By Edward Brown
With the popularity in Air BNB [for discussion purposes, we are using Air BNB, but there are other similar companies that could be substituted in] gaining traction in the market place, many real estate investors have been looking at purchasing residential real estate for the specific purpose of renting the real estate on a short term basis similar to the hotel model.
Rather than attempting to garner a month to month tenant or a longer term lessee, some real estate investors have been looking at a model wherein they forgo the security of known monthly rent in exchange for the hope of higher income per month by renting to vacationers on a short term basis. This type of rental is especially the case in popular vacation destinations such as San Francisco and the Napa Valley as well as the outlining areas.
There are pros and cons to this model. From a pro standpoint, many times, renting to vacationers for less than half a month can earn more than a full month under a typical month to month tenant. In the Bay Area, monthly rental may be $3,000 on average, but the nightly rental of an Air BNB for the same house may average $300 per night. Also, eviction is not usually a factor in the vacation model. Most vacationers are not squatters by nature, and lessee evictions [especially in tenant friendly states such as California] can be expensive in time, aggravation, and money. Although there will always be the horror stories of the vacationer who does a fair amount of damage to the house, these instances are much less than the usual monthly renter.
On the con side of renting via Air BNB, there is no security of rental income surety. One never knows how many days the house will be rented. Also, some months may be more seasonal than others. For instance, attempting to rent your Napa Valley place out in February may rent for far fewer days than in August when the vineyards are more in bloom. Other cons include the movement by cities to either tax the income via a “transient” tax or to not allow rentals for shorter than 30 days. This has recently been a big issue as neighbors complain about noise, constant flow of traffic, and so many different renters coming and going as well as the belief that property values go down when living next to this type of rental. Since the number of renters using Air BNB for more than 30 days is much smaller, the odds of getting a renter for more than 30 days to make up for the lack of days being rented in totality as compared to the desired occupancy of the Air BNB rental are very slim. In addition, someone desiring to rent under these circumstances is usually not willing to pay the typical nightly rent for the whole 30 days. Either the “landlord” will advertise a bargain rate for 30 days, or the prospective renter will negotiate a lower rent. A typical $300 per night rental using Air BNB might go for $150 per night for a 30 day rental.
Security deposits are normal for both Air BNB and typical rental situations, but Air BNB will most likely have an additional cleaning fee that may or may not match the actual cost of cleanup. In addition, the Air BNB rental will need to be furnished including bedding, towels, and other necessities whereas most typical rentals usually come unfurnished. This adds to the cost of the set up and continuing maintenance of the Air BNB as well as having someone keep an eye on the rental to make sure the unit is in the same condition from tenant to tenant.
As with Uber, Air BNB has gained traction. With Uber, it took some time for the general public to see that this was similar to taking a taxi and, once people got the hang of it, it became the norm. With Air BNB many vacationers feel comfortable staying in someone’s house that they know has been prepared for them in the same way a hotel makes up a room. There is no room service with Air BNB, nor are the sheets changed on a daily basis, but the costs can be quite attractive to the renter as well as the usually much larger space they get by staying in a house versus a hotel room.
From a lending standpoint, most lenders will severely discount the anticipated rent expected from the borrower who wants to buy a house to place in the Air BNB system. In fact, many traditional lenders will not look at lending in these circumstances with unknown income. Traditional lenders may impute income if the rental is a typical leased situation [although usually discounted somewhat], but Air BNB income is not like a hotel that has many rooms. Either the Air BNB unit is 100% rented or 100% vacant. Hotels have the luxury [from a lenders point of view] that the hotel’s experience may show 60-80% occupancy. Especially if the Air BNB owner is a first timer, most banks will be very wary of lending to borrowers looking to buy a house for Air BNB income. How does the new owner know how much to charge? These and other questions will make banks turn down more often than approve these types of loans.
If the buyer of an Air BNB house has experience and other rentals in their portfolio, the bank may be more inclined to take a closer look. Otherwise, the buyer of the Air BNB house will have to look for alternative lenders. If the buyer/borrower puts a significant down payment, the alternative lender may be able to be convinced to make the loan since this type of loan would be considered a non-owner occupied [no consumer] loan and not have as many restrictions in its lending practices due to Dodd Frank, TRID, ATR, and other regulations. The alternative lender is more willing to look at what can be done with the house upon a foreclosure. Can the property be sold easily to an owner/user? Can it be rented to a normal tenant lease? Most likely, the alternative lender will not look at keeping the house [upon foreclosure] as an Air BNB; that is a business rather than a rental and in need of more management.
The prospective buyer of an Air BNB should look at what a typical lease would look like should the Air BNB model not work for any number of reasons previously mentioned. If the typical lease income is too far below what is prudent from the standpoint of NOI, the buyer may decide to choose a different property to Air BNB if that model is so desired.
Edward Brown currently hosts two radio shows, The Best of Investing and Sports Econ 101. He is also in the Investor Relations department for Pacific Private Money, a private real estate lending company. Edward has published many articles in various financial magazines as well as been an expert on CNN, in addition to appearing as an expert witness and consultant in cases involving investments and analysis of financial statements and tax returns