The purpose of this blog post is to discuss three approaches to operating in the short term rental (STR) marketplace. We’ll take an unbiased look at each of the three operating models, as well as discuss the pros and cons of each of the operating models.
3 Operation Models
Before we continue with an explanation of each of the three operating models, it’s important to note the following:
- Check the local laws within your city to see what the STR guidelines are. Different cities have different laws which prevent certain types of operating models from operating in their cities. However, there are often situations where not all operating methodologies are unlawful. If you’re in a situation where you have to question the legalities what you’re doing, please consult a professional.
- If the law permits, you can mix and match these operating methodologies!
Owning is the most straight-forward way of participating within the STR market. The process of owning involves buying a property (apartment, condo, house, etc) and promoting it on a marketplace. Profit is made by charging a daily rate higher than your monthly mortgage, property taxes, utilities, and other fees (insurance, etc).
When Owning: Profit = (Average Daily Rate*Number of Days Rented+Your Booking Fees) – (Mortgage + Property Taxes + Utilities + Other Fees)
Pros of Owning
- It’s significantly easier to make decisions involving your property because you own the property.
- Mortgage is oftentimes lower than rent, therefore owning tends to provide higher profit than arbitraging a unit with the same amount of bedrooms and bathrooms.
- Generally, owning a house allows you to customize it to a higher degree than when arbitraging a house.
- Because owners oftentimes have a mortgage payment that is lower than the rent payment for a similar unit, they can easily transition into specific types of short term renting such as travel nurse housing. This is because an owner can still make good profit providing housing for travelling nurses while most arbitragers cannot do this.
- As you pay down your mortgage, you’re building equity which can be used to scale your operation.
Cons of Owning
- Scaling a portfolio of homes is significantly harder than scaling a portfolio of arbitraged apartments. In this particular case, I’m referring to apartments which are managed by large property management companies. Homes are difficult to scale because you’ll need to build out a team of handymen who can care for your units as you grow. Someone needs to cut the lawn, change the bulbs, fix plumbing issues, and fix electricity issues.
- To add on to my last point, typically arbitragers have a service request system provided to them by a large property management company if working with apartments.
- HOAs can be a nightmare, and many hosts jokingly argue that they’re above the law. Avoid HOAs at all costs
- It’s significantly harder to exit out of an ownership situation compared to co-hosting and arbitraging. This is because you’d either have to find someone willing to buy or assume responsibility of your home, condo, etc.
Arbitrage is slightly complex. However, at a high-level, the arbitrage method is essentially signing a lease with a property owner and advertising the unit on a STR marketplace. This is not limited to apartments. In theory, this method can be applied to any property which can be leased. Profit is made by charging a daily rate higher than your daily rental rate, utilities, and other fees.
When Arbitraging: Profit = (Average Daily Rate*Number of Days Rented+Your Booking Fees) – (Rent + Utilities + Other Fees)
Pros of Arbitrage
- It’s very easy to scale an arbitrage operation compared to a housing operation. This is because you aren’t tied down by mortgages. The only thing you need to scale an arbitrage operation is time and capital.
- When arbitraging large apartment complexes, maintenance systems are provided for you. They also provide same-day service in some situations.
- There are numerous amenities that you can take advantage of. This includes a pool, gym, and a business center. In some cases you’re even given free yoga classes!
- Exiting out of a bad deal is very easy.
Cons of Arbitrage
- Operating costs (rent, utilities, etc) are typically higher, which leads to lower profit.
- If you are not careful with how you approach and structure your arbitrage deals, you could place yourself in “uncomfortable” situations which could cost you money. For example, you could sign a contract which allows corporate housing, but prevents Airbnb. It’s up to you to understand the contract your signing and negotiate the terms of the contract. Get everything in writing.
- More people are involved than in an owning situation. Since more people are involved, arbitragers need to be more careful with who they let into their units. This applies across the board for all operating models, but even more when arbitraging. The last thing you want is a rowdy guest getting you evicted from your unit.
- You aren’t gaining any equity from arbitraging, but some people don’t see an issue with this. Ideally, you could rapidly grow an arbitrage business and sell the business for millions. Larger hosts have done this.
- Certain apartment complexes or properties have strict screening guidelines. You’ll need to create a cost-effective communication system for how you can get your guests screened.
- You’ll need to informally screen and build a relationship with the leasing office staff of a complex to see how they operate and if it’s worthwhile to bring your operations to their property.
Cohosting involves managing a property owned by someone. Typically, both the co-host and owner will agree on some contract detailing the terms of the co-hosting services. The co-host typically makes their money through a percentage-based management fee.
When Cohosting: Profit = (Average Daily Rate*Number of Days Rented)*Management Percentage
This formula could change depending on your co-hosting contract.
Pros of Cohosting
- The barrier to entry is lower than the previously mentioned methods. In some cases the cost to become a co-host is $0.
- Cohosting is a flexible business model which allows you to offer different management packages at different prices. In other words, you can potentially attract a wide audience of property owners because you offer different levels of services.
- In a standard contract, it’s very easy to exit a deal. In some cases, you can make money if your host exits a deal.
- Depending on your market, you can hit the same margins as an arbitrager.
Cons of Cohosting
- (For Airbnb) In most situations, you are not the primary host. This leads to situations where Airbnb support may contact the host when they need to contact you. However, this is rare.
- Depending on your contract, your host still has the final say on property-level decisions.
- A host will have to reimburse you for cleaning fees, typically. Depending on the quality of your host, you may receive your reimbursements immediately or at their convenience.
- Generally, cohosting offers the least individual control when compared to arbitraging or owning. All decision making involves your hosts, and this can lead to longer wait times for providing guests service, etc.
- New hosts may place unnecessary pressure on you because they have the ability to monitor your chat history, booking calendar, and other things.
- Hosts need to be informally screened in order ensure your compatibility.
- If a host has a strict set of guidelines for their property, you’ll have to follow them unless you negotiate around them.
There are numerous ways to get involved in the STR marketplace. Identify what works best for you and take action!
Remember, you don’t have to do this alone.
Thanks for reading this!