Self-Managed Vacation Rentals are Not “Passive” Income, but the ROC is Worth It

When my husband and I first began our journey to financial independence to retire early (FIRE), we had no idea where to even begin (nor did we even know about that fancy acronym for the FIRE Movement and its online community). All we knew was that somehow, we were going to go live in Central America and have a passive income stream that would fund that lifestyle. We wrote down the dream on a LIFE GOALS list and stuck it on the fridge. We had a clear vision of where we wanted to go and what it would look like, but we didn’t have a clear roadmap.

My husband already owned a home in another state that he converted into a long-term rental. With this being the only investment we had any experience with, we thought perhaps we would try to continue replicating it. So we saved-saved-saved and began house-hunting to find a home that would make a great long-term rental. In the process, we began a deep-dive into real-estate investing books, which then led us to other investment tools, which then led us to the FIRE community. Along the way, listening to podcasts like Afford Anything and Bigger Pockets, we understood more about leveraging and how to calculate ROI and the value of ROC and cash flow.

We began meeting others within our network that had short-term vacation rentals and we started studying the numbers…we were blown away at what these folks were reporting! There was far more money to be gained in vacation rentals (in a year-round tourist town) than in long-term rentals and we pivoted our focus.

Now, our long-term rental experience has been very passive. We are fortunate with our tenant situation and it requires very little maintenance or management. In some naive way, we thought we found a rental solution that far outpaced the return on a long-term rental and still classified it as “passive income.”

We were right on the first point–and I’ll talk numbers with you in a moment (second half of post)–but I laugh heartily at the thought of calling any of this “passive.”

IT IS WORK. HARD WORK.

I wanted to write this post to give an honest description of what actively managing just two vacation rentals looks like in order to get the high return that you want. You should know what you’re getting into so you can better decide if this is an investment path you want.

Daily Messaging

This aspect isn’t hard for someone like me who is both social and finds writing easy. For my husband, who feels the opposite on both of those points, thinks that my “job” is a nightmare.

I receive a lot of questions that could easily be answered if the person would have read the entire listing information or if they read the digital Guidebook link I sent them or flipped through the physical Guidebook I left in the property in clear view. But I’ve learned that most people don’t want to read and would rather just ask me questions all day long.

The hard part is being tethered to your phone to quickly respond to people and always keeping a chipper happy tone. I have pre-made blocks of text ready to answer some of the questions I receive most often, but even then I usually need to edit it and customize the reply to fit our personal conversation. Some of these questions are inquiries from folks considering to book and they may decide not to book after all, and this can feel like a waste of time. The platforms consider your response time, so if you are going to manage a vacation rental, be prepared to be a nonstop happy hostess via text messages.

Cleaning

Cinderella stopping to take a selfie at The Wave Home cocktail bar. High-waisted red bikini can be spotted because I absolutely want to hop in a cold swimming pool after the sweat-inducing hard work of cleaning a rental.

On top of managing the bookings, we also clean our properties in between each guest as well. THIS is a doozy. Most people hire cleaners for their vacation rentals and I totally understand why. I’ve been cleaning properties about every three days for two years now and it’s exhausting and gross and not that fun.

It’s stressful because we are almost always on a tight-turnaround, with only a few hours in between check-out for one guest and check-in for the next guest. It is hard for us to take vacations while we are doing our own cleanings because the properties don’t always line up in their bookings, of course, so that means one day we clean the first property and then the next day we clean the other property and then two days later we go back and clean the first property…it just never ends. There’s rarely a large chunk of time where both of them are simply booked for a while. Even worse are the days when both properties have check-outs and check-ins on the same days. I’d wager this happens three times a month for us. So not only do we have a tight-turnaround, but we have to squeeze both of the cleanings into the same time-slot. The TIME required to clean vacation rentals is significant.

Of course it’s gross. I’m frequently appalled at how filthy some people can make a place in just three or four days. I can’t imagine what their home must be like. I don’t have a problem with things being broken or being stolen–which is something I kept being warned about. Instead, the most common issue is just cleaning up after gross people who have zero respect for someone else’s property. Sand and food crumbs are to be expected. But you don’t realize just how much human hair we all shed until you’ve been cleaning rentals. People love to say “I always leave my rentals cleaner than they were when I arrived.” I appreciate those people because they are the tidy ones. But what they don’t realize is that they, too, shed a bucket load of hair while they were there. And if you allow dogs? There will be so, so much more…

So why do we clean them ourselves? Because there’s a LOT of money to be made doing this. I’ll explain that in a moment.

Landscaping

The front of The Inlet Cottage vacation rental…complete with a water hose/sprinkler that is being moved around until an irrigation system can be installed.

One of our vacation rentals is a condo, so the HOA covers the landscaping maintenance around the resort. HOAs are not fun to add to the list of things draining away your income but it is certainly nice to not have to physically maintain the land. The other vacation rental is a cottage on a decent-sized lot. The place stays booked in large-part due to this yard…it attracts pet owners and families with kids, especially with the fenced-in back yard. There are several pretty gardens that we’ve added around the front, the deck and the back patio. While they make lovely listing photos and lovelier experiences for people, they do come at a cost–both in money and in TIME.

The gardens require frequent watering, mulching, pruning and weeding. The lawn requires lots of cutting with a lawn mower. My husband handles these outdoor tasks and is currently hard at work installing an underground irrigation and sprinkler system (again, more money and time). We also plan to create a sort of “xeriscape” garden in the front yard so that it will be less maintenance.

Maintenance

I think we far underestimated the amount of maintenance vacation rentals required when we began. This was incredibly difficult to pull off when my husband was still working. He had to either leave work for bigger maintenance emergencies or wait until a cleaning landed on a weekend for him. After he FIRE-d, however, he’s been able to knock out 1-3 maintenance projects every time someone checks out. Considering the turnover is about every three days, that’s a lot of projects!

Examples would be: spray pesticide around the perimeter; fix the washing machine drain; completely dig out the pipes running from the bathroom to the street and rent a massive machine from Home Depot to unclog it (a doozy!); fix the sliding tracks on a drawer; remove a sliding door to replace the rollers in the track; install a new screened door; fix random plumbing leaks as they crop up; replace a bathroom fan; replace a ceiling fan; make a hanging rack for the bikes and kayaks; install new flooring; protect the entry wall from suitcases with beadboard; beef up the floor joists; etc. etc. These are all examples of things we are currently working on or just finished this month.

So far, it’s been a never-ending list of things to tackle. We are very lucky my husband is handy, so if you’re considering a vacation rental and you are not a handy DIY-er, you ‘ll need to factor in the extra cost of contractor labor. As it is, it’s already a lot of time and money involved in the upkeep and making these places worthy of five-star reviews.

We try to make each place 1% better after each cleaning. Our goal for 2021 is to make these places “bullet proof” so we are tackling a lot of maintenance and renovation projects in the hopes that it will be easier to leave on our geoarbitrage adventure and pass this along to a property management company. At the moment, we just don’t think it’s quite ready for someone else to manage. We want this place to be really easy to handle and not cost us an arm & a leg to handle extra work.

Stocking Products & Fresh Linens

Renters on AirBnB and VRBO expect their vacation rentals to be fully stocked. Not only do you need to fully furnish these rentals and have a fully stocked kitchen with ample cutlery, pots and pans, but you need to keep it stocked with paper towels, dish soap, dishwashing soap, cleaning supplies, trash bags, ziploc bags, foil, saran wrap, salt, pepper, olive oil, coffee and tea. The bathrooms also need soap, shampoo, conditioner, lotion, hand soap, ample toilet paper and other items.

Linens need to constantly be replaced. I prefer white linens so we can bleach them, but there are some stains that even bleach won’t get out. They also get washed so frequently that they just wear out faster than any linens would in your personal home. Sheets, covers, pillow cases, hand cloths, face cloths, bath mats, towels and beach towels are things you need to factor in to your regular budget several times a year. I’ve found that offering black makeup cloths help reduce the amount of stained face cloths and recommend shopping at Home Goods for quality linens (never buy them from WalMart or Target! They only last a week or two, it seems).

The Numbers

So now that I’ve thoroughly scared you away from wanting to get into the short-term rental biz, let me re-convince you why they are so GREAT.

First, let’s have a vocabulary recap:

ROI “return on investment.” This means the return you get back on the entire price of the investment/asset.

Net profit / Total cost x 100 = ROI

In real estate, the big ROI rule of thumb is to follow “The 1% Rule.”

If you are purchasing $100,000 house, then you need to be sure that the property rents for at least 1% (in this case, $1,000 a month.) (Or, pretend you bought a duplex for $100K, then you would want to be able to collect $500 from each side each month. Easy peasy, right?)

There are 12 months in a year, so collecting at least 1% each month means you’ll be grossing at least 12% each year. (Learn more about “The 1% Rule” here.)

$1,000 x 12 = $12,000

$12,000 gross profit divided by $100K total cost = .12 (x 100 = 12% ROI showing “The 1% Rule” checks out)

Now, keep in mind, most long-term rentals figure in 30% of that for maintenance and other associated costs.

Let’s plug this into the ROI formula seen above.

So let’s take that 30% maintenance costs out of $12,000 …that’s $3,600.

$12,000- $3,600 = $8,400

The ROI formula is determined with net profit, so let’s do that math:

$8,400 net profit divided by $100K total cost = 0.084 (x 100 = 8.4% ROI …the true ROI).

Keep in mind that most investors are trying to achieve at least a 7% gain on their investments. This is usually the conservative number used to calculate future gains when investing in total stock market index funds (like VTI or VTSAX) in the financial independence community. (These index funds/ETFs usually achieve around 10%, but you subtract 3% for inflation). So getting anything over 7% is pretty rad. But you have to weigh whether you are game for the extra work and headaches that come with being a landlord or host.

ROC “return on cash.” This means the return you get back only on the amount you put into the investment/asset. (**Note: ROC is often professionally used for “return on capital” in evaluating businesses and the more common term in real estate is actually COC, “cash on cash.” I will continue referring to it as “return on cash” to make a clearer point).

For example, if you are getting a $100K house, but you only put 20% down ($20K), then you now are more concerned on the return on the cash you actually put into this investment–the $20K.

I’m going to do some “back of the envelope” math of one our short-term vacation rental investment properties–“The Wave Home” beach condo to give a real-life example of ROC. The numbers are nice and round, but pretty close to what we’re experiencing.

ROC of a short-term rental example:

The beach condo was $220K but we put down $80K. (Side note: It would appear that less than two years later, the condo is already worth $350-$400K + with this hot, hot real estate market we are experiencing. Wild, huh?!)

Let’s say there is $50K coming in from the condo’s rentals.

Let’s say there is $25K coming out for maintenance, stocking supplies, taxes, permit fees, HOA, etc.

That leaves you with a round $25K.

That equates to a 31.25% Return on Cash (ROC). Because remember, we only put in $80K but we are netting $25K.

Want to see that as a mathematical equation?

(Annual Cash Flow/Actual Cash Invested) x 100 = ROC (“return on cash”)(also known as COC, “cash on cash”)

25K divided by 80K x 100 = 31.25

Now let’s look at the ROI of the beach condo, that is netting $25K after all the costs come out, and was purchased for $220K.

$25K divided by $200K x 100 = 11.36% ROI

That’s well over the 7% most investors are hoping for, so it’s a good one.

ROC of a long-term duplex example:

We live in a duplex rental right now that is worth around $400K at the moment. Let’s just have one more “back of the envelope” scenario to work through whether it is still worth purchasing one, even at this price, as a long-term rental (an exercise we just did, as we looked at one).

Duplex is listed at $400k, but let’s say we put $120K cash on it.

$3K comes in each month (average rent is $1,500 for each side).

So that’s $36k coming in that year.

Let’s figure that 30% of revenue goes to maintenance, taxes, etc.

So that’s 11K coming out.

This leaves us with $25K (the same amount as the short term rental beach condo!)

But because we put in $120K cash (instead of the $80K cash at the condo), this means it is a

21% ROC

Now, this is still good returns, but that short-term rental mathematically looks like a clear winner. I’ll take 31% ROC over 21%, of course!

If you figure the ROI for this pricey long-term duplex example, it comes out to just 6.25% ROI. Not bad, but then you compare that to the short-term beach condo which had 11.36% ROI, and it still is a clear winner.

Now, keep in mind we are actively managing and cleaning it ourselves. Once we turn this over to a property management company complete with their own cleaners… that will take a cut from this ROC and it may turn out looking exactly like the long-term rental scenario we just went through.

Another little side-note I want to quickly mention is the equity part. Of course another reason people are interested in real estate is because they are hoping it appreciates. I want to emphasize hoping–it’s no guarantee. Our long-term rental has not really appreciated at all in value, despite the nation’s current housing frenzy. It’s a good thing we were not banking on that to be our investment, like many home-owners do. But it fits “The 1% Rule” perfectly so it’s still remained a good investment. However, we checked on the housing market where our vacation rentals are and they have appreciated over 20% in just the past year. In the past ten years, homes have appreciated 23.8%. So think of equity gains as a bonus, but don’t count on this as your sole measure for an investment property. You should be more concerned with ROC and ROI.

ROC rocks

Setting the table for upcoming guests at The Inlet Cottage

It’s hard to save up that initial cash-on-hand to invest. But it’s a lot easier to save up $80K than it is to save up $220K. I like considering ROC and figuring out how to make the bit I can actually save work for me, rather than feeling disillusioned thinking I can never afford the fancy beach properties that require a seemingly large lump sum. It’s a great mindset switch to consider ROC instead of focusing on just ROI.

Once we had that initial $80K saved and invested, it churned out even more money and only a year & a half later, we were able to afford a second investment property. It was much easier and faster to save that same amount of money once we had that one rental property bringing in an extra cash flow.

Even if you could easily save up the cash to pay for an entire property in full…why would you? It’s wiser to use that leverage and deploy all that extra cash on either another real estate property or stick it into the stock market such as total stock market index funds. What you are really interested in is the cash-flow the property generates. Too often, people who are not familiar with real estate investments (including myself in the not-so-distant-past) incorrectly believe that someone is not actually making any profit until the property is completely paid-off. This view is simple and does not understand cash flow and leverage. If the property eventually pays for itself over time, then cool! But the goal for real estate property is not to pay it off. Instead, start examining the ROC and cash flow.

ROI & ROC/COC….which is better?

Mashvisor says in this article: ” Both cash on cash (COC/ROC) return and ROI are critical metrics measured in percentages. Real estate investors use both in a return on investment analysis to determine the return and stability of any real estate investment. So when you’re wondering about cash on cash return vs ROI, you’re measuring stability vs total return. The cash on cash return is a better representation of an investment’s stability. Investors look for a high cash on cash return when searching for an investment property. This shows that the property can pay for itself over the long-term and is sustainable.

Want to peek at some more numbers?

As of April 2021, we have already booked over $50K for 50% of the year on AirBnB for both properties (this does not include VRBO bookings!).

We also already have collected $10,050 in cleaning fees…and we are not even halfway through the year! Our area is a tourist destination year-round (no “off-season”, meaning close to 100% occupancy rates) and cleaning fees are an average of $150. Tourists usually only stay for 2, 3 or 4 days, so that means a LOT of cleanings. You see now why it is a big benefit to manage and clean these properties ourselves. It’s going to hurt a little bit when we do hand it over to a property management company. But for now, this surplus is going into index funds and will continue to grow in the future.

I’m still getting used to the idea of sharing actual numbers with strangers, but I have always appreciated the transparency of other personal finance bloggers and investor friends we have made.

Deciding whether or not to get into real estate investing takes a lot of weighing pros and cons, running numbers, understanding your specific market, understanding your risk tolerance, and deciding what level of involvement you are game for.

I hope you understand a little bit more about short-term vacation rentals when they are actively managed: They are NOT “passive” income…they are hard work. But the return on your money is so worth it. Now, go make your money grow. 😉

Related links:

The Inlet Cottage renovation, Before & After photos

The Inlet Cottage on AirBnB

The Wave Home on AirBnB