely what comes to mind when you think of a rental property — a landlord going into an agreement with a tenant to rent a property for a set term, typically a year. The tenant pays rent each month, giving the owner a consistent stream of income for the duration of the lease term.
Pros and Cons of Each Rental Type
Short-term rentals provide the opportunity for investors to earn more income than they would with a long-term rental. They can adjust their nightly rates to reflect the current tourism season. Additionally, you’re not committed to meeting the needs of one tenant for an extended period of time as you would be with a long-term rental.
However, it’s more likely that you’ll experience more periods of vacancy with a short-term rental throughout the course of a year. If the weather doesn’t work in your favor or there’s a specific time of year when very few vacationers are in your city, it can be challenging to get bookings for your property.
With long-term rentals, you have a more consistent stream of income — provided your tenants pay in full and on time each month. But, there’s less flexibility with the rental rate. Your tenant’s rent amount will be set for the duration of their lease term.
You’ll also experience more wear and tear on your property because it’s being used more frequently than a guest in a short-term rental would use it. More use of your property’s appliances and major systems will eventually lead to repair or replacement costs.
Still, you’ll probably have fewer advertising and marketing expenses than you would with a short-term rental. Once you have a tenant in place, you won’t have to worry about finding a new one for at least the next year — in most cases.
What About Taxes?
Whether it’s a short-term or long-term rental, the money you receive from guests and tenants is income, which means Uncle Sam wants his cut. You’ll need to report your rental income on your tax return, just as you report the income received from your 9-to-5. The Internal Revenue Service defines rental income as “any payment you receive for the use or occupation of property.”
Fortunately, you can deduct common rental expenses from your taxable income. Common expenses include but aren’t limited to:
- Mortgage interest
- Property taxes
For more guidance on the tax implications related to rental properties, consult your tax professional.
A Real-Life Example
I recently finished renovating a property I purchased for $65,000, spending about $90,000 in renovations, plus holding costs. I did a cash-out refinance on this property and pulled out my $155,000, leaving me with a mortgage payment of $1,135.
If I had a long-term tenant, I could’ve rented this property for about $1,650 and netted $515 in income each month. However, because I’ve listed the property on Airbnb and maintain a 95% occupancy rate, I’ve been able to average $3,400 each month in short-term rental income. Although I have additional expenses (cable, internet, security, housekeeping and electric/water), I still net approximately $1,800 in income each month.
This particular property was a better candidate for Airbnb based on its location. That won’t always be the case, though, which is why you should complete the proper analysis for any rental property investment you’re considering.
Do you think you’d benefit more from owning a short-term or long-term rental property? Comment below.