“If you don't find a way to make money while you sleep, you will work until you die” - Warren Buffett
To get rich, you have to save your money and invest it into assets that generate wealth. Wealth is not the same as money. Money is how you exchange your time for wealth. If you don't ever save your money to invest, then you are simply trading your time for things. Wealth is having assets that create money for you while you sleep.
Numerous assets generate wealth, all at different rates of return with different levels of risk associated. Generally, the riskier the asset, the higher the rate of return. By definition, that riskier assets could on average generate a negative return and even lose your investment principle.
Short Term Rentals make 2X to 3X the rental income of long term rentals per month
The first reason to even bother looking at short term rentals, which is an active business, rather than standard long term rentals, which is a passive business, is that short term rentals almost always cash flow better than long term rentals. On average, hosts I've talked to in the community and online report anywhere from 200% to 300% more income per month by hosting on Airbnb, VRBO, Booking.com than by using the same property as a long term rental.
Because of the ability of short term rentals to generate significantly more income for the same property, owners of short term rentals will always have higher net operating income and higher cash on cash returns than owners of long term rentals for the same property.
Control over your investment performance and profitability
If you own a stock, a REIT or any other fractional share of a company, you do not get to determine how the business is run. Management can make all the bad decisions, run the business into the ground and leave with golden parachutes while the shareholders are left holding the bag.
In the case of an index fund or an ETF, you will be fractionally invested in every single company in that fund, including all the ones you are bearish. There's no way for you to apply your expertise in a particular industry or company.
On the other hand, short term rentals have combinations of being both an investment and an active business. Your nightly rate and occupancy rate are directly controlled by you, the business owner. If your occupancy rate is high, you can increase your price and make more per night. If negative reviews are holding back your listing, you can work on identifying exactly why you are not getting 5 stars. The ability to address problems is a blessing.
Laws against squatters and problematic tenants are more favorable
One of the worst mistakes you can make in a long term rental is not doing your due diligence and renting out to a horrible tenant. The fact is that in most states, tenant rights laws are in favor of the tenant rather than the landlord. If the tenant stops paying the landlord, there is a lengthy and expensive legal process the evict the tenant. The landlord can't just shut off utilities and change the locks. If so, it's the landlord that is in trouble and can even go to jail!
From the government's point of you, they want to restrict homelessness, even if it comes at the expense of property rights. Is it fair? Of course not, but when has the government been about what's fair?
This is not to say that short term rental owners don't have to deal with problematic guests. In fact, with the turnover, owners will likely encounter unreasonable people even more often. However, anybody who stays less than 28 days on your property is not considered a tenant. They do not enjoy the same protections as a long term tenant. This means that if they refuse to leave, you can call the police for trespassing.
Ownership of a real asset
As a former startup employee, where a good deal of my compensation was in "stock options" which had a value of being worth millions or zero, depending on if we achieved an exit event, I've grown to appreciate that real estate is fairly straight forward to value. There are comparable houses in your neighborhood. You can generally come close to estimating the value of your real estate versus what an appraiser will tell you.
Another benefit of real estate being a real asset is that it is positively impacted by inflation. As the cost of goods like food and rent rises in the economy, so will the value of your real estate investment. Real assets are a hedge against inflation.
Rents generally rise, and if you have a fixed mortgage, the cost of future payments goes "down" since the value of money in the future is worth less than the value of money now. You lock in your future payments, but inflation will lower the value of a dollar in the future, making your investment substantially cheaper to own on a real basis.
Diversification from the market
If the economy goes into a recession, the losses in your stock, ETF and S&P 500 indexes holdings will adjust in real-time. That high flying tech company that went up 50% this year and made you look like the next coming of Warren Buffett can just as quickly lose 50% as institutional investors become skittish and rotate their money out.
Traditionally, investors used bonds to balance out their stock exposure. However, as we saw in the global financial crisis in 2007, bonds moved in parallel with stocks and crashed right alongside them.
Real estate, on the other hand, will adjust must slower in value and generally lags the stock market by a few months. You won't wake up the next day with your house being worth half of what it was yesterday. And while people might travel less in a recession or be willing to pay less per night, people will still want to take vacations. If anything, short term rentals are much cheaper for a family than traditional hotels. We might see a recession increased demand for short term rentals.
Let me start this section by saying that I am not a CPA and that you should always talk to your accountant about your taxes. With that out of the way, let's talk about the numerous tax benefits.
First of all, is the depreciation benefit of owning real estate as a business. In short, this means you can depreciate the purchase price of your residential real estate investment, excluding land. You simply divide your cost basis by 27.5 to determine your annual depreciation. This is because the IRS says that residential real estate depreciates on that schedule. With short term rentals, this gets taken to another level. You can take depreciation expense against your ordinary W-2 income. This is because short term rentals with an average stay of fewer than 7 days count as an active business. Let's say your W-2 income was $200K for the year. But because of depreciation in your real estate along with other expenses, you show a paper loss of $10K. You can file tax returns that show $190k of adjusted gross income since you "lost" money on the expenses related to the real estate, regardless of the actual cash flow of the house.
Lack of competition from institutional money
Generally, every stock in the market reflects all of the public information in a security, and everything is pretty much priced in. Institutional money from endowments, pension funds operated by hedge funds have algorithms that compete with each other to trade in milliseconds. It's really hard to find "alpha" (wall street lingo for nonperformance) in the market.
There are of course exceptions to the rule. Perhaps a stock is improperly priced or perhaps the market cap of a stock is too low to get serious coverage from the big banks. Perhaps you operate in an industry and think you have a much better understanding of the various companies in the value chain than a financial manager.
But over time, numerous studies have shown that small retail investors almost always loses to the big institutional money. He generally sells when he should buy and vice versa, letting the two sides of greed and fear ruin any returns.
However, what if there was a market where assets were constantly mis-priced because institutional investors simply thought the market to be too small and ignored it? That's what's happening with short term rentals today. Most of the institutional money hasn't bother yet, which is why the cap rates are so darn high.
Low cost of leverage (other people's money)
To build wealth, you'll need to be able to access capital greater than your own, otherwise known as other people's money. Generally, the cost of capital is not cheap. For example, Investors in a startup typically take a large chunk of equity from the founders. Another example may be somebody borrowing capital on margin to play the markets. Access to capital as a form of leverage is expensive given the risk to the borrower.
But in America, the cost of capital for real estate leverage is at all-time lows given where interest rates sit today! By getting leverage, you'll multiply your upside (and downside). And given the lower risk profile of short term rentals to other asset classes, it's worth getting leverage.
How long can this opportunity last?
Maybe this opportunity won't exist in the future, as markets generally tend to find an equilibrium, but who knows when that's going to happen. It could be a few years, or it could be 5 to 10 years. Right now though, short term rentals are crushing almost any other asset class in performance, especially when taking into account the amount of risk you are taking.