Five Things to Consider Before Investing in a Luxury Rental Property

A diversified portfolio is the key to any investment strategy, no matter your net worth. Adding real estate is one way to balance your portfolio. This may mean buying something in the vacation rentals market, the global value of which is expected to reach $315 billion by 2031. With this market’s luxury segment projected to grow 13.1% compared to 12.3% for the mid-range segment, a higher-end purchase may appeal to you. Let’s see if it’s worth the investment.

What are the benefits of owning a luxury rental property?

An investment in any vacation rental property comes with several pros, each of which can be further amplified when you buy a luxury property:

• Safe investment: Real estate is considered a stable investment because it tends to retain its value, limiting the risk that you’ll lose money on it. The nicer the property and the better the location—hallmarks of luxury rental properties—the more this holds true.
• Property appreciation: Real estate tends to increase in value over time. As examples of this maxim, median home sale prices increased 2,310% between 1963 and 2023, and in just one year (July 2022 to July 2023), luxury homes enjoyed a 2% increase.
• Potential income stream: Rental real estate generates incoming cash, and you can charge higher rental rates for a luxury property, further increasing this potential money stream.
• Tax deductions: If your property meets IRS rules, you can deduct all or part of things like its property tax, repairs, improvements, mortgage interest, cleaning, advertising and depreciation (consult your tax advisor).
• Personal enjoyment and enrichment: You have a property, an upscale one at that, where you and your family can vacation or celebrate milestone anniversaries and other special events. Likewise, you can invite friends or business associates to your property to deepen your relationships.

There is another benefit specific to luxury rental property: Demand for them comes from high-net-worth individuals who are less likely to feel as big a cash pinch from economic conditions like inflation or a recession. This typically means less fluctuation in rental income during weaker economies.

The cons of investing in a luxury rental property?

Like any investment, some cons exist. All vacation rentals experience a higher level of wear and tear than a primary residence due to guests visiting them. Elements like sand, wind, water, snow, floods and storms common in coastal and mountain areas where many rentals are located can also take a heavy toll on such properties.

Additionally, there are some cons particular to the luxury market:

• Bigger initial cash outlay: The cost of a luxury rental property is higher than your standard vacation home. Consider recent median list prices in several popular locations: Telluride, $6.6 million; Lake Tahoe, $3.75 million; Cape Cod, $2.65 million; and Hilton Head, $1.96 million.
• More expensive upkeep: The very amenities indicative of luxury rentals (e.g., chef kitchens, infinity pools, custom-designed outdoor living spaces, smart home automation, etc.) are more expensive to install, maintain and repair.
• More demanding clientele: With renters paying more for their accommodations, they expect the condition of the property and all its amenities to measure up.
• A limited pool of renters and buyers: At a higher rental rate and eventual sale price, your pool of potential renters and buyers is smaller than that of a mid-range vacation property.

How does it fit within your overall financial picture?

While stable and a good portfolio balancer, real estate is less liquid than other investments like stocks and mutual funds. Assessing your existing portfolio will help you determine how the addition of a luxury property will change your overall asset allocation and help you meet your financial goals.

Likewise, running a cost/benefit analysis of the luxury rental rates in your desired area versus the anticipated costs of maintaining a property is essential to estimating your net rental income. Include things like utilities, property taxes, insurance and a cleaning service in this calculation. Moreover, if improvements to the property (e.g., painting, remodeling, HVAC replacement, etc.) will be needed at the outset, factor such costs into your equation.

When and where to buy?

The best deals occur during a bear market or when inventory for luxury vacation homes is high. If you plan to finance your purchase, buying when interest rates are lower makes more sense. However, if all other factors favor a purchase, you can always refinance when higher interest rates come down.

When considering where to buy, keep in mind that the clientele for luxury rental properties prize domestic and foreign locations featuring access to other resort-style luxuries, such as country club-caliber golf courses, water sports and boating, bucket list-worthy adventures, exclusive boutique shopping and top-chef dining.

You’ll also want to analyze the property’s market, ideally with the help of a local expert. Is it on the up or downswing? Are investments being made in the area that will increase your property’s value? Are rentals in the area used year-round or only in-season? If the latter, can you generate enough income in those months to offset your total annual expenses and still generate the net income you desire?

Who will manage the property?

Finally, do you plan to hire someone to market the property to renters or will you do it? Either way, you’ll want your property listed on sites that cater to luxury vacation rentals, such as Airbnb Luxe, Plum Guide and Villaway. And don’t forget to think about who will maintain the property, handling tasks such as winterizing it or getting it ready for a peak season full of guests.

Fully addressing these questions should help determine if investing in a luxury vacation rental will be worth it to you.

Editor’s note: Quorum is not affiliated with any of the companies mentioned in this article and derives no benefit from these businesses for placement in this article.