Rental Arbitrage Unpacked: From Basics to Profits

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.

What is rental arbitrage?

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. 

How does rental arbitrage work?

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.

What is the difference between rental arbitrage and subletting?

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.

Is short-term rental arbitrage legal?

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:

• their landlord is ok with rental arbitration and,
• short-term rentals are legal in the area the property is located.

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.

Pros of rental arbitrage

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.

Curbing the real estate market

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. 

Diversification

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.

Low barrier to entry

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. 

Cons of rental arbitrage

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. 

Ongoing cleaning and maintenance

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. 

Many bookings to manage

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. 

Responsibility for damages 

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. 

Is rental arbitrage right for me?

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. 

• Location: Depending on where the property is located, a long-term rental may be a better option than a short-term rental. If the short-term rental property you have in mind is located in somewhat of a remote, unvisited area, it may not attract the foot traffic required for a short-term rental to be successful. 
• Regulations: Some cities across the country have placed strict regulations on short-term rentals due to local housing crises. In places like New York and Los Angeles where housing is tight, county and city officials have regulated short-term rentals in a way that often makes it less attractive for real estate investors to engage in. This is done with the intent to free up housing for those who need it most. 
• Time commitment: A major part of determining whether or not rental arbitrage is right for you is assessing the time you have available to dedicate to your short-term rental business. If you’re just thinking about renting out a single room in your 2-bedroom apartment, then your time commitment is relatively low. However, if you are planning to manage multiple properties across a 50 mile radius, that’s a whole different ball game. Make sure you have a good idea of how long it's going to take you to actually manage those properties on a daily basis.
• Financial resources: Lastly, you want to consider how much money you have to invest into a rental arbitrage property. While you won’t have to spend the big bucks acquiring a new property, at minimum, you will have to set aside some money for furniture, marketing, and cleaning supplies. Make sure you have enough to get started. 

Exploring rental arbitrage as an investment strategy

Rental arbitrage has become an increasingly popular real estate strategy, especially with the rise of platforms like Airbnb and VRBO. While it might sound like a modern concept, it's essentially a nuanced form of subleasing. Its appeal lies in the potential for increased profitability, especially for those who might not have the resources to buy properties but still wish to tap into the real estate market. The model is quite flexible, allowing both property owners and tenants to leverage market fluctuations for profit.

However, with any venture, there are challenges. From managing frequent bookings and property maintenance to navigating regulations and potential pushbacks from traditional landlords, rental arbitrage is not a hands-off investment. Its success requires a blend of market insight, dedication, and adaptability.

Before diving into rental arbitrage, it's vital to assess factors like property location, local regulations, available time, and financial readiness. Each investor's situation is unique, and what works for one may not work for another. But for those willing to navigate its intricacies, rental arbitrage can be a rewarding venture into the real estate world. Whether you're a seasoned landlord or a new player in the field, understanding rental arbitrage can expand your horizons and open up new opportunities.

Rental Arbitrage FAQs

How profitable is rental arbitrage?

The profitability of rental arbitrage can vary widely based on several factors, including the difference between long-term lease costs and short-term rental income, location, market demand, occupancy rates, and operational expenses. While many entrepreneurs have found significant success with rental arbitrage, achieving consistent profitability requires thorough market research, effective property management, and an understanding of short-term rental dynamics. It's also important to factor in costs such as utilities, furnishings, maintenance, and platform fees (like those charged by Airbnb or VRBO).

What is an arbitrage rental?

Arbitrage rental, commonly referred to as rental arbitrage, is a business model where an individual or company leases a property under a long-term agreement and then sublets or rents it out on a short-term basis at a higher rate. The "arbitrage" refers to the profit made from the difference between the long-term lease cost and the income generated from short-term rentals. This model is commonly used on platforms like Airbnb, where the renter does not own the property but rents it out to short-term guests.

How risky is rental arbitrage?

Rental arbitrage carries several risks. Market fluctuations can impact short-term rental demand, potentially leading to periods of low occupancy. Additionally, there's the risk of increased competition, which can force prices down. Leases for rental arbitrage must be explicitly or implicitly permissible; otherwise, renters risk eviction if subletting is against the terms of their lease.

There's also the challenge of managing multiple properties, dealing with guest issues, and ensuring consistent property maintenance. Like any business venture, success in rental arbitrage requires understanding and mitigating these risks.

Remember, the answers provided are general in nature, and the specifics can vary based on local regulations, market conditions, and individual circumstances. Always consult with a local expert or conduct thorough research when considering rental arbitrage.