I've been a real estate investor for about a decade now, but until this point I've exclusively focused on long-term residential rental properties. Simply put, I prefer to take a more hands-off approach to investing and like to keep my cash flow as steady and predictable as possible. Plus, there's a feeling of comfort in having my investment properties a short drive away, as all of my long-term rentals are in my local market.
However, we've finally decided to dip our toes into the vacation rental market after several years on the fence. And we recently pulled the trigger on our first vacation property, despite a roughly 15% rise in prices over the past year. Here are a few reasons why we decided to take the plunge, even though the price of admission has risen.
There's more certainty now, and that's a valuable commodity
Sure, I could have bought the same house for about 15% less a year ago. However, think about what was going on at that time -- the COVID-19 pandemic was still in the early days, most places were still essentially shut down (including the area where I wound up buying), and there was no way to know whether a safe, effective vaccine would be developed. For all we knew at the time, the pandemic would last for years, and large-scale gatherings as we knew them would be a thing of the past.
Now, we have much more clarity. The pandemic isn't completely over yet, but we have widely available vaccines, and life is rapidly returning to normal in the United States. Pent-up demand for vacations is starting to show, and in simple terms, there's much less uncertainty now than there was a year ago. In my mind, the difference is worth paying a premium for.
Prices have increased -- or have they?
Shortly before the COVID-19 pandemic hit, in late 2019, I applied for a second-home mortgage preapproval. I was approved with an interest rate of 4.25%. Fast-forward to the present day, and the mortgage I just used to buy my vacation home came with a rate of 3.125%.
Consider these numbers. In principal and interest, a 4.25% interest rate on a 30-year fixed-rate mortgage translates to a $492 monthly payment per $100,000 borrowed. At 3.125%, this drops to $428.
So, home prices have increased by about 15% since we initially started our search about a year and a half ago. However, because of lower interest rates, our mortgage payment is virtually unchanged from what it would have been at a 15% lower price tag.
Vacation rental economics have become much better for owners
There's a general war on fees in the real estate industry. For example, the average commission paid when selling a home has declined from 6% to less than 5%.
The same is true in vacation rentals. Easy-to-use platforms like Airbnb (NASDAQ: ABNB) and VRBO have made it easy for do-it-yourselfers and professionals to rent properties on a short-term basis, and traditional managers (which we're using) have had to adapt in order to remain competitive. The standard rental income split for vacation rentals has been 60% for the owner and 40% for the manager, or something in that ballpark, but it's not uncommon to see 80%/20% splits these days.
The start of a journey
For the time being, I'm still a long-term rental investor at heart, but I'm excited to add a vacation rental to my portfolio. In addition to the reasons discussed earlier, my new vacation rental adds geographic diversification to my portfolio and gives me upside potential if the pent-up demand for vacations in the United States leads to a rise in rental prices.