The rise of 'short-term rental funds': A new business for agents

After real estate broker Iddo Gavish started making a killing by buying and renting out houses on Airbnb, some local investors took notice.

“I’ve had many people approach me, and a lot of people are jealous,” said Gavish, CEO of Las Vegas-based Gavish Real Estate, a brokerage and property management firm that specializes in distressed sales. “They said, ‘Why don’t we do it on a bigger scale?”

That’s why he’s employing an increasingly popular real estate investment strategy: He’s raising cash from investors to buy single-family properties, lease them out on short-term rental platforms like Airbnb and then split the profits with those investors.

Ventures like Gavish’s have been around for some time, but some observers say they’ve spread like wildfire in the last year. And now some investors are taking what could be called “short-term rental funds” to a whole new level.

At least one institutional investor is already buying and renting out properties on short-term rental sites while others are circling the market. Spearheaded by tech entrepreneurs, other funds focused on short-term rentals have raised or are seeking to raise millions — or tens of millions, industry insiders say.

These operations are opening up a potentially lucrative asset class to a larger swath of investors, fueling the growth of short-term rentals in various markets. But short-term rental funds will have to navigate a wide array of risks, including choppy regulatory waters that could sour if investments nettle neighbors.

Regardless, the growing appetite among travelers and investors for short-term rentals points towards lucrative business opportunities for agents. Like Gavish, agents can use their market expertise or property-management know-how to win the business of investors or snap up units to rent out to guests themselves.

Quadrupling rental revenue

Gavish first became acquainted with the short-term rental business after he found accommodations for a visiting Ultimate Fighting Championship (UFC) fighter on behalf of a big local property investor.

The investor runs a de-facto hotel business with a portfolio of over 100 short-term rentals, according to Gavish. The real estate agent who managed this investor’s properties “had dropped the ball” and failed to secure a unit for the athlete, he said. Gavish had stepped in to save the day.

Soon enough, Gavish found himself managing vacation rentals for multiple investors. Of the 100 or so short-term listings he now oversees, a few rent for up to $1,500 a night and are occupied two out of three nights, while cheaper units in the $150 to $250 range are booked almost nonstop, he said.

In Las Vegas, properties rented out on a short-term basis can generate up to four times as much monthly revenue as traditional, long-term rentals, according to Gavish. He earns a large cut of that cash under his management model.

If aspiring short-term rental owners hire Gavish, the broker gives their properties the makeovers they need to wring out the highest nightly rates possible and comply with local regulations.

That can mean some remodeling and the addition of fire extinguishers, carbon monoxide detectors and a map of a home’s interior. Gavish may even throw in some decorative flourishes, such as Frank Sinatra and Elvis paraphernalia.

Gavish then handles booking, housekeeping, upkeep, expenses and hospitality services, which can include greeting guests and responding to their requests — or, occasionally, the complaints of neighbors.

Investors are guaranteed a minimum amount of monthly revenue after expenses are paid. Gavish then collects half of any earnings generated by a property on top of that amount.

“One guy was getting $3,000 a month; now, he’s getting $6,000,” Gavish said. “He gets the first $3,000 after expenses, and then, after that, it’s split 50-50.” That means Gavish pockets $3,000 a month by managing the property.

‘Passive investors’ getting in on the action

The business is so lucrative that Gavish began building his own portfolio of short-term rentals. Now, at the prompting of some investors, he’s formed a limited liability company (LLC) to pool his money with others to further milk the market. He says he plans to raise at least $1 million.

Investors that contribute to the fund, including Gavish, are co-owners of the company and split the profits (or losses) generated by the properties purchased by the firm.

Because Gavish will operate the company while the other co-owners sit back and let him put their money to work, he will earn a management fee or a higher share of the returns than the other co-owners, he said.

Gavish anticipates that the fund will produce an annual yield of around 20 percent (after expenses), but he’s not promising that to investors.

Short-term rental operations like Gavish’s that raise capital from so-called “passive investors” have been around for some time, but they have recently begun to proliferate, observers say.

They join the types of professional short-term rental landlords that have been already widely covered by the media: primarily, long-time landlords that have converted what were once traditional long-term units into short-term rentals, individuals who have bought short-term rentals without support from outside investors, and long-established vacation rental firms.

A portrait of the short-term rental investor

Sixty-five percent of the 550,000 short-term rentals listed on Airbnb in December 2015 were home rentals rather than private rooms in a home or rooms shared by hosts, according to Airdna, a provider of short-term rental market data. That’s up from 63 percent the year before, said CEO Scott Shatford.

A little under 8 percent of the 250,000 U.S. Airbnb hosts examined in a recent report listed three or more listings between October 2014 and October 2015.

That means roughly 20,000 U.S. hosts were operating as “professional hosts,” or focused on generating a significant source of income through Airbnb, according to David Ordal, the CEO of Everbooked, an Airbnb market analytics and pricing startup that jointly produced the report with Airbnb data provider LearnAirbnb.com.

The hosts with three or more listings fall into four camps, said Ordal:

• “Aggressive individuals”
• Property managers
• “Landlords” (property owners who convert some of the long-term rentals they own into short-term rentals)
• Investors (individuals or firms buying properties to lease out as short-term rentals)

He said his analysis suggests that 2,500 to 5,000 Airbnb hosts (1 to 2 percent of all hosts) would meet his definition of “investor.” A subset of those investors would represent short-term rental funds.

About 2 percent of hosts collected more than $100,000 in annual booked revenue in 2015, which, assuming a net profit margin of 33 percent, would mean only 1 percent of hosts earned $50,000 or more, according to the report.

Startups fanning the flames

The number of professional short-term rental investors who use Pillow, a property management service for short-term rentals, has tripled in the last year, said CEO Sean Conway.

Pillow is among a growing crop of property management and data providers — which include Airdna, LearnAirbnb.com and Everbooked, Flatbook, TurnKey, and Guesty — that are built to optimize returns for investors playing in the single-family rental market.

Pillow combines services like guest support and housekeeping with technology, including a tool that adjusts a short-term rental’s pricing multiple times a day based on estimated demand.

Conway said this maximizes efficiency, resulting in low operating costs that enable the startup to offer discount rates. Pillow charges a 15 percent management fee, which is well under half of what Conway says is the typical rate.

Heavy hitters stepping up

Facilitated by startups like Pillow, short-term rental funds are opening up the asset class to a much larger swath of investors searching for high yields in a low-interest rate environment.

Now, some individuals and firms, including at least a few institutional investors, are adding fuel to the fire, industry insiders say: They’re minting short-term rental funds worth tens of millions.

These funds are inclined to keep a low profile, largely due to the tendency for short-term rentals to raise the hackles of communities and draw scrutiny from regulators, according to industry insiders.

“It’s a really secretive space because it’s set in this tumultuous legal gray area right now that a lot of people really don’t want to put the bull’s-eye on their plan, or their fund or their development in fear of some sort of retribution at the city level,” Shatford said. “Really any press is not good press for this industry right now.”

The “AirFund” may be the only short-term rental fund around to take the opposite view. Instead of shunning the limelight, the fund is publicly seeking around $20 million from wealthy investors to snap up single and multi-family properties “friendly to short term rentals” in the U.S., Canada, the Caribbean and Europe. The goal is to generate a gross yield of 15 to 25 percent for investors.

Reuven Cohen, co-founder of Airvestor, yet another short-term rental data provider, says his startup is partnering with some managers of traditional property funds to launch “AirFund.”

AirFund enlisting help of agents

“Our goal is automate the selection of properties using aggregated data sources with local support to help vet the specific neighborhoods and properties,” he said.

The AirFund has been talking to real estate agents and may turn to them for help with finding and purchasing properties. “Agents provide additional local insights that machines just can’t match,” Cohen said.

The fund appears to be taking advantage of a recent loosening of securities laws to advertise to the public online, rather than marketing the fund behind an online registration wall that’s only lifted for people who self-certify that they are “accredited investors” (people who earn at least $200,000 a year or are worth more than $1 million).

Cohen didn’t respond by email when asked if AirFund was leveraging regulatory changes to publicly drum up interest from investors. Still, even though anyone can review AirFund’s investment pitch, only accredited investors can contribute to the fund. The minimum investment is $5,000.

This is a flavor of real estate crowdfunding — though AirFund is using an all-purpose crowdfunder, AngelList, rather than a specialized “real estate crowdfunder,” like Fundrise, Realty Mogul or RealtyShares. Real estate crowdfunders pool money online to finance real estate projects on behalf of companies, some of which might have difficulty acquiring funds from other sources. They could potentially give a boost to short-term rental funds.

Markets primed for short-term rental investment

The AirFund would target long-time vacation hotspots with spillover demand for short-term units, such as some areas in Florida, according to Cohen. It might also focus on markets that aren’t traditionally thought of as vacation destinations but have depressed property values and receive plenty of visitors, such as markets in Pennsylvania and Ohio, he said.

Neighborhoods near airports, conference centers and universities often provide some of the most fertile ground for short-term rentals, in Cohen’s view.

Palm Springs, Florida; Phoenix; Charleston, South Carolina, and Nashville, Tennessee, are among the many other markets primed for more investment in short-term rentals, said Airdna’s Shatford.

Hedge funds wading in

LDJ Capital, a private investment and equity firm, is buying properties to rent out on short-term rental platforms. Some of LDJ Capital’s own funds, as well some of the firm’s clients, are executing on this investment strategy, said LDJ Capital Chairman David Drake, via email.

Drake didn’t respond when asked by email for details, and LDJ Capital’s New York office didn’t respond to a voicemail. LDJ Capital owns and manages equities, hedge funds, venture capital and alternative investments that focus on industries including real estate, hotel and hospitality management.

Shatford said he knows of at least one hedge fund that’s “dedicated” to short-term rentals and is already active in the space. The two people he knows who are channeling hedge fund capital into short-term rentals didn’t want to be named, discussed or contacted, he said.

“A few large funds,” as well as some hedge funds, have also reached out to LearnAirbnb.com, a short-term rental consultant and information source, to discuss purchasing the startup’s data, said LearnAirbnb.com co-founder Jim Breese.

Breese, who emphasized that neither he nor LearnAirbnb.com is helping operate a short-term rental fund, declined to identify any of these funds, saying they wouldn’t want to be named or contacted.

Short-term rental funds launched by tech entrepreneurs?

John Banczak, the founder and chairman of short-term rental management and listing platform TurnKey Vacation Rentals, is one example of a tech entrepreneur that’s invested in a short-term rental fund.

While a source had said Banczak was raising millions to buy and rent out short-term units, Banczak said he wasn’t involved in an operation of that scale, though he does jointly own a firm that owns a boutique hotel and “several other small investments.” In addition, Banczak personally owns two vacation rentals, he said.

TurnKey recently secured $10 million in a Series B funding round, bringing its total funding to $20 million. The startup counts Zillow Executive Chairman Rich Barton and Zillow CEO Spencer Rascoff among its investors

TurnKey CEO T.J. Clark said that TurnKey manages properties for two short-term rental funds, both of which he said were worth less than $10 million.

Another source said that Aneel Ranadive, a tech entrepreneur and the son of the majority owner of the Sacramento Kings, is among individuals involved in building short-term rental funds, with the aim of raising $20 million to plough into the asset class. Ranadive also didn’t respond to requests for comment.

Seeing the writing on the wall

Traditional property investment funds also smell the bacon. Several real estate investment trusts (REITs) have been in discussions with Airbnb about allowing tenants to list their units Airbnb in exchange for a share of the revenue.

The venture capital arm of Sterling Equities, whose real estate division owns five real estate investment funds representing thousands of apartment units, has invested in Pillow with the goal of using the startup to help convert a fraction of its apartments into short-term rentals, Pillow’s Conway said.

At least one real estate crowdfunder is also eyeing the short-term market.

Raising money for short-term rentals funds is “not far off on the horizon because we’ve considered it at a high level internally before,” said Nav Athwal, CEO of RealtyShares, which has crowdfunded the purchases of some properties that have been rented out on Airbnb. “We just haven’t come across the right opportunity.”

Airbnb and FlipKey, another popular short-term rental site, did not respond when asked by email about their reaction to the emergence of short-term rental funds or if they had any policies regarding the use of their platforms by large short-term rental landlords.

HomeAway, which also owns short-term rental sites VRBO and VacationRentals.com, “has not seen a significant representation of larger investment groups entering our marketplace,” said Jeff Hurst, the firm’s chief strategy officer.

“However, we do see the pooling of resources by families or groups of friends who invest in a vacation home together, for personal use and to rent during times of vacancy in order to help pay down the cost of ownership,” he said.

HomeAway’s total number of listings worldwide jumped by about 38 percent to 1.23 million from 2013 to 2015. 360,000 of those listings are in the U.S.

Where is all the demand coming from? 

The swell in short-term rental inventory may hit a ceiling at some point, but there’s still plenty of demand to support short-term rental funds, observers say.

That demand has been driven, in part, by the emergence of short-term rentals as an attractive alternative to hotels. That’s thanks to short-term rental platforms, most notably, Airbnb, that make it easy for anyone to list and collect payment from guests.

Short-term rentals can provide accommodations that can cost less than traditional lodging, offer a uniquely immersive experience of destinations and better suit groups. Airbnb has claimed that 35 percent of people who travel using Airbnb say they wouldn’t have traveled or stayed as long if they couldn’t have used Airbnb.

In another sign that the short-term rental market is ripe for investment, the likelihood that a person prefers traditional hotels is halved (79 percent to 40 percent) if they’ve stayed in peer-to-peer lodging, according to Goldman Sachs.

Why short-term rental funds don’t want attention

The primary reason many short-term rental investors, particularly those constructing or operating funds built from scratch, might seek to avoid publicity is the tendency for short-term rentals to cause stir controversy and land on the radar of local regulators, many of whom haven’t yet enacted rules that clearly govern short-term rentals.

The spread of short-term rentals has raised the hackles of some residents and housing groups. Some say they have watched short-term units turn their communities into party zones teeming with raucous strangers.

The possibility that short-term rentals are chipping away at housing affordability by removing units from the long-term rental supply and driving up prices has also frequently been cited as a concern by critics.

The pushback has led some local governments to impose severe restrictions or bans on short-term rentals, particularly the type that would be operated by funds: properties that aren’t owner-occupied.

Pulling the rug out

Santa Monica, California and Austin, Texas are among cities that have recently moved to effectively ban the types of units that would be operated by short-term rental funds, demonstrating the potential for local governments to pull the rug out from investors.

Isabel Affinito, an Austin-based agent with JB Goodwin Realtors, says she’s seen for-sale listings in the local multiple listing service noting that they are being leased as short-term rentals.

Estimating potential short-term rental revenue had become part of how investors were evaluating properties and could serve as a holding strategy for home flippers in the event of a downturn, Affinito said.

While Austin’s ban was designed to stem a flood of short-term rental investors, it could deter some of Affinitos’ clients in other parts of the country from buying in Austin, even though all they want is a winter home, she said.

“They fall into the investor category, and they can’t do short-term rentals, which makes it much harder for them to justify buying something in Texas,” she said.

According to a report released by R Street, a conservative think tank, other cities that have similar bans on non-owner-occupied short-term rentals, but not necessarily home-sharing (when a host occupies a home with a guest), include:

• Fort Worth, Texas
• Jacksonville, Florida
• Kansas City, Missouri
• Los Angeles
• New Orleans
• Oklahoma City
• Santa Barbara, California
• Atlanta, Georgia
• Denver
• Fresno, California

Local governments in ‘wait-and-see mode’

Short-term rental funds would likely steer clear of these markets, along with others that impose certain restrictions, like tight caps on the number of days a property may be rented without the owner present.

The trick will be to pinpoint places that not only generously accommodate short-term rentals at the moment, but are likely to do so long into the future.

That’s not so easy. Most governments are in a “wait-and-see mode” when it comes to regulating short-term rentals, Airdna’s Shatford said.

Only 21 out of 59 cities analyzed by the R Street Institute were deemed to have a “tailored legal framework” for short-term rentals, with just four of those markets receiving an A rating for their friendliness to short-term rentals.

Taxes vary

Local taxes and business license requirements will also factor into the calculus of investors seeking to get into the short-term rental game. These can include hotel taxes, sales, Value Added Tax (VAT), Goods and Services Tax (GST) and income tax. Taxes may be levied at the city, “Special District,” county and state level.

The combined tax rates on short-term rentals can range from over 20 percent to well under 10, according to Cohen, the founder of the AirFund.

Markets with the highest combined rates include St. Louis, Missouri (21.97 percent) and Salt Lake City (19.2 percent), while Lancaster, California (7 percent) and Fontana and Moreno Valley, California (8 percent) rank among those with the lowest rates, he said. (Cohen said the tax rates he provided were “for informational purposes only.”)

Cohen also offered the combined tax rates on short-term rentals in Las Vegas (11.5 percent), Los Angeles (15.5 percent) and San Francisco (15.5 percent).

And as if all of that isn’t enough, short-term rental funds will also have to navigate zoning laws that may prohibit short-term rentals in residential neighborhoods, and, like Gavish, ensure they are compliant with safety and health regulations.

In addition, they would be well-advised to stay away from properties governed by homeowners associations (HOAs) or co-op boards that prohibit or severely restrict short-term rental hosting.

“I don’t recommend you put an Airbnb there,” Gavish said of listing property part of an HOA as a short-term rental. In most associations, that “flies against the rules,” he said.

While all of these factors and pitfalls may make short-term rental funds sound like more trouble than they’re worth, the people behind efforts like AirFund say they have data analytics tools that can help them fly the hazards and find the green.

The spread of short-term rental funds might exacerbate affordability issues in some markets and set the stage for some conflicts between investors and community stakeholders.

But sooner or later, the industry will settle on a “happy medium” that balances the interests of investors with neighbors, and provides a legal framework within which short-term rental funds can operate with minimal risk, according to Pillow’s Conway.

That’s when the institutional investors will really move in, he said.

Email Teke Wiggin.

Editor’s note: This story has been updated with comments from John Banczak clarifying his investments in short-term rentals.