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The Short-Term Rental Dilemma

by JoAnn Apostol

A couple of years ago, I was having a conversation with some colleagues on short-term rental analysis requests from lenders. One person said that a Certified Residential appraiser should never complete these requests. I held my breath and thought about this for a while and listened to their argument for their position. I also thought to myself, “Have I been doing these all wrong for 20 years?”

After listening to the information presented by the other appraiser, I realized that his work was a going concern assignment. The property was located in an area where the short-term rental properties sold for more than properties that weren’t rented. This remains a likely scenario for an assignment and could require competencies beyond a residential appraiser’s expertise. I continued to have these conversations with different colleagues across the country.

I work in ski resort areas and have for many years. There are condominium complexes that are on the ski area, and those complexes are filled with short-term rental units. These sell like any other condominiums in towns, and people buy them to stay in when they go skiing, or to spend time in the local area. I’ve interviewed many owners who mostly have responded that they rent them out to cover the costs of ownership. The multiple listing services in these areas usually have a field for furnishings, and I’ve done analyses on the impact of furnishings being sold with the real estate. The client has always asked for a fee simple interest, which is a straightforward assignment.

I also taught licensing courses for many years. I taught courses for all the residential levels. The courses cover income stream analysis, including the potential, effective and net income analyses. These topics are also on the National Uniform Licensing and Certification Examination for appraisers. So even a Licensed Residential Appraiser is armed with the basic tools to do the analyses required in a short-term rental analysis. Residential appraisers are not limited to using the GRM method for income. This analysis is not as complex as one would expect. It does take some research, analysis and understanding of the method to become competent, but we all have this basic tool.

The COVID-19 pandemic changed the short-term rental market significantly. Even before COVID-19, there had been an increase in single-family houses available to rent on a short-term basis. In subsequent years lenders, including FNMA, were allowing this income to offset the debt-to-income ratio of the borrower. The issue really came with the requests to place short-term rental income on the “1007” FNMA form because it wasn’t designed for this type of income.

I’ve heard many appraisers flat-out refuse these assignments. I’ve read social media posts arguing that this income shouldn’t be made by appraisers; the reasonings are different in each post. The one consistent theme is the lack of common sense in so many of the conversations.

From the beginning, I was trying to understand if a Certified Residential appraiser could complete these assignments. From all the research I have done, the straightforward, commonsense answer is yes. However, if there is a state law that prohibits it, then the law takes precedence. Think about it for a minute. We hold real estate licenses, and most states don’t license personal or business property appraisers. Therefore, there is nothing that violates our license, or any license.

Is it a violation of USPAP? Likely not if the appraiser is competent. Is it a violation of the intended use? That depends on the assignment. If the use is for income purposes, possibly because the lender would be asking for a “Going Concern Value.” In identifying the problem in USPAP, we must identify the type and definition of value in the assignment. This is often linked to the intended use and the client’s expectations. If an appraiser has the knowledge and experience to appraise a going concern value, then they are competent.

One note to remember about USPAP is that the requirements have no relationship to the license level an appraiser holds. That’s because USPAP compliance is required when either the service or the appraiser is required to comply based on laws, regulations or agreements with the client.

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Even in appraising a property to a market value for the fee simple interest, the appraiser should be aware of the impact on price of the personal property or business interest of a short-term rental.

It took a while, but FNMA did finally come out and say that short-term rental income should not be reported on the 1007 form. Does that mean we don’t still get requests to report short-term rental income on the 1007 form? Definitely not! I still get them regularly. There are lenders out there who don’t sell their loans to a Government Sponsored Enterprise. There are also hard money lenders and non-banks that make loans on real estate.

Last month, I was on a webinar that was introducing a new format for reporting short-term rental income. Having been an AQB Certified USPAP Instructor since 2008, I listened intently to the presentation. The speaker indicated that coming to an opinion of short-term rentals fell outside of the standards of USPAP! I couldn’t believe what I was hearing!

From the beginning of my USPAP training and in the Instructor Certification Course, it has always been stressed that an opinion of market rent is an appraisal. I sent a question to the Appraisal Foundation to ensure that I was correct. The initial response was that they were working on answering an inquiry from an organization on just that topic!

The response finally came through a few days later, and it confirmed what I had thought and had always done. Doing just an opinion of market rent is an appraisal that has to comply with USPAP, including Standards 1 and 2.

Here is what they sent to me:

Regarding whether an “analysis of short-term rental income” constitutes an “opinion of value” and how this relates to USPAP. Some of the relevant definitions and considerations for a clear understanding include:

Key USPAP Definitions
Appraisal: Defined in USPAP as: “(noun) the act or process of developing an opinion of value; an opinion of value. (adjective) of or pertaining to appraising and related functions such as appraisal practice or appraisal services. Comment: An appraisal is numerically expressed as a specific amount, as a range of numbers, or as a relationship (e.g., not more than, not less than) to a previous value opinion or numerical benchmark (e.g., assessed value, collateral value).” (emphasis added)

Appraiser: Defined in USPAP as: “one who is expected to perform valuation services competently and in a manner that is independent, impartial, and objective.” (emphasis added)

Valuation Service: Defined in USPAP as: “a service pertaining to an aspect of property value, regardless of the type of service and whether it is performed by appraisers or by others.” (emphasis added)

Value: USPAP defines this as: “the monetary relationship between properties and those who buy, sell, or use those properties, expressed as an opinion of the worth of a property at a given time. Comment: In appraisal practice, value will always be qualified—for example, market value, liquidation value, or investment value.” (emphasis added)

From the Preamble and associated guidance (e.g., AO-21, FAQ 172 which specifically states the opinion of market rent is an appraisal, as well as FAQs 4, 310, and 348), it’s clear that:

Any opinion formed using appraiser expertise and judgment—particularly when based on analysis of factors such as income potential—qualifies as an appraisal if it results in an opinion of value.

The ETHICS RULE states that an individual should comply any time that individual represents that he or she is performing the service as an appraiser.

Market rent is explicitly recognized as an opinion of value (see AO-21, Illustration #3).

When an appraiser develops an opinion of market rent, it is an appraisal within USPAP and thus is an assignment within Appraisal Practice, not just a Valuation Service.

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The webinar was still interesting because they were designing a form to report short-term rental information. They had sections for the high season and the low season, since many short-term rental areas are very seasonal. They had areas for vacancies, furnishings, condition, age, bed and bath counts and other amenities. The conclusion was a nightly rental conclusion.

The problem with this approach is that the average daily rent for a one-unit property is zero on the days it’s vacant and using a zero in the average skews the average. The consistent theme is that we MUST conclude to an average daily rate which is a hotel/motel term, not a single-family term. I see people trying to make these into hotel/motel valuations consistently, but they are not the same. I’m not saying they aren’t similar; I am saying these are not identical to a hotel or motel. Therefore, the analysis shouldn’t be identical either.

I actually own a short-term rental, so I can speak from experience. The guests who book my house tend to book for a weekend, a few weeks, a month, or longer. My property manager offers a monthly discount for a booking. I’ve used AirDNA for rental analysis in different areas and I’ve done research on annual income in other areas. There are other resources available also like Rento-meter and others, depending on where the property is located. The key difference between these is the location of the property.

In the ski resort towns where I work, property management agencies and condominium/resort operators tend to provide an annual gross income based on the rating of the unit. A unit with a Platinum or Gold rating will be rented first and will generate more income. These areas are often better to look at as annual income. Depending on the information you can find, you could use either gross or net income, but the management fees should be removed. When these folks say “gross” they really mean effective gross income. The management fees are the business side of this business. In the resort towns, management fees are 40 percent or more of the gross income. They are high because they offer 24-hour desk staff and other additional services that aren’t available in a single-family rental situation.

My property manager in Arizona charges me 20 percent of the effective gross income. Anyone can call enough property managers to figure out what the typical management charge is in an area. USPAP allows interviews of industry professionals as support for an adjustment; just keep notes on this information in your workfile. This should still be applied to the income because it removes the business portion from the conclusion. Owner-operators manage their own properties to increase their revenue, which is their business income. We are getting closer to a rental conclusion with the management, but there are so many other considerations in doing these short-term rental analyses.

I mentioned earlier that the length of the stay may be different depending on the location of the rental. I believe that this should be considered when doing the analysis and in the final number reported. I agree with all the sources that one should not just simply divide annual income by 12 to get a monthly income. I also believe that the final amount should be driven by the short-term rental market.

The seasonality of the area and income should be considered, and the typical vacancy rates should be applied. This can be done on a daily, weekly or monthly basis based on the location and the typical stay in the area. I know in Arizona and the Carolinas that houses are rented for the entire high season to the same person. The same person tends to rent the same house year after year, also. This rental market is significantly different than a ski area rental market.

How the analysis is completed may be different depending on the client, assignment, property or location. We should discuss those factors with the client during the engagement process to thoroughly understand the needs and expectations of the client. We must ensure that our results are credible and not misleading for their intended use and users. If we are doing this in conjunction with an opinion of market value, we must be sure to also include a definition of market rent in the report. I use the definition from the Appraisal Institute’s “The Appraisal of Real Estate.”

If asked to do this as a standalone product, get your USPAP book out and use Standard 2 as a checklist to ensure you comply with USPAP. These are more difficult because we aren’t given a form that has most of the basic items included. I’ve completed these in both scenarios as a Certified Residential Appraiser; remember that it’s more about your competency than your license level.

About the Author
 JoAnn Apostol has been a Certified Residential Appraiser in Colorado since 2002. She specializes in mountain properties west of Denver and complex residential properties throughout the 6-county Denver Metropolitan Area. She taught for a national appraisal education program for 17 years, where she taught qualifying education, continuing education, and USPAP, and was the national appraisal instructor. An AQB-Certified USPAP Instructor and Certified Distance Educator, JoAnn has a bachelor’s degree in mathematics with an education emphasis and a minor in special education. She volunteers with the National Association of Appraisers as Chair of the Communications Committee, publishes a quarterly newsletter, tutors students preparing for the National Appraiser Exam and mentors new appraisers in industry standards and acceptable appraisal methods.

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