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August 27, 2021
Renting a real estate property is one of the ways to gain a passive income. But, which one is better between short term or long term? The exact definition of what constitutes a short or long term rental is different in the Mayan Riviera compared to other parts of the world.
Basically, renting a property to tourists is considered a short term rental, and the relevant period of time could be one to two weeks.
Instead, a six-month contract to foreign digital nomads is a long-term rental.
But, what about the financial considerations that an investor has to take into account when deciding between short or long term rental?
In general, you can make more money from your investment in the Mayan Riviera if you rent your property to tourists for a short-term period of time, than decide to lease for a long term.
When you assign your property as vacation rental, you can set different rates depending on high, medium or low season (for example, Christmas holidays are considered the highest season in the Mayan Riviera, Easter being the second).
The Mayan Riviera can provide you with higher rents than other places in Mexico, and can ensure you a capital gain on the properties’ value over the years.
For example, we assume that you invest in a 430 sq.ft. central and modern apartment in Playa del Carmen, located at a short walking distance from the beach and the main streets.
You can rely on an average daily income of US $130 if you rent short term (which will be higher during the high season and lower during the low season).
If this property is rented long-term, the average annual income could be, instead, around half of the vacation rental.
Nevertheless, you have to take into account that a vacation rental does not ensure a 100% property’s occupancy; therefore, you must always calculate a vacancy rate, which usually is between 30 to 35% per year at the Mayan Riviera. This will reduce your expected annual income.
This is not the case for long-term rent, because you ensure a tenant for at least 6 months to 1 year, without no need to think about high, medium or low season.
The main operating expenses related to a real estate property are:
• internet connection
• property taxes
• ordinary repairs and maintenance
• administration expenses
• platform / agent expenses
You can find all of these costs in a short-term rental as well as other expenses such as laundry, cleaning and ordinary maintenance costs, which will be particularly high.
But, moreover, tenants will not make any changes to the apartment during a vacation rental, and they would use the property without the need to customize or refurnish it.
On the other hand, in a long-term rental, many of these operating expenses will be paid by the tenant: especially, utilities (electricity, internet, water, gas) and administration costs.
However, when renting long term, anticipating extraordinary capital expenditures provision would be a sound financial management strategy. These repair and renovation expenses (e.g. replacing appliances or the annual maintenance of air conditioners) are not scheduled maintenance activities.
Based on the above assumptions, we can calculate a potential return both for long-term and short-term income, in order to find out which might be the most profitable investment.
In the case of vacation rentals property, the financial metric Capitalization Rate (Cap Rate), calculated by dividing the net operating income ( that is, the difference between the rental income, the net vacancy rate set at 30%, and the operating expenses) divided by the purchase price, is around 16%.
For a long-term rental property, that gauge is around 11%, with a lower rental income but, at the same time, reduced operating expenses and no vacancy rate.
If you wish to know the property’s return over a 5-year period, you may take into account the Internal Rate of Return (IRR), by assuming an expected rent increase per year corresponding to the inflation rate (3.5%), and a 10% property’s appreciation per year.
According to those assumptions, the property’s Internal Rate of Return for a short-term rental will be 22% per year, and 17% per year for a long-term rental.
The choice between short or long term rental is not so easy.
As demonstrated above, the total return on a short-term rental investment is greater than a long-term one. However, the numbers don’t tell the whole story, because there are other factors that come into play as well.
Despite the return on a long-term rental is lower than a short-term rental, it is more stable, because it ensures a steady income month-to-month. In addition, a long-term rental will give you less worries: once the lease is signed, you will not have to create and launch marketing campaigns to promote your property or hire a property manager; you will rely on a fix income according to the length of your tenant’s stay; and you will only have to promote your property every time the contract ends (1 -2 times per year).
Short-term has fewer risks, because is virtually nil the case of a failed payment of the rent, particularly if you use online booking channels (Airbnb, Booking.com, Homeaway).
Short-term rental provides greater flexibility, because the owners may reserve the right to use the property for their vacations at certain periods of the year.
You can decide to rent the property short term while waiting to sell it: it is a good strategy to make some money and to make it more attractive for other investors as you are selling an already operating unit that has already built a reputation within the online booking channels
By renting short-term, the owner can inspect the property in between vacation rentals, in order to check if everything is in order and something is broken or damaged. This is a bit more complicated for long-term rentals: even though you can rely on a security deposit to protect your building and the appliances.
Both options are quite attractive and provide you with a good return on your investment, also they represent a minimal risk with generous appreciation of your properties.