I recently attended the webinar hosted by Appraiser eLearning regarding how to handle properties being used for short term rentals (STRs) in the context of an appraisal. (You can watch the recording of this webinar here!) There were a lot of interesting perspectives represented, but the only thing that was clear was…well, the lack of clarity. I’m no expert on the matter, but I wonder if these thoughts might bring some clarity to the issue.
In the discussion on how to handle STRs, I think it might be helpful to think first about the source of the revenue. The potential gross income from a STR business (AirBnB, VRB0) can be attributed to 3 sources, which all have value:
- The value of the underlying real estate
- The value of personal property/furnishings
- The value of the business/going-concern
If this is the case, the question becomes how to apportion the income to each source. I think an easy logic test which can be applied is that of answering the following question:
What would the revenue be of a vacant property advertised on AirBnB or VRBO?
The obvious answer is $0. Noone would choose to stay at a STR without furnishings. That logical conclusion helps a great deal to separate the value of the real estate from the value of the furnishings and business.
The next logical question would be what the revenue would be of a vacant property as a long term rental. Since long term rentals are often vacant properties, it becomes fairly straightforward to calculate the potential revenue from long term rental. Someone could make an argument that long term rentals are also a business in a sense; however, there are many differences between a long term rental and STR business structure. In the case of a long term rental, that is fairly easily quantified. In most cases, that would be equal to the cost of a full service property management company, with the remaining income being representative of passive income (which could therefore be capitalized back to the real estate as its source).
So, let’s consider this case:
123 Main St is part of an STR business on AirBnB. The gross revenue of the property on an annual basis is $60,000. The appraiser has determined that the monthly market rent for that property is $2000/month, which would render an annual gross revenue of $24,000. So the appraiser could reasonably conclude that the revenue which is derived from the real estate is $24,000, and the revenue which is derived from the business (and personal property items as capital for that business) at $36,000. That is straightforward and logical…if the highest and best use is deemed to be residential.
If the highest and best use were as a STR, the calculation becomes more difficult. In that case, the $24,000 of potential revenue from long term rentals would represent a use of the property which is not maximally productive (an under-utilization of the property). In either case, the appraiser must still find a way to separate the source of the revenue into one of those 3 ‘buckets’ – real estate, personal property, or business value. While I have a few ideas on how to accomplish that in various scenarios, I think it is clear that most residential appraisers are going to lack the training, experience, and the data sources to answer those questions.
Here is another way to conceptualize this:
Let’s consider an ADU which could be used as a STR, but the owner instead utilizes that space as an office for an accounting business. The accounting business may be very successful and produce $100,000 of revenue from services performed in that space. The ADU would be part of the means of production for that revenue, but nobody would attempt to capitalize that entire $100,000 toward the value of the real estate. In that case, it might be reasonable to suggest that if the accountant were not working from an ADU, they would be renting office space. If the anticipated office rent for a comparable location were $10,000, then the revenue sourced from the real estate would then logically be $10,000. The $90,000 of revenue would have its source in the accounting business and any personal property used in that business. This same logic applies to STRs.
With that said, I understand that our clients need to know how to consider the STR income stream. I do think that residential appraisers can provide some direction and information to that regard, even if it doesn’t really pertain to the market value itself. We already do that. Every time I check a box for ‘Occupancy’ on the 1004, I’ve done just that. The occupancy has virtually nothing to do with the market value in almost any scenario. If an appraiser agrees to provide data that is fine, but they definitely need to know how not to mislead the client about what is being provided.
Making observations about average daily rates and occupancy rates which are common for AirBnB properties in the market is information that a lot of underwriters need. Appraisers that know how to find that information and report it in a manner which is not misleading will be prepared to provide a valuable service for their clients. Part of providing information that is not misleading is going to involve being very clear about the limitations of that information. The appraiser must caution the intended user from drawing any conclusions with regards to attributing the capitalization of any potential STR income stream to the real estate alone.
Thinking of those 3 sources of revenue brought a lot of clarity to the issue for me. I hope it clears things up for you. What do you think? Does this clarify the issue, or did I just serve to muddy the waters?
