Is Rental Arbitrage Legal? (5 Legal Risks PLUS How to Manage Them)

5 Legal Risks of Rental Arbitrage and How to Manage Them

1. Local Regulations and Zoning Laws

Not all areas allow short term rental arbitrage. Many US cities have strict local regulations and zoning laws that can affect how and where you operate. These regulations include registration or licensing requirements and a limit for how many days you can rent out a property. Understand that these laws have a purpose: They’re put in place to manage housing availability, protect the local housing market, control property usage, and keep neighborhoods stable. That’s why more areas around the world are putting regulations in place for short term rentals.

In 2014, San Francisco passed strict STR laws that limited the number of days you can rent out your property to 90 days a year if you don’t live there. And in 2015, the city required all Airbnb hosts to register through a difficult process. While the city eventually settled with Airbnb regarding the registration requirements, Airbnb listings still dropped by almost 50% from 10,000 to 5,500 listings.

Running afoul of local laws can also lead to fines and legal trouble, like in this Wired report about 9 people who built an illegal network of Airbnb units worth $5 million in New York, which is known for its strict short term rental regulations. So, if you’re not updated with these regulations, they can seriously impact your business.

How to Manage the Legal Risk of Local Regulations and Zoning Laws:

• Check the STR regulations for both your state and county. Sometimes, cities and townships inside those counties also have regulations, so look into those, too. Type the county name + “short term rental regulations” or “transient lodging regulations” on Google, and see what results come up. Make sure to vet these results and find the official source, which are most likely .gov domains from a county’s official website. If you’re doing Airbnb arbitrage, you can use Airbnb’s Help Center as a search engine for finding certain local laws.
• If the official county websites don’t have anything definitive about short term rentals, then rely on local zoning laws. Contact your local zoning board and find out if you’re allowed to short term rent and in which areas.
• Be involved in your local regulations. Join communities (like Citizens for STR in Washington, D.C.) that help fight cases that make it difficult to start a short term rental business. Joining a community, such as in local Facebook groups, can also help you learn more about a certain area’s regulations.
• To ensure you’re covering all bases, enlist the expertise of a legal professional familiar with real estate or STR laws.

2. Lease Agreement Violations

Most lease agreements have clauses that prevent subleasing or engaging in short term rental arbitrage. This is often to protect the property owner from potential property damage and maintain control over the property. Other common lease agreement violations include:

• Racking up noise complaints
• Having occupants that aren’t on lease living on the rental
• Late rent payments
• Unauthorized alterations to the property
• Getting a pet without the landlord’s consent
• Illegal activities being conducted on the property

If you violate the terms of your lease, you could face penalty fees, an eviction notice, or legal action. With rental arbitrage, the landlord has significant control over your business. So, always negotiate and get written permission from the landlord if you’re going to use the property for short-term rental purposes.

How to Manage the Legal Risk of Lease Agreement Violations:

Craft master lease agreements or lease addendums that specifically outline the terms of the rental arrangement, including the duration of subleases, the responsibility for any damage, maintenance requirements, and restrictions on property modifications. If pets are a concern, this agreement can specify the conditions under which they’re allowed, like deposits or fees.

Having the right to do repairs in your lease is generally a great idea. If you leave that responsibility to the landlord, they may not make the necessary repairs in time, leading to bad customer experience and reviews.

Establishing clear rules for noise control or the use of common areas can also be part of the agreement.

Being proactive in lease terms and conditions creates a better relationship between you and the landlord. So, ensure all parties involved understand and agree to the terms, and consult a legal expert if necessary to guarantee compliance with all applicable laws.

3. Liability Issues

In rental arbitrage, there’s a heightened liability risk of being held responsible for property damage and injuries occurring on your property. When you sublease your property to guests through platforms like Airbnb or Vrbo, you establish a legal relationship, or privity of contract, with those guests. This relationship means that if anything goes wrong, such as an issue with the property management, your guests have the legal right to sue you.

How to Manage the Legal Risk of Liability Issues:

By forming a limited liability company (LLC), you create a business structure that gives you liability protection when facing legal actions while also giving you some tax benefits. But this is only the first step in protecting your rental arbitrage business. You should also get business insurance with policies that cover STR-related details, like coverage for accidental and intentional property damage caused by guests. When choosing an insurance policy, make sure it includes these features:

• Coverage for loss of income
• Property and contents insurance
• Liability coverage
• Location-specific coverage (for areas prone to flooding or earthquakes)
• No required proof of forced entry for damage and theft coverage

If you’re an Airbnb host, Airbnb’s AirCover provides free added protection that can reimburse up to $3 million in damages and $1 million liability insurance when your guests get hurt or have their valuables damaged or stolen. But don’t rely on this service and only use it as a backup plan.

One great insurance option is Proper Insurance, as it’s specifically made for vacation rental hosts, and you get $1,000,000 in business liability. They also claim to be the only business insurance policy that has no limits on theft coverage and damages caused by a guest. And, you can add your landlord as additionally insured (AI) with the Proper policy, which can be used as a selling point for negotiating rental arbitrage lease agreements.

Other insurance companies you can look into are:

• Allstate
• CBIZ
• American Modern Insurance Group
• Erie Insurance
• Safely

For landlords, liability issues come front and center. Landlords shouldn’t allow rental arbitrage at their properties if the tenant doesn’t have liability insurance. Because if something goes wrong, you may also be held responsible (not just the person engaged in rental arbitrage).

4. Tax Obligations

Rental arbitrage tax obligations require you to report your rental property income. But tax laws around short term rentals can be complex and vary depending on your location. If you don’t adhere to these laws, you could underreport your income or fail to pay your taxes, leading to fines or audits from tax authorities.

How to Manage the Legal Risk of Tax Obligations:

Understand STR tax laws in your area. In the U.S., income from short term rentals is subject to both federal and possibly state and local taxes. Intermediaries like Airbnb, Vrbo, and Booking.com handle some of these taxes. Here are other tax requirements to be aware of, according to tax adviser David Weinstein, MBA CPA CFE:

• Transient Occupancy Tax (TOT) or Hotel Occupancy Tax: This is a common tax in many areas, charged as a percentage of the rental rate to guests.
• Sales Tax: Some places might charge this on the rental amount, and the rates and regulations differ from one locality to another.
• Specific Lodging Taxes: These are unique to certain areas and may be used to fund local initiatives.
• Business Taxes: Depending on how your business is structured, you might have to deal with local business taxes or registration fees.

Renting out part of your primary residence and renting out a separate property for short-term rental also have different tax implications. If you rent out part of your home, you’ll need to report that rental income, possibly qualify for a home office deduction, and be aware of how mortgage interest and property taxes apply. Renting for fewer than 15 days might even be tax-free under certain conditions.

On the other hand, renting a separate property involves reporting all rental income and paying both state and local taxes. You can reduce your overall tax liability through tax write-offs, like rental expenses (advertising, cleaning, maintenance, etc.), depreciation of the property, and insurance premiums. Always keep detailed records of the deductions that apply to your business.

There’s also a tax loophole worth mentioning, as explained by real estate investor Clint Coons, Esq: By setting up a self-directed IRA (SDIRA), which is a type of Roth IRA, and an LLC that’s 100% owned by your Roth, you can negotiate and contract properties using this structure for tax-free short-term rental income. It’s a more complex strategy that may be worth exploring with a tax prep expert. Hiring a tax professional experienced in short term rental taxation in your jurisdiction is always a smart move.

5. Landlord-Tenant Laws

Landlord-tenant laws govern the relationship between property owners and tenants. In rental arbitrage, you’re both a tenant and a landlord. This puts you in a unique legal position that can be fraught with risk.

According to Airbnb, landlord-tenant laws grant guests additional legal rights if they stay in your property for a period defined by your jurisdiction. This means local tenancy laws will protect them, and you’ll have to adhere to strict eviction processes to remove them from your property.

Ken McElroy, the CEO of MC Companies, highlights a practical reality: Tenants can be troublesome, and the process to evict them varies depending on the state. For instance, Phoenix allows you to get someone out in 30 days, but the rules are different in places like California, Oregon, and New York. These state-specific regulations can either favor the landlord or the tenant.

How to Manage the Legal Risk of Landlord-Tenant Laws:

It’s best to consult with a legal professional who knows the ins and outs of landlord-tenant laws in your area. This will ensure that your rental agreements are above board and that you’re on solid ground legally, both as a tenant renting from someone else and as a host renting to your own guests.

Is Rental Arbitrage Legal in California?

Yes, rental arbitrage is legal in California. On a state level, California is STR-friendly, particularly if the unit is your primary residence. In fact, a state law that was passed in 2017 prevents local municipalities from prohibiting additional dwelling units (ADUs), though regulations still vary across different localities. For instance:

• In Los Angeles, you’re required to obtain a permit from the city planning department for $183. And you can only rent out your primary residence, where you live for at least six months of the year, and for no more than 120 days per year.
• In San Francisco, you can rent out your primary residence for however long you want if you’re living in the same house, or for only 90 days a year if not. You must also register as a business or LLC with the city, and your certification number needs to be included in any STR advertising or Airbnb listing.
• San Diego requires owners to get a transient occupancy registration certificate from the city and pay necessary taxes.

Recent residential housing shortages have led to increased regulation of the STR market in places like Los Angeles and San Francisco. High state income tax also deters some investors, but with proper planning and selecting good locations, like Napa and Santa Barbara, you can succeed in doing rental arbitrage in California.

Is Rental Arbitrage Legal in Florida?

Yes, rental arbitrage is legal in Florida, and the state has generally lax regulations on short-term rental markets. In cities like Panama City Beach and Fort Lauderdale, all you need to do is pay some registration fees, get building inspections, and obtain a license. On the state level, if you plan on renting your property for less than 30 days at a time, you’ll need a license from the Florida Department of Business and Professional Regulation (DBPR) under their Division of Hotels and Restaurants. There are different applications depending on whether you’re dealing with condos or dwellings, like single-family homes or townhomes.

If you’re renting your property for 30 days or more, there’s no state license required, but you’ll still need to collect the Florida Tourist Development Tax for rentals up to 6 months. The tax rates can differ by county. For instance, in Brevard County, you’ll be responsible for collecting 6% state sales tax, 1% discretionary surtax, and 5% tourist development tax. Also, be mindful of specific municipal regulations, especially in places like Miami Beach, where the short-term rental market is under tighter control due to the impact on residential house prices.

Is Rental Arbitrage Legal in Texas?

Yes, rental arbitrage is legal in Texas. It’s also one of the top vacation rental markets in the United States. In Texas, the state-level regulations are minimal, and they largely allow city governments to enact their own laws related to short-term rentals.

The only significant requirement at the state level is that Airbnb hosts must register with the Texas Comptroller’s Office to collect a state hotel occupancy tax. There are no state-level licenses or expiration dates to be concerned about, which makes the process relatively simple and streamlined. However, different cities in Texas have their own specific rules:

• In Austin, you must obtain an operating license, with a comprehensive list of requirements, including various fees and proofs of property insurance.
• Dallas doesn’t have specific short-term rental laws, but you have to register your property and comply with tax-related regulations.
• Houston’s short-term rentals are governed by the Multiple Dwelling Law, categorizing rentals into hosted and unhosted types, with specific rules for each, along with a 7% hotel occupancy tax.

Is Rental Arbitrage Legal in Georgia?

Yes, rental arbitrage is legal in Georgia. The state doesn’t impose state-wide regulations for short-term rentals, and you’re only required to pay a 4% sales tax and hotel-motel taxes, which are remitted by platforms like Airbnb or Vrbo. You’ll also have to register with the Georgia Department of Revenue, but it’s a straightforward process. City-level regulations are more complex:

• In Atlanta, the Short Term Rental Ordinance, effective from June 2022, requires you to obtain a short-term rental license, with restrictions around non-owner occupied vacation rentals.
• Savannah’s regulations are even more restrictive, with a 20% cap on new short-term vacation rentals in the Downtown and Victorian districts, a 6% hotel-motel tax in addition to a 7% sales tax, and a $250 annual renewal fee for licenses.

Is Rental Arbitrage Legal in New Jersey?

Yes, rental arbitrage is legal in New Jersey, but it requires strategy. The state’s rental rules fall under the Continuing Certificate of Occupancy (CCO), which varies from town to town. And because each town can change its CCO at any time, some make it exceedingly complicated to do rental arbitrage by regulating how long you can rent out a property and how many guests you can have.

Some towns, like Cresskill, Englewood Cliffs, Fort Lee, and Weehawken, have gone as far as banning short-term rentals altogether or limiting rentals to 30 days or longer. Others have imposed fees and inspections that can become so costly and logistically complex that property owners just give up.

Profitable rental arbitrage in the state seems to hinge on targeting areas near attractions like the Jersey Shore and ski towns, particularly in medium-sized towns with fewer hotels and more lenient laws, such as Point Pleasant down to Cape May. Conversely, places like Jersey City, despite Airbnb’s $4 million campaign to overturn one of their STR laws, have placed such heavy restrictions that they’re practically off-limits.

Is Rental Arbitrage Legal in New York?

Yes, rental arbitrage is legal in New York, but the city has strict short term rental laws. City officials are intent on constraining platforms like Airbnb and Vrbo due to impacts on housing shortages. So, they’ve implemented laws that forbid renting entire homes for fewer than 30 days without the owner present. Even private room rentals have specific limitations such as restricting to no more than two guests and maintaining free access to every room and exit within the apartment.

The rules have tightened even further with a de facto ban on short-term rentals starting September 5, 2023. Hosts now must register with the city or face deactivation or conversion to long-term stays, and existing reservations with check-in dates after December 1 face cancellation.

Is Rental Arbitrage Legal in UK?

Yes, rental arbitrage is legal in UK, as long as you have a custom agreement with your landlord explicitly stating how you’ll be using the unit – an assured shorthold tenancy agreement won’t suffice. And similar to the US, short term rental laws vary by region:

• In Greater London, properties can be rented for less than 90 nights per year as “temporary sleeping accommodation,” although some local exceptions apply.
• Edinburgh and Glasgow require planning approval for short-term rentals.
• Northern Ireland requires host registration.

Is Rental Arbitrage Legal in Canada?

Yes, rental arbitrage is legal in Canada, but regulations vary across different municipalities. Most cities classify short-term rentals as tenancy lasting 30 consecutive days or less, and anything exceeding this limit falls under different rules. Specific cities also have distinct regulations:

• Quebec requires registration for short-term rentals of fewer than 31 days, and it was the first province to regulate this business.
• Vancouver only allows short-term rental licenses for main residences, which means hosts must live on the property while operating.
• In Edmonton and Calgary, you must have a business license for your short-term rentals.

Is Rental Arbitrage Legal in Ontario?

Yes, rental arbitrage is legal in Ontario, with its Municipal Act and City of Toronto Act giving individual cities the authority to regulate short-term rentals. That means different cities have unique rules for zoning, licensing, noise, and safety:

• In Toronto, you must register online with the city, with restrictions for renting out your primary residence for less than 28 consecutive days. There are also regulations on how many people you can host and for how many nights, plus a 4% Municipal Accommodation Tax.
• Ottawa has a bylaw for rentals of less than 30 days and requires hosts to register for a 2-year permit costing $110, with restrictions on the number of guests allowed (up to 10 guests with 2 people max per bedroom).
• In Huntsville, you can participate in the Short-Term Rental Accommodation (STRA) program with a yearly license fee ranging from $500 to $750, depending on whether it’s your primary or secondary residence.

Is Rental Arbitrage Legal in Australia?

Yes, rental arbitrage is legal in Australia, but the government imposes specific shared housing laws to regulate the short-term rental industry in the country. These laws include occupancy restrictions, guest record keeping, and minimum stay requirements. Breaking these rules can result in severe consequences like suspension or cancellation of your registration number, not to mention fines.

And each state has its own set of laws. For example, in New South Wales, local councils can decide if you can list stays on Airbnb. Without proper approval or the landlord’s consent for subleasing, sanctions can be carried out under local and state laws. Plus, all rental income must be declared to the Australian Tax Office.

How to Start Rental Arbitrage Legally?

• Research: As a vacation rental host, you should understand the STR regulations in your city, state, or province. Begin by looking into markets that don’t require you to be the owner of your short-term rentals and have no restrictions on the number of nights that you can rent them out per year. If necessary, apply for required hospitality licenses or business permits. Ensure you’re complying with all local laws.
• Ask Permission from the Property Owner: Make sure your lease agreement doesn’t prohibit subletting or short-term rentals. Talk to your landlord to confirm that they allow short-term and vacation rental arbitrage. Being transparent with property management will save you from legal consequences involving lease violations. As a long term tenant, you should also maintain a good relationship with your landlord, so you can foster trust, collaboration, and growth in your business.
• Get Your Finances in Order: It costs $5,000 to $10,000 to start a rental arbitrage business, depending on the location and type of property. These initial costs include your first monthly rent, security deposit, furnishings, and other startup expenses.
• Get Insurance: Make sure you’re protected and covered in case of injuries, natural disasters, or if a short term renter damages your property. Airbnb’s host protection insurance is a good starting point, but also look into renter’s insurance companies like Proper.
• Meet with a Real Estate Attorney: Consult with a legal expert so that all your agreements are solid and that you’re complying with all local laws and regulations.
• List Your Property and Attract Tenants: Once you have all the licenses, lease agreements, and insurance policies that you need, start listing your property on platforms like Airbnb. Make sure your prices align with current market rates.

To make your rental arbitrage business successful, do your research, know your numbers, secure the right property, understand local regulations, and follow all the steps above.

What Are the Legal Requirements for Starting a Rental Arbitrage Business?

The legal requirements for starting a rental arbitrage business vary per state, county, and city. Here are some common requirements for the rental arbitrage model, particularly in strictly-regulated US cities, like New York, San Francisco, and Las Vegas:

• License and Business Registration: Some cities require short term rental hosts to get a short term rental license, a business registration certificate, or a short term rental registration certificate. The process can sometimes be done online and often for a fee. Once you’re registered, you’ll be required to put your registration details on your listings and online ads.
• Lease Agreement: When negotiating with landlords, your lease should outline the terms and conditions you need to operate a rental arbitrage business. These terms include lease duration, monthly rent, short-term rental clauses, and property management responsibilities of both the tenant and landlord. Have a lawyer review your lease agreement to make sure your STR or Airbnb sublet is compliant with local laws.
• LLC: You don’t need an LLC to do rental arbitrage, but you’ll get added protection if you lease your properties through your LLC. If you’re planning on scaling your rental arbitrage business, then you should get an LLC for the tax benefits.
• Proof of Primary Residence: Some municipalities will only let you operate a short term rental business if it’s your primary residence, meaning you have to live in the rental property for 75% of the year.
• Proof of Insurance: Business registrations may require you to show proof of liability insurance coverage, typically with a minimum amount of $500,000. Although, you should get your business insured whether or not it’s required. Liability insurance is so important for rental arbitrage because it covers potential damages and legal liabilities that might arise from your rental arbitrage business.
• Taxes: Each locality has different tax requirements. Example taxes are Transient Occupancy Tax (TOT), state and county sales tax, value-added tax (VAT), tourism tax, and other local-specific taxes. Sometimes, Airbnb and other STR platforms will remit these for you. But consult with a tax professional with short term rental expertise to get advice for your specific business.
• Zoning Restrictions: Some cities have zoning laws that dictate how you can use your space. In Las Vegas, for instance, you’re only allowed to use your short term rentals for dwelling, lodging, or overnight accommodations. You can’t hold commercial events, like weddings or parties, because it’s prohibited. Always check with your county and state to verify their zoning laws.

What Are Legal Short Term Rental Platforms?

The legaa short term rental platforms are Airbnb, VRBO, Booking.com, FlipKey, HomeToGo, Homestay.com, and Expedia. Airbnb leads the market with over 6 million active listings, offering a range of accommodations to potential guests, while VRBO has specialized in the vacation rental sector since 1995, providing whole-home rentals, such as beach houses, cabins, and even castles.

Booking.com doesn’t just offer hotels anymore but has extended its reach to short term vacation rentals, and FlipKey, a subsidiary of Tripadvisor Rentals since 2008, has more than 830,000 properties worldwide. HomeToGo, Homestay.com, and Expedia each add unique elements, with HomeToGo aggregating millions of short term rental offers from other platforms, Homestay.com focusing on cultural connections, and Expedia offering broad travel solutions, like flights, cars, and activities, not just vacation rentals.

Is Rental Arbitrage Worth It?

Rental arbitrage is worth it for those looking to enter the real estate market without the heavy investment tied to traditional property ownership. If you’re a real estate investor, you can capitalize on the rental arbitrage model, which requires relatively low startup costs and opens doors to a vast market in the vacation rental industry.

Rental arbitrage is right for you if you’re willing to invest time in understanding STR market dynamics, regulatory compliance, and strategically selecting properties with high-profit potential. On the other hand, rental arbitrage is not a good idea if you’re risk-averse, unwilling to invest time in research and management, or if you’re operating in markets with strict regulations that may limit your ability to do rental arbitrage.

Is Rental Arbitrage Still Profitable?

Yes, rental arbitrage is still profitable, but less so in 2023 compared to 2021 and 2022, as the demand for vacation rentals dropped to 10.4% from 22.6% in 2021 and 18.1% in 2022, according to this year’s STR mid-year outlook report by AirDNA. However, this rate is better than the anticipated 5.5% projection at the end of 2022. While this business model won’t make you a millionaire (unless you lease hundreds of properties, which is difficult with ongoing STR crackdowns across the US), you can make $1,000 to $5,000+ in rent per property doing rental arbitrage.

Conclusion: Why Local Lead Gen Is Better Investment Than Rental Arbitrage?

Local lead generation is a better investment than rental arbitrage. While rental arbitrage is a good way to enter the real estate market without owning property, it’s susceptible to regulatory changes and unpredictable market conditions that lead to unstable income. You’re also required to spend at least $5,000 in startup costs to secure just one property. Your potential revenue ranges from $1,000 to $5,000+ per month per property, but it’s not consistent, and you probably won’t break even for the first few months.

In contrast, local lead generation focuses on digital real estate, requiring less upfront investment (as little as $500), while offering more stability and potentially higher returns. The idea is to rank lead gen websites at the top of Google, capturing 53% of organic search traffic, which converts better than paid ads.

You then profit from this inflow of leads by renting out your website to local businesses in exchange for the leads you generate for them, and depending on your niche, you can charge $1,000 to $5,000+ per month per website. It’s almost the same as rental arbitrage but with less overhead costs, and it’s more consistent. Plus, unlike rental arbitrage, you have more control because you own your online assets. If your local business partner decides that they don’t want to rent your website anymore, you simply find a different client.

Local lead generation is also more scalable, as you don’t have to worry about adapting to different local short term rental regulations – you simply repeat the same process for each website. Once you get the ball rolling, your income here can become completely passive. To find out more about this strategy, learn how to own your slice of digital real estate through local lead gen coaching .