Can you use a Vacation Home Mortgage to buy a STR Business?

As we enter 2022, competition is still intense for properties that can be used as vacation home rentals here in the Poconos.  The rapid rise in prices looked like it was slowing down in late 2021, but demand seems to have risen and prices have taken off again fueled by a number of factors.  That has created several new problems for people looking to finance their purchase as appraisal gaps are once again a big concern.  I wrote this article to help put this challenge into perspective.

What is causing the latest spike in interest?

• A number of individual Investors are shifting away from long term rentals (LTR), selling those properties and looking to buy STR properties.   They cite higher rental income, strong occupancy and having guests (not tenants) leave at the end of their stay as contracted – no squatters rights
• Rules for Vacation Home Mortgages are starting to change, and lenient conditions are tightening as lenders see more risk in this segment.  Added upfront fees on vacation homes are one recent change.
• Interest Rates are rising and there is a rush to get properties closed before more of this happens

As most people know, the amount of a mortgage is based not on the purchase price of the home, but the appraised value.  Just after the financial crisis of 2008, rules for appraisers have become much tighter and today, appraisals often fall short of the purchase price.  In an era when home price inflation is nearly 1.5% PER MONTH, the appraisal is all about the comps and with recent comps in short supply, getting an appraisal at market rate is rare.  So rare that the Penna Association of Realtors is offering a standard addendum to our standard agreement of sale that is designed to state the buyer’s intent with a low appraisal.  Let unaddressed, this “Appraisal Gap” gives extra advantage to cash bidders as they can ignore the whole appraisal process.  I recommend to my mortgage using clients that they address the possibility of the appraisal gap in each of their offers and that they back it with cash to be most competitive.

YOU USE A MORTGAGE TO PURCHASE A PROPERTY, YOU USE A COMMERCIAL LOAN TO PURCHASE A BUSINESS.

As a realtor who specializes in the purchase of vacation homes, I get inquiries asking for help in finding a “turnkey” Short-term Rental (STR) property.  In reality, a STR property is a business that is the rationale behind all the recent regulation.  Buying a business is different from buying a vacation home.  I can easily find turnkey STR businesses if the buyer has cash, or they have commercial financing, but if your intent as a buyer is to purchase a property to exclusively use as a business, then you will have troubles today if you intend to only use a vacation home mortgage with very little cash down.  A vacation home is appraised as a home, and mortgages come from a highly regulated industry and are issued based on property value, not business potential.  Mortgages won’t take into account the value of furniture, pool tables, hot tubs and the collection of rainy-day games and books that come with “turnkey” operations.  Mortgages won’t take into account income potential from rental operations.

Recently we are seeing a rise in the number of turnkey STR listings from current operators who seem to have entered the market with greatly inflated prices with a mindset of “what do I have to lose by selling today?”  They can continue to rent while testing the waters to see how high desperate bidders will go.  As of February 2022, the answer seems to be buyers will go quite high, but these are not properties that can be financed with vacation home loans with a minimal cash down payment.

If you are seeking a traditional mortgage for your vacation home business, be prepared to assess the value of those added assets and to come the table with CASH or commercial credit to cover them.  A vacation home mortgage covers the property, a different source of capital covers the furniture, furnishings, set-up and business value of the opportunity.  If you cannot cover this significant premium, then a “turnkey STR opportunity” may not be right for you.

This said, there are alternative commercial financing options available to back a growing STR business.  A portfolio loan is one approach, DSCR is yet another.  Here is a discussion around the topic Can DSCR work for STR? 

Special thanks to Svetlana Hanover for this perspective.  Svetlana specializes in investment properties and her Ananda Property Management  helps people get their STR businesses going.