If you’re a short-term rental host or vacation rental manager, you’ve likely heard about rental arbitrage. It can be a lucrative, but sometimes risky way to make money in the vacation rental market.

And this strategy isn’t just for hosts. There’s serious money to be made in rental arbitrage, with companies like Lyric (a startup that just raised a $160 million round of funding, led by Airbnb) basing their entire business model on this tactic.

In short, rental arbitrage entails signing long-term leases for properties, then listing them on short-term rental sites like Airbnb and HomeAway. The revenue potential for arbitrage is highly dependent on the difference between long-term and short-term rental prices in your market.

Regulation is a major factor in arbitrage since many cities have strict rules around when (and if) traditional rentals can be used as short-term rentals. However, some cities have realized how short-term rentals can benefit both vacation rental managers and local economies. For example, Arizona and Ohio are states where non-restrictive regulations have been put in place, and as a result, these states — and, specifically, Arizona — have seen significant tax revenue from Airbnb.

One other major challenge of rental arbitrage is getting the approval of the owner you’re leasing the property from. We’ve seen some long-term tenants pay 20% above market rate or set up profit-sharing agreements (e.g., the landlord gets 10% of all bookings) to make arbitrage mutually beneficial for both the landlord and tenant

Rental Arbitrage as an Option for Median-Income Earners

With home prices on the rise across the United States, fewer people are able to purchase a home—and consequently enter the short-term rental market. In 2018, there were only 19 states where the median household income was above the threshold needed to purchase a home.

In many markets, rental prices have skyrocketed right alongside housing prices. A recent report by Apartment List found that in 24 out of the 100 largest U.S. cities, renting a median two-bedroom apartment will cost-burden a median-income-earning renter.

For median-income earners, rental arbitrage—whether by renting out an entire place or private rooms in a house—is a viable way for people to enter the short-term rental market without purchasing a home or to make ends meet when renting in an expensive city.

Methodology to Determine the Spread

We love what Zumper has done to show trends across major U.S. cities in their monthly long-term rental analysis. After reading Zumper’s April report, we thought it would be interesting to combine their figures with AirDNA’s property-level data to give you an idea of which cities are the best—and worst—when it comes to arbitrage opportunities on Airbnb and HomeAway.

Since short-term rental markets can be highly seasonal, we looked at the average monthly revenue over the last 12 months for 1 and 2-bedroom properties. A property’s performance can vary widely by percentile, so for this analysis, we’re only looking at properties performing at the 75th percentile.

To calculate the monthly potential arbitrage opportunity for each market, we subtracted Zumper’s average monthly rental price from our own figures to get each city’s monthly arbitrage revenue potential.

For example, in Columbus, Ohio, the average 1-bedroom rental (as of April 2019) is $700. AirDNA data shows that 1-bedroom listings at the 75th percentile saw an average RevPAR of $1,622 over the last 12 months. $1,622 minus $700 gives us a monthly arbitrage revenue potential of $922.

The Best and Worst Cities for Rental Arbitrage

Worst Markets for 1-Bedroom Properties

Market	Monthly Rent	Short-Term RevPAR	Arbitrage Potential
San Francisco, CA	$3,700	$3,245	-$455
San Jose, CA	$2,850	$2,108	-$412
New York, NY	$2,850	$2,548	-$302
Oakland, CA	$2,270	$1,975	-$295
Laredo, TX	$830	$545	-$285

 

Worst Markets for 2-Bedroom Properties

Market	Monthly Rent	Short-Term RevPAR	Arbitrage Potential
Scottsdale, AZ	$2,080	$1,677	-$403
Irving, TX	$1,490	$1,091	-$399
Chandler, AZ	$1,440	$1,177	-$263
Laredo, TX	$940	$710	-$230
Oakland, CA	$2,720	$2,631	-$89

The Bay Area (which includes San Francisco, San Jose, and Oakland) and New York City are two of the most expensive rental markets in the United States, so it is not surprising to see that they’re among the worst markets for arbitrage opportunities in the U.S.

Irving, Chandler, and Laredo are all cities with low prices for 2-bedroom rentals, but short-term rentals in these markets don’t have a high enough RevPAR to make arbitrage a smart investment.

Best Markets for 1-Bedroom Properties

Market	Monthly Rent	Short-Term RevPAR	Arbitrage Potential
Honolulu, HI	$1,700	$3,446	$1,746
Nashville, TN	$1,380	$3,043	$1,663
Boston, MA	$2,400	$3,920	$1,520
Detroit, MI	$610	$1,883	$1,273
Des Moines, IA	$810	$2,000	$1,190

 

Best Markets for 2-Bedroom Properties

Market	Monthly Rent	Short-Term RevPAR	Arbitrage Potential
Boston, MA	$2,750	$5,338	$2,588
Honolulu, HI	$2,230	$4,772	$2,542
Nashville, TN	$1,390	$3,580	$2,190
Corpus Christi, TX	$1,070	$2,690	$1,620
Detroit, MI	$690	$2,165	$1,475

 

None of the cities on this list are where most would expect to see the best arbitrage opportunities. All of these markets have one thing in common: they see a steady stream of travelers year-round who are looking to book short-term rentals for business or personal travel.

Hawaii and Tennessee are booming short-term rental markets for both arbitrage and traditional real estate investment. In our analysis of the top 100 vacation rental markets in the United States, Hawaiian markets (including Honolulu) showed up on our list 19 times and Tennessee (including Nashville) showed up three times.

For a look at the challenges and opportunities of each of these markets,  read our post on Bigger Pockets.