Any real estate entrepreneur with short-term rentals in New York City (or elsewhere) may have been having sleepless nights since the introduction in September of Local Law 18, which effectively kills that business model.
The new law requires hosts to register with the city, and licenses are only granted to those who live in the place they are renting, and are present when someone is staying. Oh, and there is a limit of two guests.
Local Law 18 is an attempt to respond to concerns that a high volume of short-term rentals in the Big Apple is making it harder, and pushing up prices, for those seeking rental properties in which to live.
New York is an extreme example, but the city is not alone in clamping down on short-term rentals. Other municipalities are variously wrestling with issues of disruption caused by “party pads,” and the drain on neighborhoods of having multiple properties hosting only transient tenants with no attachment to or investment in the area: Dallas has limited short-term rentals to specific neighborhoods, for example, and in San Francisco the amount of time someone can list their entire residence for rent on Airbnb is limited to 90 days a year. Other cities and states are eyeing similar measures.
On top of that, Airbnb CEO Brian Chesky is encouraging owners of short-term rental units to make them “more affordable” — in other words, shrink their margins.
All of this is a rude awakening for those real estate investors relying on a steady revenue stream from a portfolio of short-term rentals, and many real estate entrepreneurs are now faced with tough decisions.
This changing regulatory landscape is a stark reminder of the importance of diversifying your real estate investment strategy.
The Risks of Relying Solely on Short-Term Rentals
- Regulatory uncertainty: As we’ve seen in New York and other areas, regulations surrounding short-term rentals can change swiftly and dramatically. New laws may restrict the use of platforms like Airbnb, impose stricter licensing requirements, or limit the number of days a property can be rented. Relying solely on short-term rentals exposes investors to the risk of sudden regulatory shifts, potentially undermining your investment strategy overnight. But this is not the only argument for a diversified strategy.
- Market saturation: The rise of Airbnb and similar platforms has led to increased competition in the short-term rental market. This, in turn, can lead to market saturation, making it harder to stand out and maintain high occupancy rates. In densely populated tourist destinations, property owners may face declining rental income due to oversupply.
- Seasonal fluctuations: Short-term rentals are often subject to significant seasonal fluctuations. Depending on your location, you may have high demand during certain months and low demand during others. Seasonal variations can make it challenging to maintain a stable income throughout the year, which can be especially problematic for investors who depend on rental income to cover expenses.
- Operational challenges: Short-term rentals require a significant amount of effort to manage successfully. From cleaning and maintenance to guest communication, it can be a demanding endeavor. Depending on the location and type of property, it may be necessary to hire property management services (which will cut into profits margins) or invest in your own time to oversee operations effectively.
- Economic downturns: Economic downturns can have a severe impact on the short-term rental market. We all know the effects of travel restrictions and lockdowns, but even without a global pandemic, economic downturns lead to decreased tourism, which can leave property owners with empty units and a lack of income.
The Case for Diversification
- Risk mitigation: This has to be the number one reason. Diversifying your real estate investment portfolio helps spread risk across different asset types, reducing your exposure to any one sector. When short-term rentals are adversely affected by regulatory changes or other external factors, having other types of investments can help maintain your financial stability.
- Steady income: Long-term rentals offer a more predictable and stable income stream, compared with short-term rentals. They often involve signing leases for extended periods, reducing the impact of seasonal fluctuations and occupancy issues. This reliable income can be critical for covering expenses and maintaining cash flow.
- Capital appreciation: Diversifying into different types of real estate, such as multifamily units, can provide opportunities for capital appreciation. While short-term rentals may yield high cash flow, other property types may offer longer-term growth potential through appreciation in property value.
- Exit strategy: Diversification provides you with more flexibility when it comes to exit strategies. If the regulatory landscape becomes too challenging for short-term rentals, you can adjust your strategy and focus on other types of properties that are less impacted by such changes. This adaptability is essential for long-term success in the real estate market. Check out this great post about 9 (well, 9½) exit strategies.
The recent regulatory changes affecting short-term rentals in New York state and beyond serve as a stark reminder of the importance of diversifying your real estate investment strategy. Relying solely on short-term rentals can expose you to significant risks, including regulatory uncertainties, market saturation, seasonal fluctuations, operational challenges, and economic downturns. By diversifying your portfolio with long-term rentals, commercial properties, or other real estate asset types, you can mitigate these risks, maintain steady income, and position yourself for long-term success in the ever-evolving real estate market. Remember that a well-balanced portfolio is a key to weathering the storms and achieving financial stability in the real estate industry.