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This is all about investing in real estate. However, there are other ways to enter the short-term rental world without actually investing in real estate. That is by lease arbitrage: Leasing property from a landlord and then sub-leasing to short-term rental guests and making the difference.
Not just for my deal but anyone operating short-term rentals under the lease arbitrage model.
So I talk a lot about the upsides in real estate in short term rentals, and that’s because I’m super bullish, and I think it’s got a lot of room to run, especially if you’re in the right market, but there are a couple of areas that.
Maybe we need to be a little more careful about one of those is LEASE ARBITRAGE.
There are some more potential downsides that I want to bring up to you. I mainly own all my properties, but I did do a lease arbitrage deal with 10 apartments. It’s now working very, very well, although we have had a few issues.
What happens if the landlord doesn’t fix significant maintenance issues? We can have this in our lease, right and I hope you do if you have a lease arbitrage deal. An implied assurance of habitability is included in every lease agreement that a tenant enters with a landlord. This means that the landlord is responsible for keeping the rental in good working order. It is a basic requirement that all essential services be operational and in excellent repair and that the rental property is clean and secure. Still, even if we have, at least it doesn’t mean that the landlord’s going to fix it overnight.
I can tell you this property that I lease 10 units in a fantastic historic building. It was 90 percent renovated, but the part that wasn’t renovated has a couple of challenges. Getting delayed, and it’s getting delayed, and it’s preventing us from renting some of the units. I don’t know when they’re going to be able to be rented out. There are some noise issues and stuff like that. The good news is I have a good relationship with the owner, and I’m not paying for those leases while I’m not able to rent them out, but this has taken a long time, and now, if you’re in a lease deal with an owner that maybe isn’t so easy to work with, you could kind of running out of that deal right.
California, where I’m originally from, is now one of just two states in the country to have enacted a statewide rent control law, along with Oregon. With limited exclusions, California Senate-Assembly Bill 1482 legalizes statewide rent control. It permits most property owners to raise rents by 5% annually plus the cost of inflation as assessed by the consumer price index (CPI). A landlord can’t raise their rents, and they have a tenant in there that’s way under rented while they stop fixing things. First of all, they’re not making as much money, but it’s also something that they might be doing and hopes that the tenant moves out so that they can raise rents, so it’s not good for either side. The lease arbitrage deals were locked into a lease rate and a lot of these lease arbitrage deals, like the one I signed, are 7 years long. That means if the landlord or owner thinks that he’s missing out on a lot of cash, well, then maybe some of these similar things might start happening. We can, of course, covers movies main expenses, and I have that in our lease that you know if it’s under $200, we’re going to fix it because we want to get it fixed as soon as possible so that our guests are happy, but there’s only so far we can go with that before it starts even.
That’s a big issue that you might encounter. The landlord may not want to fix the problem. Now another one that might come up, and as property prices are booming because we’ve printed so much money and asset prices are getting higher and higher, many landlords would like to REFINANCE their properties and pull cash out. In the real estate market, refinancing is common to replace an existing mortgage with a new one that offers the landlord or the owner more advantageous terms. You may be able to cut your monthly mortgage payments, negotiate a lower interest rate, renegotiate periodic loan terms, remove or add borrowers from the loan obligation, and maybe access funds by refinancing your mortgage. So if a landlord comes along and someone says I would like to lease all of your apartments, well, that’s a way for them to lease them up quickly. The check comes in regularly, and the banks will probably be more comfortable providing them with a new loan because that property is fully occupied. Now, what if hopefully this doesn’t happen, but what if the landlord just wanted to lease that property up so they can cash-out refinance, and then he doesn’t care what happens afterward. It could kind of go downhill, you know what I mean, so hopefully, that will not occur.
This third one we talked about a lot, and that’s if the laws change in a city and you don’t have it in your lease. You don’t have that as an out in your lease, so for example, if the city comes along says you can’t do lease arbitrage. You’re still required to pay that lease, and you don’t have that out in your release. I highly recommend putting in your lease arbitrage deal—if you’re going to do that. I have this clause in our lease.
Mainly one other thing that’s happening in the real estate world —The rents are going up. They are going up quickly, right an average of over 10 percent nationwide. Some cities are as much as 30 percent, so if you’re locked into a long-term lease. That’s great because that means that your arbitrage has the difference between what you’re leasing the property for what you’re very likely able to sublease out to short-term rental guests.
But what happens when that lease runs out? It’s only a year to year from now, and your landlord wants to jack your lease up 20 percent? If you’re not in a lease, well, then they can do that in most states— some states have restrictions around that, but what’s going to happen at the end of the lease? The one that I signed was seven years. I’ve already got my money back, basically, and it has even been a year yet. So it’s working out well, but incorporated a lease increases on my 7-year term. A 23 percent rent increase, which means at the end of the 7 years, I’m going to be running those apartments for way way way less than the market value, and what is a landlord very likely going to want to do is to jack his way to operate. So at
the end of the 7-year lease could very well be the end of my lease arbitrage deal, seven but I’m prepared for that. As I said, I got in this deal because it already has the operations in place. We’ve talked about that before —lease arbitrage deals are operated just like a regular short-term rental for the most part on all the guest relations everything in that sense, so I think they can be excellent. There are just things that we have to be careful of. And with rents rising like this, maybe they’re not going to be as lucrative as many of us wanted them to be.
Yes, there are barriers to purchasing your properties, which can be a bit of a hurdle, but this is a long-term strategy. Owning the property is a long-term strategy. If the rules change in the city, I can go back to long-term rents. If the rents rise well, then good for me is good for all of us who own the property because we can charge higher rents. I make more, and that’s not even the fact that we can do these cash-out refinances.
I’m not saying this arbitrage doesn’t have a space in your portfolio. If you already have the operation set up and it could be a perfect way to get started, keep in mind that the future outlook may not look as bright as it used to. At the very end of this, you’ve got to think that this is not a long-term solution, we know. It’s not an investment, right? If you stop leasing those properties well, then you’re going to stop making money. In contrast, if you own the properties, you’re going to continue to have tenants. They’re going to continue to bring cash, so that is the ultimate goal. I know it’s not super easy to get into that we’ve got that initial hurdle of coming up with our down payment. Still, you can do it if you haven’t yet, so I just want to bring up some of these points, and I don’t want to intimidate anyone from getting in the short-term rental because I think it’s fantastic. However, you must perform extensive due diligence before jumping in with both feet.
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If you are planning on acquiring property to operate as a short-term rental (Airbnb) there are a number of additional due diligence items you will not want to overlook.
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