Short-term rentals: the affordable and profitable overseas property investment

Last year, our overseas real estate brokerage, Tranio, received more requests than ever for foreign commercial property in reliable markets like Western Europe and the USA. However, considering the current climate, it's actually not surprising: our main source of business is Russian and CIS investors who had just seen their assets’ value wiped out by the devaluation of their national currency.

It may seem a bit counter-intuitive that they wanted to buy in places that had become twice as expensive but there is a rather simple explanation: the crisis forced investors to consider options that would safeguard their remaining capital from further currency risk while diversifying their assets.

Times are changing and, according to our research and experience in overseas investments at Tranio, there are now two main types of investment strategy:

• preventing future losses, pursuing stable and reliable assets with what is left of the investor’s funds.
• reinvesting profits, making money on the capital that has been saved.

Proponents of both strategies are choosing commercial property, which they consider to be the most promising, but when it comes to buying, they have a problem. This type of property (e.g., office space, supermarkets and street retail) requires either more funds than they have at their disposal or does not meet their needs and expectations. For example, in the mid-price segment (€100,000−500,000) investors must choose between high-risk commercial properties with high yields (6−7% per annum) or reliable residential property with low yields (2−3%). This is why many investors frequently decide to just keep their assets in cash.

However, there is actually an investment vehicle on the market that offers an attractive balance of yields and risk: short-term rental flats, which are affordable even on small budgets (transactions worth €100,000–120,000 are often closed there).

The short-term rental strategy

Short-term rental investments target apartments in the central districts of big cities with stable property markets. By renting them out for short period with efficient management, the owner can earn up to 5% net yields (higher than long-term rentals) in a foreign (and stronger) currency, while keeping risks at bay (i.e., at the same level as long-term rental earning 2–3% yields).

Short term or daily holiday rental accommodation can be managed in two ways, either personally by using platforms like Airbnb, or with the help of a professional management company, a popular trend that took off about two years ago. This type of accommodation is in great demand in leading cities around the world: our research at Tranio shows that 57% of flats in London's Westminster district and 23% of all the Paris flats are rented via Airbnb, and these figures are growing every year.

By investing in short-term rentals, in addition to good net yields, owners are also choosing property that is easy to sell because it is in demand as well as excellent capitalisation potential. In other words, these flats can be sold quickly with no discount, because they are popular with local buyers. Moreover, this type of real estate is more affordable because prices start as low as €100,000. These flats can also be used for holidays and business trips and even a residence in case of “force majeure”.

Financing the purchase and structuring the rental business

1. Getting a loan: many countries allow foreign buyers to take out a mortgage with a maximum loan-to-value ratio (LTV) of 60% at a rate of 2−5% annual interest. The best way for non-national to get a good deal on a loan is to work with a local agent or broker who is well connected and can negotiate better lending terms. When the rental yields exceed the interest on a loan, this “leverages” the investment: each borrowed euro increases the yields proportionally to the interest rate.
2. Acquisition tax applies to any property purchase and varies depending on how the transaction is structured it (e.g., personal purchase or via a legal entity). In the UK, buyers pay Stamp Duty, in other countries, it can be called Land Tax or Property Transfer Tax), which is usually about 2–4% of the property price.
3. Rental income tax is imposed by the country where the property is located and usually ranges from 15 to 25%. Local tax advisors are necessary in order to structure the investment in the least costly manner possible because many expenses can actually be deducted from the taxable base, such as mortgage repayments, management expenses and even air tickets cost.
4. Registering the purchase to an individual or legal entity depends on how many flats are in the portfolio. When starting out, the first few properties can be registered to an individual – further down the line, if and when there is more activity, it will probably be more profitable to register as a business. For example, in Germany the tax scale is flat for legal entities and progressive for individuals. Therefore, running a short-term rental business as a GmbH (LLC) is more profitable when annual profit is €200,000 or more.

Where to buy

First and foremost, it is important to choose a country and city that have a stable property market. Elements to look out for are demographics (i.e., growing population) and rising GDP. Property in these places will be easier to sell and reduce the risk of selling the property at a loss if there is a market downturn in the future. Additionally, property prices grow faster (capitalisation).

Good locations for short-term rentals are cities with a developed travel industry and business environment that, in turn, guarantee demand for the property throughout the year (as opposed to seasonal demand).

Finally, always check if that it is possible to legally register this activity as a business because short-term rentals drive long-term rental growth and can be considered competition for hotels. Case-in-point, Barcelona, Amsterdam and Berlin don’t currently issue licenses for short-term rental activity. Skirting this responsibility can be costly. Take Munich for example, running an unauthorised short-term rental business can incur a penalty of up to €50,000.

Amenities and attractions in the area that enhance occupancy rates are important to keep the property full throughout the year. For example, the above cities are renowned tourist destinations and have a wide range of things to do.

Investing in property is a business that requires serious thought before signing anything because, while it is one of the most reliable investments, poorly thought out decisions can cost money, time and effort to rectify.

What to buy

Generally "the smaller, the better" principle: studios, one- or two-bedroom flats make ideal short-term rentals. These properties are cheaper and usually have higher occupancy rates (about 70% throughout the year on average and 90% during the peak season). The flat should be fully equipped. Choosing a contemporary design with quality fittings will increase the rental price by 25% during peak times.

How to manage the business

There are two ways of managing this type of business, either personally with the help of friends and family or by hiring a professional management company.

Managing the property personally is not suitable for overseas investors as they can’t be present to manage the client turnover, take care of paperwork or make sure the property is maintained unless they are permanent local residents. Secondly, entrusting the care of an investment to a close relation or friend means taking on the additional financial risk and responsibility that this person may not do it correctly, thus affecting the income and profitability.

Property management companies are the best option for foreign owners but it is important to find a professional and reputable service provider. Experts in this field take care of everything like declaring taxes, cleaning the flat and organising the tenant schedule. It also spares the worry while getting the maximum financial result out of your asset. The hardest part is, of course, deciding whether the company is competent or not.

Always choose a company that is specifically specialised in short-term rentals. Their services cost 20–25% of the total rental revenue on average. If it is more or less, it is worth finding out how they operate and what additional or less services they provide. Unfortunately, more often that not, it is because the company is overcharging or incompetent – but there are some companies reduce expenses by using electronic keys for tenants, a new high-tech solution that is safe and reduces costs.

Host services (i.e., how the manager looks after tenants and deals with things) has a big effect on occupancy rates over the long run. Therefore, it’s important to review all the services provided in the chosen management package in order to make sure all aspects are covered. Optional services like airport transfers, welcome packs with postcards and city maps, shampoos and shower gels, 24/7 support all encourage customer loyalty and better rankings on online booking platforms.

When signing the agreement, make sure that it includes a clause regarding the management company's liability for any damages to the property by tenants. This is legal proof that the management company is functioning with your interests in mind (rather than theirs).

Another important nuance about the agreement, affecting the total yield greatly, is who and how the utility bills and maintenance costs are paid. Usually the company pays them from the total rental revenue before distributing the profits.