There are more than 10 million landlords in the U.S. today, according to the most recent available data. In fact, you probably even know someone who makes good money renting out property. If you’ve been wondering how to get started, rental arbitrage could be the answer.
Essentially, rental arbitrage is a form of subleasing: you rent a property long-term to rent it out again as a short-term rental. The process allows people to become landlords and realize their dream of generating passive income. But is it the right choice for you?
In this article, we’ll go over the ins and outs of rental arbitrage, including what it is, its pros and cons, and whether you can make rental income from this strategy. If you want to learn how to become a landlord without investment capital, keep reading.
What Is Rental Arbitrage?
Also known as “rent-to-rent,” rental arbitrage means renting a property from someone else long-term, then renting it out short-term to profit off the difference. For those who can make it work, rental arbitrage offers an excellent opportunity to earn passive income with minimal up-front investment.
Imagine renting an apartment for $1,500 per month, then renting it out to others as a vacation rental for $200 a night. That translates to an impressive $4,500 in potential profit over 30 days (not counting additional operational costs, which we’ll explore shortly).
Is Rental Arbitrage Legal?
The practice of rental arbitrage itself is legal in all 50 states (but don’t get excited just yet). Many major metros, including New York City and Los Angeles, have enacted strict regulations on short-term rentals, so you’ll have to research local laws carefully before getting started.
How Rental Arbitrage Works in Practice
If you don’t have much investment capital, rental arbitrage might seem like your ticket to passive income, as long as you know what it takes. First, you’ll have to find a property in an area without short-term rental restrictions, run by a landlord who allows rental arbitrage.
Next, you’ll have to rent out “your” property on platforms like Airbnb or VRBO, at a rate that will attract guests. Finding the right balance between price and payoff can be tricky, especially since you’ll also need to cover property maintenance and guest turnover costs.
In some cases, you might agree to share profits with your landlord, or keep everything yourself after covering your operating costs (including rent). Though it’s not a get-rich-quick scheme by any means, with the proper planning and know-how, rental arbitrage can lead to a decent paycheck.
How Rental Arbitrage Differs From Traditional Landlording
Let’s start with the obvious: You don’t actually own the property that you’re renting out. This means that if you need to do property improvements or make any other major changes as part of your short-term rental business, you’ll need to get your landlord’s permission.
Although rental arbitrage might incur lower up-front costs. After all, paying rent on an apartment is typically cheaper than making a down payment and taking out a mortgage. While doing so, you also won’t be building equity in a property. So, your investment won’t appreciate over time, unlike a typical rental property.
Last but not least, your financial goals for rental arbitrage will differ significantly from those of a traditional landlord. While landlords typically focus on long-term investment, rental arbitrage requires a more short-term strategy. It’s ideal for someone who can think quickly and pivot easily.
Pros of Rental Arbitrage
While rental arbitrage might not be the easiest passive income strategy, it does have certain benefits for aspiring landlords. You’ll get to benefit from:
Lower Startup Costs Compared to Property Ownership
Since you won’t have to fork over a down payment or a monthly mortgage, you don’t need as much money to start rental arbitrage. You can even avoid the paperwork involved in purchasing a property. Instead, you just need to find the right place with an affordable rent payment.
Faster Market Entry
Rental arbitrage lets you tap into hot short-term rental markets without costly delays. Rather than lose weeks or months on the purchasing process, you can get into rental arbitrage right away by simply coming to an agreement with your landlord and signing a lease.
Flexibility Across Markets
Rental arbitrage also provides significant flexibility compared to traditional rentals. Property owners are generally stuck with their investment regardless of its profitability, but if a rental isn’t earning as much as you expected, you can easily move to a new location after your lease is up.
Cons and Risks of Rental Arbitrage
As good as rental arbitrage may sound, it does come with its fair share of downsides. You’ll need to be aware of potential drawbacks like:
Lease Violations and Eviction Risk
If you want to do rental arbitrage, it’s essential to secure your landlord’s permission before even attempting the process. However, you’ll still run the risk that your guests will violate your lease agreement, which could lead to you (and potentially those problematic guests) being evicted.
Regulatory and Short-Term Rental Restrictions
As we mentioned, many places in the U.S. strictly regulate short-term rentals. Even if you set up shop in a place that doesn’t prohibit or limit STRs right now, local authorities may choose to do so in the future, locking you into an unprofitable lease.
Thin Margins and High Operating Costs
Depending on how much you pay in rent and other costs, such as cleaning, you might struggle to squeeze profits out of a rental arbitrage property. Because of its associated costs and lack of appreciation, rental arbitrage typically doesn’t pay as well as traditional landlording.
How to Find Suitable Properties for Rent-to-Rent
If you decide you want to try rental arbitrage, then you’ll have to do plenty of research to find the perfect property. As you look for the right rental investment, keep these factors in mind before you sign your next lease agreement.
Identify Landlord-Friendly Opportunities
As with any rental, you need to find properties in landlord-friendly areas that can support a healthy cash flow with comparatively minimal regulations. Look at factors like property taxes, eviction processes, and other landlord-tenant laws to decide whether or not you’re in the right place.
Evaluate Market Demand and Pricing
Naturally, you want to operate in an area where your profits will outweigh your expenses. In the case of rental arbitrage, you’ll have to compare local long-term demand and pricing against short-term rentals and determine whether you can charge enough to profit from the difference.
Scrutinize Lease Agreements and Subleasing Clauses
Even if you find a landlord who’s amenable to rental arbitrage, pay close attention to all aspects of your lease agreement. You and your landlord may have the best of intentions, but it’s crucial to know what you’re agreeing to, especially regarding subleasing.
Study Local Laws and Zoning Considerations
First and foremost, you should pick a rental arbitrage property in an area that doesn’t restrict short-term rentals. But you should also read up on other local laws and commercial versus residential zoning regulations so you don’t get stuck renting something you can’t profit from.
How to Structure a Rental Arbitrage Agreement
No matter where you are or who your landlord is, it’s essential to have a rental arbitrage agreement that clearly outlines everyone’s rights and responsibilities. These contracts prevent miscommunication and can protect you if any disputes arise during the rental arbitrage process.
Negotiate Terms With Property Owners
First, you’ll need to address a few unknowns. Will you share profits with your landlord, who will be allowed into the property, and who will be responsible for property insurance? Answering these questions from the start will provide peace of mind and protection on both sides.
Address Common Lease Terms Upfront
Don’t forget to review the typical lease agreement terms in addition to the ones that are specific to your rental arbitrage business. Your lease agreement should include state-specific terms to ensure compliance with local laws, as well as the nuts-and-bolts details (like lease duration).
Define Exit Clauses, Renewal Options, and Risk Allocation
A rental arbitrage agreement should include clear information about the end of the lease and potential renewals, and how you and your landlord will split the risks. For example, you’ll likely be responsible for guest-related risks, while landlords often cover long-term, normal wear and tear.
Tips for Managing Rent-to-Rent Properties
While you might think that managing rent-to-rent properties is as simple as traditional landlording or short-term rental management, you’ll need to keep a few different factors in mind if you want to pursue rental arbitrage. Follow these strategies to make the most of your rent-to-rent property:
Implement Clear Tenant and Guest Screening Standards
Since you’re not just risking your own property here, thorough, standardized tenant and guest screening is all the more essential. You don’t want to rent to someone who will party all night and trash the place, or, even worse, move in and refuse to leave.
Create Systems for Maintenance, Repairs, and Unit Turnover
This is one area you’ll have to figure out with your landlord. Work together to develop and implement an easily understood system for routine maintenance, damage repairs, and cleaning between guests. Better yet, take time to test those systems before you begin renting out your property.
Stay Compliant Through Consistent Communication and Oversight
Though we hope this goes without saying, you should never attempt to hide rental arbitrage from your landlord. Clearly communicate everything you’re doing and keep a close eye on your rental arbitrage property to prevent unwelcome surprises for either of you.
Common Mistakes to Avoid in Rental Arbitrage
Rental arbitrage comes with plenty of pitfalls, especially for first-timers. But if you watch out for these scenarios, you’ll vastly increase your chances of success:
Underestimating Legal Risk
If anything goes wrong (think serious property damage, renters who refuse to leave, lawsuit-worthy accidents on the property, etc.), you’re typically the one on the hook. Be ready for situations like these, because, as unlikely as they may seem, you never know what might happen.
Overestimating Cash Flow
It’s easy to get starry-eyed and start seeing dollar signs on every rental property. But by overestimating your profits, you could lose a good chunk of change. Remember, you’re working with thin profit margins here, and rental arbitrage is far from a guaranteed moneymaking strategy.
Failing to Secure Written Permission From the Property Owner
Obtaining your landlord’s written permission is essential if you want to try rental arbitrage. Even if you come to a verbal agreement, you could face eviction if your landlord changes their mind, and without a paper trail to protect you, you’d be out of luck.
Is Rental Arbitrage Right for You?
Now that we’ve gone over all the details of rental arbitrage, there’s nothing left to do but decide whether or not you want to dive in. It’s a unique process with its own risks and upsides, so you’ll need to weigh the good against the bad.
While rental arbitrage isn’t always easy, it does offer many aspiring landlords a way to enter the rental income game with minimal startup funding. You’ll have to do your due diligence, of course, but there are definitely ways to make this practice work for you.
Ready to give rental arbitrage a try? Start looking at markets near you to find out where you can make a buck off rental housing. You never know—your next rental arbitrage opportunity could be waiting right around the corner.
