September 5, 2023, will be a day of infamy for thousands of real estate investors in New York City. It is the day the city effectively banned rentals under 30 days.
The current law allows only primary homes to be rented by the room because property owners can accept a maximum of two people and must remain on the property while guests are there.
The ban was so profound that within days, Airbnb listings in New York City dropped by over 70%.
Airbnb responded by making changes to its website that get back to its roots of renting spare bedrooms as opposed to whole houses.
If New York were the only threat, it would be a smaller matter. But that is not the case. In cities across the country, new regulations are making it increasingly challenging to operate short-term rentals.
Cities allowing individuals (and investors) to rent homes are increasing the red tape, registration fees, and other costs, making it more difficult for those staying to remain profitable.
How Can Real Estate Investors Respond?
Fortunately, the world of real estate investing has always been dynamic, and there are many ways to build wealth. If you are in a city affected by new regulations, you have several options to remain in real estate while operating within the law.
Convert to a long-term rental: The primary reason cities claim to be cracking down is to address local housing shortages. Cities passing regulations ultimately want you to convert units to long-term housing to ease the affordability crisis in these markets.
The challenge is that fewer homes will cash flow under the long-term rental scenario, even after including the higher operating costs of short-term units. Because long-term rentals are not generally furnished, you also must store or dispose of furniture, bedding, appliances, etc.
Convert to a mid-term rental: Renting a home for more than 30 days but less than a year is a popular response. These rentals tend to charge higher rates than its long-term counterparts, producing more cash flow for unit conversions. These units also tend to be furnished, making transitioning from short to mid-term rentals easy.
The challenge is the limited demand for one-to-six-month rentals. Even with the increase in remote workers beefing up demand, only a small percentage of units could convert without saturating the market.
Move to a different market. You could sell the home and trade it for a short-term rental in another market. When you utilize a 1031 exchange, you can defer taxes, making it easier to change locations.
The challenge is that high-interest rates could mean trading a low-cost loan for higher borrowing costs. These elevated expenses make it difficult to cash flow the new property. The other risk is that the new market will pass rental restrictions like we saw in New York City.
Trade in your investment and participate passively. Commercial real estate deals create the opportunity to invest passively. They tend to offer steady returns without the time commitment. Using a 1031 exchange, you can avoid taxation on the transfer.
Commercial real estate often provides similar returns without the work involved in operating and managing a short-term rental.
If you are inclined to get out of short-term rentals due to new regulations in your market, passive real estate investing may meet your financial objectives.
To learn more about how to convert your Airbnb investment property into a passive real estate investment without paying taxes on the transfer, watch our introductory video.