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What are the risks of investing in a vacation rental property?

On Behalf of | Dec 13, 2021 | Real Estate Law |

As tourism increases in the St. George area, you may consider various ways to profit from an expanding market. While investments like cafes and shops can be tempting options, tourists on a budget may look for a way to visit southern Utah without a lot of extra expense.

Regardless of their spending plans, visitors will always need a place to stay during their trip. Now that vacation rental websites make finding occupants easy, you may be pondering investing in a vacation property.

This post discusses some of the potential risks you should consider before shopping for a vacation rental property.

Zoning and local regulations

Not all areas permit properties to be used as vacation rentals. It is important to understand the particular rules that apply to your area.

For example, in our local area, the city of Santa Clara only allows vacation rentals in designated areas. (See Santa Clara City Code 17.20.260(B), which says in part, “Short term residential properties are prohibited in all zones within the city of Santa Clara except where allowed by conditional use permit in the planned development residential district or historic district/mixed use zone.”)

In addition, even where short term rentals are permitted, there may be special rules to be aware of before you decide to use your property as a rental. Santa Clara City, for example, requires a property owner or manager to obtain a residential business license under Santa Clara City Code 17.74.035(B). There are also ordinances about such things as the number and placement of parking spaces (see Santa Clara City Code 17.74.035(A) and 17.68.060(J)).

It is vital that you familiarize yourself not only with the state statutes, but also know and understand the local rules and regulations your property will be subject to before investing your money and time in a vacation rental business.

Liability Concerns

It is also prudent to consider liability concerns regarding such rental properties, for example think of the possibility of someone getting injured on the property as more a matter of “when” than “if.” As you consider owning a rental property, you need to decide how you will handle potential liability risks on your property, such as:

  • Slips and falls
  • Damage to a renter’s personal property
  • Flood or fire
  • Injury to a renter’s guest

Liability can be a significant risk if you are not prepared. In addition to paying for the damage to a person’s health or property, you could risk a broader lawsuit. Also, depending on whether you have a business entity for your rental property and what entity you choose, your personal assets, including your home, could be at risk.

As you prepare for the potential liability that could come with a rental property, you should consider getting both insurance and experienced legal counsel. While the insurance can cover some (or all) of any damages, an experienced attorney may be able to help you prevent future liabilities on your rental property.

Additionally, before you decide on a rental property, consider the type of person you would prefer in your rental. You should consider if your property is going to be child-friendly or if it should be adults-only. You may also need to instruct visitors on whether they may bring pets to your vacation property.

Maintenance

Some of the other considerations in owning such property, include maintenance costs and obligations of owning such property. A vacation rental property has additional features that can make ownership and maintenance more complex.  In addition, outside costs may also be required such as a suitable property management company, insurance and expenses associated with frequent guests and usage.

First of all, your rental property (hopefully) has people coming and going regularly. Each time a new renter comes in, they bring unknown risks for damage to the property. They may, for example, cause accidental damage with a suitcase or have a child who draws on the walls.

You will need a plan and policy for how you will charge renters for damage to the property and how you will make repairs. This is an area where it is typically better to be proactive than reactive. When your renters know what to expect if they cause damage, they will be more likely to accept the consequences of their actions.

Also, you will need to plan for routine maintenance. In addition to helping your rental property maintain its value and visual appeal, many maintenance tasks are part of preventing falls and other injuries on the property.

Taxes

When you think about vacationers visiting your property, it is easy to see the property as a revenue stream. On the other hand, when you think about the mortgage you need to purchase the property, it may be easy to forget that the property is a potential source of income.

You will need to prepare for the taxes that will come with your vacation rental property revenue. While the IRS will allow you to rent your property for a small number of days each year without paying taxes, if you are interested in renting for more than a handful of days, you will likely need to pay taxes.

Moreover, keep in mind that your vacation rental property is like a business. You will need to consider whether you need to create a business entity and what tax implications come with the different entity options.

You will likely also need to plan for taxes on state and local levels, including the transient room tax (TRT). The transient room tax applies to stays of less than 30 days and to places like hotels, tourist homes and other similar rentals. In Utah, there is a specific return for reporting and paying the TRT.

What if no one rents it?

One of the appealing features of owning a rental property is that, if all goes well, you can have an income stream with little effort. Unfortunately, not all rental properties have the same level of demand, especially if we experience a downturn in the economy.

There will always be the risk that you will not have enough vacationers to pay for the space. Your property may not have guests for reasons such as:

  • Overpricing
  • Insufficient marketing
  • Lack of demand
  • Inconvenient location
  • Seasonal slowdowns
  • Other

Depending on the reason for the lack of renters, you may need to invest more time and money into the property before you start seeing a profit. Before you decide to purchase a rental property, you should have a plan for supporting it if there is no one renting it.

These are just a few of the considerations to keep in mind when investing in vacation rental property.  Investing in vacation rental property can be a valuable source of income but may also be a challenging path to navigate alone. An essential first step is talking to an experienced professional about your plans and having a clear understanding of many of the potential risks, liability and costs associated with owning the same.