Future Returns: Evaluating Investments in the High-End Rental Market

Whether penthouses with breathtaking views, stately mansions surrounded by natural beauty, or vacation villas in sought-after destinations, luxury rental properties are an increasingly attractive investment.

Recent figures from London-based real estate firm Savills show that across 30 leading markets worldwide, average prime rental values increased by 5.9% in 2022.

“It is largely still a landlord’s market across the majority of our 30 global cities,” Savills research analyst Lucy Palk said in a video released with the report. “This is driven by lack of stock and pent-up demand.”

Owning rentals in the top 10% of the real estate market might offer investors a chance to diversify their portfolios with an asset that has no or little correlation to stock or bond markets.

It’s not without risks, however, says Jonathan Woloshin, a real estate and lodging analyst at UBS Wealth Management. But the risks are different than conventional markets, meaning investors should take emotion out of the process, and do their homework before taking the plunge.

It’s critical to define what segment of luxury you want to play in, says Woloshin. While there may be a property in the US$50 million range, for example, “there’s going to be a smaller subset of people who are going to be able to rent it.”

Though real estate is historically a safe investment, Woloshin wants potential landlords to hope for the best while planning for the worst.

Woloshin spoke to Penta about the critical questions investors need to ask before becoming a high-end landlord.

Avoid Emotional Decisions

There are some investors who view high-end rentals only as a source of cash flow and depreciation. But owning property has an emotional component.

Whenever clients indicate they want to purchase investment properties, he asks them questions designed to remove emotion from the decision. For example, what are the client’s near-, mid-, and long-term liquidity needs, and for how long do they expect to own the property?

“Everybody wants liquidity at the same time, which is always the wrong time,” Woloshin says. Even if investors can afford a cash purchase, it might be more advantageous to borrow to meet liquidity needs, particularly if interest rates are favourable.

His thought exercises extend to worst-case scenarios as well. Woloshin says investors need to determine if purchasing the property or experiencing a significant decline in the property value will significantly impact their lifestyle.

Prepare for Carrying and Management Costs

Whether investors are buying properties in the low seven figures or at the US$100 million level, “occupancy is either zero or 100,” Woloshin says. “There’s no in-between.” Therefore investors need to think long and hard about carrying costs when deciding if they wish to become landlords.

Single-family rental companies tell Woloshin the average time between tenants is typically 30 days—though this was for comparatively modest properties. Higher-end rentals may have condo boards or homeowner associations to deal with when changing tenants, which could extend this time horizon.

Investors will typically have to factor in the cost of hiring a property manager to oversee rent collection and maintenance for a percentage of rental income as well, Woloshin adds. Some high-end gated communities may have onsite management which can help reduce such expenses.

Consider a Post-Rental Future in the Family

Investing in a high-end rental property isn’t always a purely financial transaction. Woloshin says he’s encountered multiple investors who build or buy luxury properties to rent for several years, before keeping the home within the family. This second life could be as a retirement or vacation home, or it could be passed down to another generation as a primary residence. Renting out a desired property initially can help defray costs until the family is ready to use it.

If an individual is considering turning a high-end rental into a family home down the line (or even if it’s a strong possibility), then it’s necessary to“do a lot of research about where you think you want to be,” Woloshin says. This includes how easy or hard it is to travel to the property from a primary residence. He offers the example of the flight-time difference in traveling from the East Coast to Hawaii versus Utah—to local politics and regulations that investors are already taking into account.

Buying International Comes With Special Challenges

High-end international properties can offer particularly lucrative opportunities for investors. For instance, Savills reports that prime rents in Dubai, Lisbon, and Singapore all grew above 20% in 2022.

But Woloshin says one reason “so many investment dollars come to U.S. real estate is because of our property laws.” Circumstances vary between countries, so investors who want to invest abroad need to look closely into issues that may affect the integrity of their investment, from government stability, property laws and tax regimes to ensure any risks match with their comfort levels. It’s also essential to consider any potential legal, tax, and foreign exchange rate issues with repatriating earnings from international rentals.

Depending on the location, Woloshin adds that environmental risks may come into play. Investors looking at buying coastal property in the Caribbean, for instance, will want to consider issues like hurricane risk and the cost and availability of flood insurance.