Rental property investing is a popular strategy for generating income and building wealth over time. However, not all rental properties are the same, and different strategies may suit different investors depending on their goals, preferences and risk tolerance. There are three main types of rental property investing: short-term, mid-term and long-term. Understanding how each work and becoming familiar with some of the different benefits and drawbacks can help you see how they can be lucrative alternative investments, individually or when combined to create a diversified portfolio.
Short-term rental property investing involves renting out a property for a few days or weeks at a time, usually through platforms like Airbnb or VRBO. This strategy can generate high returns per night, as well as tax benefits and flexibility in managing the property. However, it also comes with higher costs, such as cleaning fees, maintenance expenses, insurance premiums and occupancy taxes. Also, short-term rentals are subject to market fluctuations, seasonal variations and regulatory changes that can affect the demand and profitability of the property.
One of the many advantages of short-term rentals is the higher rental income generally associated with these types of investments. Short-term rentals can charge higher rates per night than long-term rentals, especially as vacation rentals in popular tourist destinations or during peak seasons. They also offer flexibility by allowing the owner or manager to adjust the availability and pricing of the property according to market demand and personal preferences.
Short-term rental investing also comes with some challenges and risks. Short-term rentals simply require more maintenance, cleaning, marketing, and management than long-term rentals. They may also incur higher operating expenses with utility bills, insurance premiums, and fees from the rental platforms. These types of rentals are also subject to different laws and regulations in different jurisdictions, which may limit or prohibit their operation, as we’ve seen become an issue for some states across the US. Some homeowner’s associations or landlords may have rules against short-term rentals. Also, since short-term rentals are more sensitive to seasonal fluctuations, economic downturns, natural disasters, pandemics, and other factors, travel demand can sometimes be affected which inevitably will also affect a short-term rental in your investment portfolio.
Mid-term rental property investing involves renting out a property for a few months at a time, usually to corporate clients, students or travelers who need temporary accommodation, or displaced homeowners after a disaster. This strategy can provide steady rental income and lower vacancy rates than short-term rentals, as well as lower costs and less hassle than long-term rentals. However, it also requires more marketing and screening efforts to find suitable tenants, as well as more legal and contractual obligations to protect the property and the landlord.
Like short-term investments, mid-term rentals can charge higher rates than long-term rentals, as they offer more flexibility and convenience to tenants. Mid-term rentals can also avoid vacancy periods by adjusting the prices according to the season and demand. But, also similar to short-term, mid-term rentals require more maintenance and cleaning than long-term rentals as well as higher utility bills, insurance premiums, and management fees. Mid-term rentals also face market uncertainty over other types of rental strategies, because mid-term rental investing depends on the demand and supply of the rental market, which can vary depending on the season, location, and economic conditions. Mid-term rentals may experience lower occupancy rates or reduced income during off-peak periods.
The last type of rental method covered in this article is long-term rental investing. Long-term rental property investing involves renting out a property for a year or more at a time, usually to residential tenants who sign a lease agreement. Many investors like this method, as it can offer consistent cash flow and passive income, as well as appreciation and equity growth over time. But long-term rentals come with their own drawbacks, too, such as more responsibilities and risks which can include tenant management, property maintenance, repairs and renovations, taxes and fees, and potential eviction issues. If the investor does not want to take on these duties, then paying for the services of a property manager or property management company is another expense.
Arguably the biggest advantage of long-term investment properties is the positive cash flow an investor can usually expect. In most cases, long-term rentals generate consistent monthly income from rent payments, which can help cover the mortgage, taxes, insurance and maintenance costs of the property. This can also provide a hedge against inflation, as rents tend to increase over time. Because long-term rentals can appreciate in value over time, depending on the market conditions, location, demand and supply factors, this can increase the net worth and equity of the investor and provide an opportunity to sell the property for a profit in the future.
While some may like the fact that rentals can be held for extended periods of time, others might see the illiquidity as a negative. Long-term rentals are not easily convertible into cash since they require time and effort to sell. This can limit the flexibility and mobility of the investor, making it harder to access the equity in the property in case of an emergency or a change of plans. This is certainly something to consider for self-directed IRA investors who may be needing to take distributions They also might not be the best choice for those who want to take a more passive investing approach, because long-term rentals require ongoing management and maintenance, which can be time-consuming and stressful if the investor has to deal with tenants, repairs, vacancies, legal issues, regulations and other challenges that come with being a landlord.
Understanding the Right Strategy for You
You may find that one type of rental strategy suits you more than another, or you might be thinking, “Wow! All of those sound like they have something unique to offer” and be interested in trying all three. While some could argue that it’s best to start with one rather than jumping in headfirst all at once, it’s certainly possible.
One way to combine these three types of rental property investment strategies is to allocate different properties or units to different strategies depending on their location, features and market conditions. Let’s say that an investor owns a condo in a tourist destination that is rented out short-term during peak seasons. Then, they use this same condo as a mid-term rental during off-seasons. At the same time, they also have a single-family home in a suburban area around the same location that is rented out long-term to a stable tenant. In this example the investor has diversified their income sources and reduced their exposure to market volatility utilizing all three rental strategies.
If taking on all three at once seems overwhelming, real estate investors may also switch between strategies for the same property or unit depending on the changing circumstances and opportunities. For example, an investor may rent out their property long-term until they find a good deal to sell it for a profit, or they may rent out their property short-term until they find a reliable tenant to sign a long-term lease. This strategy works different than the first example, but still gives an investor the chance to maximize their returns and optimize their asset.
As you can see, rental property investing is not a “one-size-fits-all” approach, but rather a combination of different options that can be tailored to fit different situations and financial goals. By understanding how each work, the pros and cons of each type, and combining them in creative ways to create unique opportunities, investors can achieve their desired outcomes and enjoy the benefits of real estate investing!
Rental properties can also be held in a self-directed IRA. Learn more about holding short-term rentals in your IRA in our blog article. If you are interested in learning about the tax advantages of holding rental properties in your self-directed IRA or have any questions, schedule a 1-on-1 consultation with a Quest IRA Specialist.