Beware of Rental Arbitrage – Do This Instead and Make Money 6 Ways
When we are talking about rental arbitrage, it might sound like weird terminology. If you already know what rental arbitrage is, you know what the word arbitrage means. When I first heard this word, I wondered what it was and how it could be a bad business model.
Rental arbitrage is where you utilize Airbnb and somebody else’s property to rent it as a short term rental. You don't own the property, but are leasing the property from the owner and finding vacationers through sites like Airbnb.
For example, a person can ask someone who has a rental property if they can sublease it to other people for the short term. Basically, the person rents it from the landlord for full asking price or more, they furnish it, insure it, and take care of it. Then, they use Airbnb, Craigslist, or VRBO for short-term tenants.
Rental Arbitrage is Totally Different Than You Renting Out Your Property Short Term
Rental arbitrage boils down to using someone else’s asset, signing a lease, putting furniture in it, and then collecting the rent. Doing short-term rentals is amazing, because you make so much more money renting per day then you do per month.
If I were to rent out my house, it would get about $1,500 or $1,600 per month with a long-term tenant. If I rented it out my house through Airbnb, I could get maybe $100 per night, which could potentially be $3,000 for 30 days.
Watch the Rental Arbitrage Video Here:
However, there are fluctuations with short-term rentals, because sometimes it won’t be rented. Even if it is rented 20 nights, it is more than monthly rent.
With rental arbitrage, you are basically renting the property per day and your cost is furniture and the lease you signed with the current owner.
You are going to make the difference of the lease and expenses and what you make from rent.
You are starting a business.
The great thing about this is you are making money on top of what you are spending for the lease and other expenses, like utilities, and you are making passive income.
Real Estate Rental Properties Makes You Money in 6 Different Ways
I wrote extensively on the subject of making money in 6 different ways. You can check it out here:
Every month you make money from the rent you receive.
Here is the VERY simple math for passive income: Income minus your rents equals your profits.
Income – Rents = Passive Income Profit
$1500 rent – $1200 expenses = $300 in passive income
After you negotiate the price, you buy the house for less than it’s worth.
For example, if a house is for sale for $120,000 and you offer $95,000, eventually you may buy it for $100,000. If it is worth $120,000, you just made $20,000 in equity.
If your property is worth $120,000 as it sits, and then you spend $5,000 to paint the walls, redo flooring, paint the outside, etc., the property may be worth $140,000, and that is an increase of $15,000.
Not only did you get equity capture of $20,000, you just made another $15,000.
Housing prices keep going up and up. It is just how it is with the economy and inflation. We are always going to be making money.
Listen to the Rental Arbitrage Podcast Episode:
Tax Advantages of Real Estate
You can do a 1031 exchange, set up a business, and you have expenses that you can write off.
There are so many tax advantages, like using your 401(k) or IRA to buy rental properties. All of my students know how to do this, because it is another great way to make money on a rental property.
Tenants Pay Mortgage
I don’t pay my taxes, insurance, property manager, rehab, utilities, or mortgage, because my tenants do. They pay me in the form of rent each month.
If I have $1,200 per month in expenses and rent the property for $1,500 a month, that is $300 per month I get to keep.
The bare minimum you should get from a rental property, after expenses, is $250, or $3,000 per year. If your boss offered you a $3,000 per year raise, you would be happy to take it.
If you have a property that makes $3,000 per year, it is passive income. Imaging that you buy a house for $100,000 with an FHA loan, live in it for a year, and put 3.5% down, and now you owe $96,500.
You will not pay that mortgage, because it is paid for by tenants.
I have properties that have been paid off by the tenants.
I want to show you how to make money by buying rental properties. Go to www.masterpassiveincome.com/freecourse and I will send you my free course. This course will show you how to invest in long-term rental properties where you own the asset.
I’ll show you how to find the properties, how to fund the properties, how to make sure you get others to do the work for you, and how to make sure you are covering your bases with income for expenses. I’ll show you everything about the business.
Real Estate Investing in Rental Properties Works in Good, Bad, or Indifferent Markets
The Coronavirus has made it very difficult for short-term rental properties, but if you own it, you can turn it into a long-term rental property.
When I talk about rental arbitrage, it is specific where you go to a landlord, ask to rent the property, furnish it, and use a platform like Airbnb to get tenants per night.
Back in 2014 or 2015, rental arbitrage became something people were doing as a business model.
In 2008, Airbnb started, and, if you remember, it was a really bad time for economy. I started investing in 2006, 2007, and 2008 and, since then, I’ve made money in every single market, whether it went up, down, or sideways.
I make at least $250 per month on every single property I own. That is $3,000 per year. If you have 10 properties, that is $30,000 per year!
When you have rental arbitrage, there are so many issues that come up. In 2016, I was still building my business and I hadn’t quit my job yet.
I looked into rental arbitrage and thought I might want to use it as a business model, but I realized it wasn’t for me. When I own the property, I make money six ways, but if I did rental arbitrage, I would only make money one way, through passive income.
With Airbnb starting at the bottom of the market, right after the crash, we’ve only seen it work well in a good economy.
Rental arbitrage only works when it is a good market. My business model has worked in every economy, good and bad.
Why Rental Arbitrage is A Bad Business To Be In
With rental arbitrage, if there is a recession, people are not going to travel. If there is a pandemic, where the government says you cannot travel, you are not able to rent out the property and people will cancel.
Dependent on a Good Economy
Rental arbitrage and short-term rentals only work when people are traveling. If there is no money, like in 2008 and 2009, very few people will be traveling and moving around.
You still have your expenses and you have to pay them. I love long-term tenants, because it is stable income and there are not many expenses.
Regulation on AirBNB VRBO and Short Term Rentals
Hotels hate Airbnb and VRBO, because it eats into their market.
It’s like taxis hating Uber and Lyft. They had a monopoly on the market and the introduction of these services disrupted the market. Hotels have been pushing very hard to get regulations and legislation so you cannot have an Airbnb.
Big cities, like San Francisco and San Diego, are already enacting laws to keep you from doing Airbnb, or they are going to tax you like a hotel.
It is not going to be cost effective for you to do this in some cities. Hotels have lobbyists that are petitioning for these regulations.
If you are considering doing rental arbitrage, read the laws in the area you are looking at.
You Don’t Own Anything with Rental Arbitrage
With rental arbitrage you only make money one way, through passive income. You own nothing, except the furniture, and that is a depreciating asset.
Recently my kids were bouncing on their bunk bed, broke the frame, and I needed to sell the mattress. Originally, I paid about $200 for the mattress and the most I could get for it was $75, and it was only a year old.
With rental arbitrage, you do not own the property. If you are having trouble renting the property, you still have to pay the lease.
The wealthy own assets. There has never been a greater way to accumulate wealth.
“Ninety percent of all millionaires became so through owning real estate”.Andrew Carnegie
Things come and go, but real estate has always been constant. You can refinance, pay off the loan, use a home equity line of credit, etc.
I have borrowed so much money out of my personal residence and my rental properties, through the B.R.R.R.R method: Buy, Rehab, Rent, Refinance, Repeat.
Click here to learn more about the BRRRR method.
I’ve done this so many times where I had equity and, for instance, borrowed $70,000 from a property that was worth $200,000 and the mortgage was $100,000, and I bought rental properties with the money. My tenants pay off those loans. Owning assets give you so many options.
Personal Responsibility to Pay the Lease, Utilities, Etc.
You have long-term leases with these properties. If you’ve done rental arbitrage right, you probably have a three-year lease.
What happens if there is another COVID-19, or 20, or 21? You are stuck with that lease, you have so many more expenses, and you don’t have tenants renting it out. People are not going anywhere right now and they are not renting Airbnbs.
As I am recording this, it is within 15 days after President Trump said we are going to lock everything down. My long-term tenants in a property I own are still paying rent.
They could lose their jobs and not pay, but I can choose to defer their payment until later. If a lease is $1,500 per month, my mortgage is only $800 per month — that’s a big difference.
If you have one rental arbitrage property, you are responsible for the rent and the utilities.
The people doing rental arbitrage right now for 10, 20, or 30 properties are going to be really hurting, because they will need to pay the leases and expenses.
If you are signing a three-year lease, you are locked into them and if you don’t pay, you will be evicted. If that happens, it will go on your credit.
Using Money that Could Be Used to Buy Rental Properties
With rental arbitrage, your business model is built on other people’s assets. Earlier in this episode, I talked about buying a property with an FHA loan and paying $3,500 in a down payment.
Instead of doing rental arbitrage and spending $3,500 in furnishings and getting a property ready, you can buy a property, live in it for a year, and then rent it out and actually own the property.
Be Ready for Refunds with Airbnb and Rental Arbitrage
If you have 20 properties that are booked out and the economy is booming, what happens if something like COVID-19 happens? Even if we are in the middle of the economy shutdown, people are canceling out for months.
Rentals probably won’t pick up until June, July, or possibly August. Imagine floating those lease payments and expenses for the entire five months. Not only that, but think about all of the refunds you will need to pay.
Hopefully, you haven’t already spent that money. If you did, you will need to go into debt to pay them back.
Beware of Rental Arbitrage Business Model Conclusion
There are so many bad things about rental arbitrage, and the biggest thing is that you will be on the hook for the leases. If you own the rental property yourself, you will be on the hook for the mortgage, but you will have long-term tenants.
They are literally hunkered down, because they can’t go anywhere.
If you have a short-term rental property that is vacant, people are not going there, because they are staying home.
With rental arbitrage, it is going to be very difficult for you to build a solid, long-lasting foundational business that has assets.
When I started investing in 2006, I learned a lot of things.
If you take anything away from this episode, it should be this: buy assets, get a tenants, and make $250 from each property, which is the difference between income and expenses.
If expenses are $1,000, you need to rent it for at least $1,250 per month.
At Master Passive Income, we know, with about 99.9% certainty, what the expenses are, what the rents will be, and who will manage the properties.
I don’t like risk, but I have 30 plus properties and the properties I bought in 2006 and 2007 are still making me money every month.
Rental arbitrage is a very rough way to do business. If you want to do short-term rental properties, I suggest that it only be 10 or 20 percent of your entire rental portfolio, and the rest should be long-term rentals. Do not do rental arbitrage.
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