Do Short-Term Rentals Remain Profitable as Interest Rates Rise?
Right now, there is a lot of confusion and doubt about the market. Some people are wondering if they can still make money from real estate, especially with interest rates going up. We’re considering the Great Recession and wondering if we might have a similar situation soon.
It’s essential to analyze market cycles to determine if we’re heading toward a recession. However, it’s important to note that every market cycle is different. The factors that contributed to the previous downturn may not be the same as those causing the next recession.
AirDNA’s 2022 Vacation Rental Outlook Report states that the pandemic has pushed STRs (short-term rentals ) into the mainstream. The industry is currently making 40% more returns with 10 percent fewer listings, and demand is 10% higher than during the pandemic. More supply from investors to meet demand leads to the industry adjusting to changing consumer trends. In the future, we can expect to see a lot of unique properties in less-traveled areas, providing one-of-a-kind experiences for guests who prefer unconventional lodging options.
More people have been working from home because of the pandemic. When they go back to the office, many of them will probably choose to work from home some days and go to the office other days.
Many people who stay at my properties during the weekdays work from home during the day and go out to see the city at night.
People will still want to rent homes for short periods in 2022 and 2023 because there aren’t enough homes available, and more people work from home. Property owners will have to work harder to make their homes stand out. They might build attractive homes like log cabins, treehouses, or tiny houses to be different from other homes.
Case Study: Examining the Impact of Doubling Your Interest Rate on Cash Flow
My initial foray into short-term rentals involved a 900-square-foot A-Frame, which I constructed from the ground up. Following a rental period of almost three years, coupled with property appreciation, I had amassed a considerable amount of equity.
I refinanced my property and used the equity to fund upcoming short-term rental projects with my partners.
I knew that the new interest rate would not match my current favorable rate, as I was transitioning from a residential loan to a loan with a more commercial aspect.
I shopped for lenders and picked one specialized in short-term rental loans. Then, we initiated the property appraisal process.
My current rate was 3.25%, but it increased to a variable rate of 4.25% for 30 years after finalizing the details.
The property was making around $82,000 every year, and after taking out expenses, I was still left with over $50,000. That’s why I wasn’t too worried about the higher interest rate. However, I was concerned that the interest rate could change, but I continued with the refinancing process.
After a few weeks, we finished the appraisal and set a closing date. However, two days before the closing, I received a disclosure that the interest rate had surged to 6.9%.
I contacted the lender to ask about the 4.25% rate, only to discover three rate hikes during the 45 days before closing. I was left speechless.
Increasing the interest rate from 3.25% to 4.25% was acceptable, but going from 3.25% to 6.9% was a significant issue. I was considering backing out of the deal because I couldn’t imagine my interest rate more than double.
Before giving up, I wanted to check if the property would still generate a positive cash flow at the 6.9% interest rate. So, I ran the numbers using different interest rates, including 3.25%, 4.25%, 6.9%, and even 8%.
I was surprised that the property still generated substantial cash flow at 6.9% and even 8% interest rates. The loan amount also increased from $178,000 to $225,000. Although the new rate is 6.9%, the difference in mortgage payment from the initial value (4.25%) was only an additional $375.
I was before charging $270 per day for that rental so that I could make up the difference with just two additional bookings. With an average occupancy rate of around 95% in the past three years, I felt confident proceeding with the closing.
This case study taught me a valuable lesson. With interest rates rising (although still low compared to historical standards), short-term rentals are among the most robust Detroit real estate investments to withstand rate increases. Thus, now is an excellent time to invest in them.
Don’t be discouraged by the higher interest rates when making a deal. Waiting for rates to return to what they were before is not a good idea because you may never invest in real estate properties. Interest rates were the lowest in history due to specific events, and waiting for those events to repeat is unlikely. As the economy faces inflation and other challenges, easy money policies are becoming less common.
If interest rates rise, it shouldn’t stop you from seeking great deals, even if they cost twice as much. Investing in a strategically located Short Term Rental (STR) can help offset additional expenses.