Hello, my friends. It’s Richard, founder of Short Term Rental University and Airbnb super host. Today’s discussion is about whether you should buy or rent if you want to be a short-term rental business owner.
I have a very strong view on this.
Own if you can, and if you can’t, work until you can own.
The reason is pretty simple. If you own the real estate you’re creating an empire that’s generating wealth, appreciates over time and if you’re not, if you’re engaged in pure rental arbitrage, meaning you go out and you rent properties and then you sublet them out, hopefully legally, to Airbnb guests and so on, that’s a trade. It provides income, it generates cash flow, but it’s at a point in time and then it may end. You’re not generating anything of lasting value. It’s just like… a job.
If you can’t afford to buy, there’s nothing wrong with renting, saving as much as you possibly can, like generate as much income as you possibly can, live as frugally as you possibly can, save as much as you can with the express desire to take that money and buy.
A second scenario where it may make sense to get your feet wet doing rental arbitrage, is if you’re uncertain how much you’re really going to like being a short-term rental host and you just want to experiment. There’s absolutely nothing wrong with doing a 12 month experiment or a lease and then figuring out whether this is something that you think has legs, you enjoy it, you’re good at it, there’s money to be made and then take that money, once again, and then expand into buying property that’s going to generate income and become a real business.
The third scenario which I think warrants a mention is being opportunistic. I don’t always say no, blanket statement, I always keep my options open. If I had a home that I owned and my neighbor came to me and said, “Hey, you’re doing really great with this. Could you help me out?” Instead of helping them out and saying, “Here’s some tips and so on,” I might ask them, “Listen, if you’re not using the property, why don’t I rent it from you and then I’ll manage it on my own. I’ll take the risk on my balance sheet.” My point is there’s definitely a place and a time to rent something, but that said, I’m going to encourage you very strongly to build real wealth, generate real income and create an entrepreneurial lifestyle by actually purchasing the assets and we’re going to get into why.
The first reason I want you to buy real estate is because historically, it’s a great investment. There’s such a thing as scarcity value. What that basically means is that there’s no more land, so if you can buy property in a place that has limited amounts of resources, that’s generally a good thing. I’m standing right now on the island of Manhattan. Almost every single square inch of this island has been completely built and developed and people go taller and buy air rights and all sorts of stuff. Why? Because scarcity equals appreciation and real estate values, while they do decline in instances, that’s a great time to buy, over the long term they tend to appreciate. So the first reason to own real estate is price appreciation.
The second reason is it’s a very prudent way to use leverage. The average person, especially if you’re not entrepreneurial, tends to not be aggressive enough in their personal life and tend to shy away from debt yet, I’ve covered in other videos that when you study finance at some of the top business schools like I have, prudent use of leverage is one of the most important things you can do to be on the efficient frontier. Remember I’ve done that drawing? It’s never zero leverage or 100% leverage. It’s somewhere in here and you can define it on you own, like where you’re comfortable.
So how does buying real estate apply to leverage? Well, most people will buy real estate using a mortgage. In essence, the bank actually owns the property. They own, say, 80% of the property and you put down 20%. You have a partner. You put down 20%, the bank puts down 80%. That is effectively leverage. Here’s the beautiful thing. Let’s use some real numbers. Let’s just say that you bought your house for $100,000, therefore, your 20% is $20,000. The bank puts up their portion, $80,000. Now you own the property.
Point number one, price appreciates. Over the course of, say, five years, maybe 10 years if you buy it right, maybe it’s three years, the price goes from the 100 that you bought it to $120,000. That’s an unbelievable return. You just made 20% more, right? Incorrect. You made 100% return on your investment. Remember, you put down $20,000. The bank, your levered partner, put in $80,000. So when you sell the property at $120,000, the bank is going to get back their 80. It’s actually less because you’ve saved. Through principal payments you’ve paid them off so you pay them a little less than the 80,000, but you’ve made 20,000 from 100 to 120. That 20,000 is the same as the 20,000 that you put in when you purchased the property, so $20,000 return on $20,000 invested, that’s 100% return, not a 20% return. So it’s a very prudent way to add and introduce a little bit of leverage into your portfolio, into your life in a very safe and conservative fashion, and we could all use a little leverage.
The third reason to own real estate is the tax advantages. There’s two different types of tax advantages. There’s the tax advantages when you own and operate the business, so current tax advantages, and then one of the best things about real estate is tax-deferred advantages when you sell the real estate. You can enter into a 1031 like kind distribution.
So let’s just take a step back here.
I’m going to buy something. It’s going to appreciate in property. Little asterisk, not everything is guaranteed. My lawyers can’t tell me anything’s guaranteed. But let’s just, for the sake of assumption, I’m going to buy something. It’s going to appreciate in value. I’m going to have a partner that’s going to loan me a lot of money so I’m going to have a levered return. I get current tax advantages like every single year that I own the property and then, once I decide that it’s too small or it’s not big enough or I’d really like to do this and I want a bigger place or I want a multi-family place, I can enter into a 1031 exchange and not pay any taxes and defer all my taxes in perpetuity. This doesn’t sound right. It sounds too good to be true. There must be a limit. How many times could I do that? In perpetuity. Indefinitely. Some of the wealthiest families in this country and in the world are real estate owners. They’ve created an empire of real estate. They’ve deferred taxes perfectly legally forever. They may never pay taxes. So just think about that opportunity versus the day trade mentality of doing rental arbitrage.
The fourth reason real estate ownership just rules is if you have a mortgage, every single month you’re forced savings and eventually if you own it for long enough, you own it outright. All the income that’s generated from your Airbnb or short-term rental business is yours to keep and live off of. If you have a why that’s consistent with mine, and you time the duration of your mortgage with your age and when you want to retire and live off the income, you can do exactly that.
Or you can be a little bit more aggressive and say, “I want to take some cash out and refinance and continue to grow the empire.” But the equity that you’re building in your home is invaluable. It’s going to open many doors for you and opportunities and create a lifestyle that doing a more safe approach, if you will, even though I think it’s actually riskier of rental arbitrage, you have less skin in the game so many people would say it’s safer. I actually think it’s a lot riskier. You have no skin in the game. It’s just a day trade. And by the way, if you want to day trade, just pick a bunch of stocks. Day trade the triple Q, day trade Bitcoin, day trade Facebook.
All right. So, look. I’ve given you a lot of reasons why owning real estate is really, really important. But I think the most important one is your “WHY”. If you don’t know what your why is, then maybe owning real estate isn’t exactly the best approach for this. But if your why has something to do with being self reliant, being entrepreneurial, owning something of value, you can then go ahead and sell this business to someone else. You can either sell the entire operating business, I have six properties in six different states, somebody could buy that portfolio, that business, or you could sell them inpidually, but you have equity. You’ve built something. It has lasting value, intrinsic value. If you have a bunch of leases, you don’t really have anything that anybody would be willing to buy.
I’m going to tell you a little story about a good friend of mine, a fraternity brother, extremely successful. He started in basically coworking. He went out and he leased space and then he pided it up and then he rents out inpidual desks. Very successful business from a cash flow perspective, but his biggest regret is that he doesn’t own the space. He hasn’t built any real equity. I think that’s incredibly valuable for people that are just getting started here, since you’re getting started and you’re going to go down a journey. Think about what the journey is. Is the journey consistent with your why? If your why is to make cash flow and spend and live lavishly, then rental arbitrage might be a great final way to go.
So, in conclusion, owning the real estate may actually not provide that lavish lifestyle or the free cash flow that the rental arbitrage will, and there’s a reason for it. Every single month when you make your mortgage payment, some portion goes to interest to pay the bank, some portion goes to pay yourself. Forced savings in the way of a principal payment. Not as glamorous, not as sexy, but long term far sexier, far more glamorous, far more freedom, far more quality of life, far more equity. So the question is are you short term focused or long term focused? I’d love to hear your comments. Go ahead and leave them below, and I’d ask you for one favor. Please subscribe to the YouTube channel.
Thanks in advance!
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