Investing in short-term rentals (STRs) requires you to apply one of the main two schools of thought that exist when it comes to real estate investing in general:
- Diversifying: Balancing risk and reward by spreading out investments across varied property types, locations, classes, and strategies.
- Specializing: Focusing on investing in the same property type—repeating what you’ve found successful without spreading your resources too thin.
Both strategies are valid approaches to grow your portfolio. One focuses on horizontal expansion, while the other does it vertically. While investors tend to stick with one over the other, there is a way to have a hybrid—focusing on STR investments across different locations but keeping just to one specific asset class. Doing this can help you mitigate risks while focusing on one property type of your choice.
Before you set out to diversify your short-term rental portfolio, let’s look at the benefits of this approach.
Why You Need to Diversify Your STR Portfolio
There are two primary reasons why you need to diversify your STR portfolio:
- To remain resilient in the market, especially with the unique rhythm of vacation rentals. Compared to long-term rentals that give consistent income year on year, the income generation of STRs is highly dependent on the season, the location, and their respective peak times.
A lake house will attract more guests in the summer, a log cabin near a ski resort will be profitable in the winter, and homes near Disneyland will be in high demand during school vacations.
- To meet the rising post-pandemic demand, where travelers are now seeking alternative accommodations to minimize human interaction and maximize flexibility.
In fact, the bookings’ reservation volume this year is now 400% higher than 2020 and 50% higher than 2019. With this increase in demand comes higher prices as well, where STRs are charging 20% more than they did last year.
As an STR investor, you want to protect your portfolio and capitalize on the growing demand—expanding your coverage to include rentals in other locations and of different class levels.
How to Diversify Your STR Portfolio
Now that we’ve discussed the benefits, let’s look at two ways you can diversify your portfolio. One way to diversify is opting to have STRs in multiple locations, which can bring more stability to your investments.
Diversifying By Geographical Location
While the STR demand in one city might be booming, another might be slowing down. By having investments in different locations, you can take advantage of a market’s natural ups and downs for a more stable and consistent revenue flow.
For example, take a look at how Big Bear Lake, South Lake Tahoe, Gulf Shores, and Sedona performed vastly differently over a two year period (thanks to seasonal demand, among other factors):
If you have STRs in only one market, the success of your investments will completely be at the mercy of that market’s performance. Instead, consider spreading your investments across different geographical locations, so you’re not vulnerable to the same risks simultaneously.
In choosing where to spread your investments, AirDNA shares a list of different markets that covers the key factors of a successful STR investment:
- Growing rental demand: Where the annual occupancy of rentals and listing growth rates are increasing. A good number means the STR and travel demand in the market is healthy.
- Financial viability: Where you compare the home value to the average income of other STRs in the area (e.g., Airbnbs) to evaluate the rent-to-price ratio. The rule of thumb is to make sure that the monthly rent you can charge is at least 1% of the purchase price.
- Increasing revenue growth: Where the income earned from STRs increases over time. You can calculate this by looking at the year-on-year change of revenue per available room (RevPAR) for the rentals that were booked in both time periods.
Here are some locations to consider, based on AirDNA’s top performers for these metrics:
Diversifying By Asset Class
Generally, real estate asset classes are divided into four letter grades: A, B, C, and D. While these scores refer to property condition and neighborhood livability, it also describes the type of guests or tenants you’ll attract:
- Class A properties: These are the most expensive and best-maintained homes in the market. They attract guests and tenants who can afford to live in luxury and enjoy the special features available in the property.
- Class B properties: These are slightly smaller and more affordable than class A properties, but are still well-maintained. They attract those who want a pleasant place to stay without spending too much money.
- Class C properties: These are reasonably maintained and decent homes. When times are tough, guests and tenants who used to stay in class A or B options might opt for class C instead.
- Class D properties: These are older homes in areas that guests find less favorable to stay in.
There are specific asset types to consider for Airbnbs as well. Properties are not divided into the same letter grades, but are categorized according to the type of guests they’ll attract:
- Unique Stays: These are unusual but beautiful places to stay for a vacation. Whether it’s a yurt in the woods or a houseboat in a scenic lake, unique stays will attract guests looking to splurge on an adventure.
- Entire Place: These are typically whole houses where guests have complete privacy to enjoy amenities and other activities exclusively.
Since these can be the likes of single-family homes, you can keep the letter grades in mind to diversify your “entire place” offers.
- Private Room: These are single rooms in a bigger property. These listings attract guests who have no problem with shared spaces, such as kitchens and bathrooms. Travelers passing through the city or students on a budget tend to choose these.
- Shared Room: These are similar to private rooms, except the guest can have another person sharing the room with them. These options often attract guests who are younger and more budget-conscious, like backpackers.
The list is not exhaustive, but it shows how STRs are attractive to guests with varying budgets. Based on how guests generally respond to economic changes, it’s safe to assume that higher-class or luxurious properties would fare better in good economic times, while lower-class or budget ones will become necessary in tougher times.
The bottom line is you should consider the guests’ needs and preferences to diversify your STR portfolio and remain profitable in all parts of the market cycle.
The goal is to diversify your STR portfolio to appeal to a broader base, creating more stable revenue streams in your investment model. Doing so will help you weather market cycles and peak seasons, helping you meet the increasing demand for STRs in the post-pandemic world.
Any other tips on how to diversify a portfolio that’s focused on STR investments?
Image courtesy of Alexandr Podvalny