Whether you’re a seasoned investor or a tenant looking to break into real estate, find out if rental arbitrage is the right investment for you.
Rental arbitrage is a real estate strategy used to manage short-term rentals listed on sites like Airbnb and VRBO. Landlords who have been in the real estate business for a few years usually refer to rental arbitrage simply as subleasing, while newbie investors often view it as an innovative and convenient way of becoming a real estate investor.
Whether you’re a seasoned investor looking to expand your existing real estate portfolio, or a tenant eager to break into the industry, it’s important to understand what rental arbitrage is, how it works, and ultimately, if it’s the right investment for you.
So what is rental arbitrage, exactly? The first thing you should know is that rental arbitrage exists because the housing market is different from the rental market. Rental markets fluctuate much faster than housing markets, allowing for investors to make a profit off of these changes in the market.
Rental arbitrage is essentially when a tenant rents out their long-term rental on a short-term basis. Through this process, the tenant becomes somewhat of a middleman between the owner of the property and the new tenant, or in some cases, the roommate.
A simple example of rental arbitrage would be a tenant signing a 12-month lease on a 2-bedroom apartment, and then renting out the second room to someone else. Another example is if the tenant decided to rent out both rooms and go live somewhere else for the duration of their agreement. In both cases, they are implementing rental arbitrage.
Although rental arbitrage is a great way for non-property owners to become real estate investors, property owners can utilize this investment strategy as well. Airbnb hosts who own multiple properties essentially run a rental arbitrage business model. It’s important to note that there are several levels to rental arbitrage, from renting out a single room to managing multiple properties across the country. Airbnb rental arbitrage is often the goal for many landlords.
Although subletting and rental arbitrage are often used interchangeably, in reality, rental arbitrage is just one type of subletting. Subletting involves a lease being turned over to one person for a certain amount of time. Rental arbitrage, on the other hand, involves renting out a space to multiple short-term renters over various amounts of time.
The introduction of short-term rental sites like Airbnb, VRBO, and Booking.com have created a viable marketplace for rental arbitrage to thrive. Airbnb rental arbitrage is relatively new and has already caused a bit of commotion among landlords and property owners.
However, tenants are typically in favor of the rental arbitrage model because it generates a rental profit for them without having to own a piece of property. While it takes time and effort, consistently renting out your long-term rental on a short-term basis could prove profitable for you as a tenant.
Renting out a property from a landlord and then listing that unit on a rental site is not technically illegal, but many lease agreements prohibit the practice. Tenants need to make sure that:
As a landlord or property owner, you want to make sure you explicitly state in your lease agreement whether or not you are ok with subletting in any capacity. This helps you protect your rental investment should any problems emerge in the future.
The biggest advantage to the Airbnb rental arbitrage is its ability to generate rental income for non-property owners. But, establishing a passive income stream without having to own a rental property is just one of many benefits to rental arbitrage. Here are a few more ways rental arbitrage favors tenants-turned-landlords.
Short-term rentals generate more revenue than long-term rentals because of rental demand. The demand for housing in your neighborhood or city depends on what is going on in that area at any given time throughout the year.
Airbnb and VRBO hosts hike up the price-per-night on their units when big events such as a music festival are taking place in close proximity to their properties, or during seasonal travel spikes like spring break or the summer holidays. Hosts can do this because the relative demand for housing at that particular time is high, given that people from outside of the community are traveling for a specific event and need a place to stay.
A traditional landlord isn’t able to take advantage of this temporary rise in demand because of long-term lease agreements. As a short-term-rental (STR) investor, you’re able to curb the monotony of the long-term housing market and take advantage of the rental market’s peaks.
Rental arbitrage allows you to diversify your real estate investment portfolio and even spread your risk across multiple geographical areas. Since you don’t need to go through the time-consuming and expensive task of purchasing a property, you’ll be able to ‘acquire’ and manage properties at a faster rate than traditional investors.
This means that if you notice the market is tanking in a certain area, you can pull out of that investment and cut your losses a lot quicker than if you were the owner of the rental property. The opposite is also true, meaning that you can quickly move into an area where the market is booming without having to go through conventional means.
Successfully diversifying your rental arbitrage properties depends on your ability to network with property owners and convince them to let you manage their short-term rentals. Building your investment portfolio in this way takes a considerable amount of tact, trust, and good judgment.
Lastly, but perhaps most importantly, rental arbitrage allows for investors with limited financial resources and/or poor credit scores to break into the world of real estate investing. But note that the rental arbitrage model requires a lot more sweat equity in the beginning than other forms of real estate such as commercial leasing or move-in ready, multifamily rentals.
Once an investor is able to scale their rental arbitrage business to successfully manage multiple short-term rentals, they can outsource cleaning, property management, staging, and booking services. But in the beginning, all of that is usually the investor’s responsibility. Still, it’s often a good trade-off for aspiring investors who are proactive and eager to get a taste of real estate investing.
As profitable and convenient as rental arbitrage may be, it doesn’t come without its troubles. A major hurdle faced by tenants is pushback from landlords who want nothing to do with the idea of rental arbitrage. It can be difficult to convince traditional landlords that subletting on a continuous basis is a good idea. But if you manage to do that, here are a few other challenges you may come up against.
By nature, vacation rentals have high turnover rates. While this is good for your pocket, it may not be so good for your property. Higher foot traffic usually translates into increased wear-and-tear, which requires more maintenance and repairs. You’ll also need to clean at least once in between bookings, and probably do a deep clean of the property every few months.
Additionally, you’ll have to do regular maintenance check ups — and you may not always be pleased with what you find. Maintaining a property’s functionality and aesthetic appeal is a time-consuming process. Be prepared to either spend a lot of time on the property cleaning and repairing, or paying someone else to do so.
Lodgify reports that the average length of a stay (ALOS) for a vacation rental home is 5.6 nights. Assuming your rental is fully booked, you’d have around 60 bookings to manage throughout the year. Even with a current average occupancy rate of 56.4%, that’s still more than 30 bookings a year! That’s quite a few bookings to manage, leaving a lot of room for error.
Hosting many short-term stays is beneficial for your rental arbitrage business because it maximizes your profit and ideally, generates positive reviews which helps your properties' visibility on rental platforms. However, it’s important to remember that bookings fluctuate according to seasonality and other uncontrollable events (such as the COVID-19 pandemic). This will impact your ability to constantly generate high profits on your rental.
Lastly, in rental arbitrage you are ultimately responsible for addressing any damage to the property, even if you’re not the owner. This is often something that is drafted into rental agreements, whether it be between you and the owner, you and the guest, or both. Ideally, you’ll have a contract going both ways to help identify who is responsible for what if anything goes wrong.
Deciding whether or not rental arbitrage is right for you as a landlord will depend on a variety of factors such as property location, local regulations, time commitment, and financial resources.
The real estate world is constantly evolving, and short-term rental platforms like Airbnb and VRBO have enabled many tenants to become real estate investors without ever owning a rental property. Whether you’re a rental property owner or a renter looking to break into the industry, rental arbitrage is an attractive new real estate investing strategy — but before you dive in, make sure you have the time, resources, and permission to manage it successfully.