Navigating the vacation rental contract process can be tough. Often, emotions run high, negotiations prove challenging, and setbacks occur, but our guide will help you move through the process as smoothly as possible.
However, before you get under contract, a lot of work needs to be done! You’ll need to learn about and analyze various markets and choose the one where you’d like to invest. Then, you have to find an agent and choose a financing strategy before putting in offers on properties you’re interested in. (See our guides on choosing the right market and financing strategy for in-depth information on these topics.)
Once you’ve gotten under contract on a property, purchasing a vacation rental is very similar to purchasing any other residential property, although there are a few key differences. Today we’ll cover the most important aspects of the contract process, starting with the inspection and due diligence period. We’ll also talk about valid and invalid reasons for contract termination, furnished property contracts, whether or not to honor the seller’s future bookings, and how vacation rental appraisals work.
When your vacation rental is ready to welcome guests, don’t forget to list it on RentalTrader! Our goal is to take back the vacation rental industry and make it more cost-effective for everyone, and we’d love to help you maximize your bookings and your revenue.
- 1 The Inspection and Due Diligence Period
- 2 The Option Period
- 3 Valid Vs. Invalid Reasons for Contract Termination
- 4 Furnished Property Contracts
- 5 Should You Honor the Previous Owner’s Future Bookings?
- 6 Do Vacation Rental Property Appraisals Take Earning Potential Into Account?
- 7 Making the Investment Worth It
- 8 Top Takeaways
The Inspection and Due Diligence Period
Most vacation rentals are viewed as residential properties, not commercial ones, so the inspection and due diligence period works the same way as it does for other residential properties. This period is the time after signing the contract when the buyer has a chance to have the property inspected and decide whether they’d like to move forward with the purchase. Appraisals are usually done at this time as well.
Inspections are crucial. The vast majority of properties will have some kind of drawback or problem that needs to be addressed, but that doesn’t necessarily mean it’s a dealbreaker. Instead, these are just things you want to be aware of and get fixed up before you rent out the property on sites like RentalTrader and Airbnb.
If something major is found during inspections that makes you reconsider purchasing the property, that’s generally a valid reason to terminate the contract. In fact, aside from the seller not sticking to all of the contingencies laid out in the contract, a material defect found during inspections is one of the only valid reasons to back out of the agreement.
You’ll need to get all of the typical inspections for the market you’re buying in. Below, we’ve provided a list of several of the most common inspection types to consider.
During a home inspection, a professional home inspector objectively examines the property’s physical systems and structure from the foundation all the way up to the roof. A typical home inspection covers the following:
- Doors and windows
- Heating system
- Air conditioning system
- Plumbing system
- Electrical system
- Walls, floors, and ceilings
- Attic and visible insulation
Home inspections usually take between two and four hours to complete. Afterward, the inspector will provide a detailed inspection report that lists any findings and includes photos, analyses, and recommendations.
Home inspections are not pass/fail; instead, they’re an objective assessment that describes the overall condition of the property. These inspections are also not the same thing as appraisals and won’t give you an idea of the home’s value.
A general home inspection is often considered the bare minimum for inspections that must be completed. It allows you to better understand the property and identifies any necessary repairs and maintenance.
Even though you’re not required to be present for the inspection, it’s a good idea to be there if possible. That way, you can speak with the inspector, ask questions, and gain more insight.
As you’ve likely guessed from its name, a pest inspection looks for bugs and other creatures that can be problematic. They can be potential health hazards, cause damage to the property, or both. Extermination companies do most pest inspections, usually around the same time as a general home inspection. They typically take between 30 minutes and an hour to complete.
These are some of the insects and creatures that a pest inspector will look for (although they can vary depending on the property’s location):
- Carpenter ants
- Termites (both underground and aboveground)
- Bees and other stinging insects
- Wood-destroying insects
Inspectors don’t just look for creepy-crawlies, though. They also check for any structural damage these pests have left behind on siding, baseboards, floorboards, walls, and other areas. After completing the inspection, the inspector will provide a report containing an overview of any pests found, where they were located, any damage they caused, and the treatments necessary to eliminate the bugs and critters and repair the damage.
Radon is a type of radioactive gas. If it’s present in your home and you breathe it in over the long term, it can eventually cause lung cancer. A radon inspection is the only way to determine whether a property has high radon levels.
There are multiple types of radon tests, such as short-term, long-term, and continuous tests. It’s a good idea to do a short-term test as its results will indicate whether or not further testing is necessary.
You may or may not need a septic inspection; only a bit more than 20% of houses located in the US have a septic system, which removes waste from the property. It’s wise to get both a visual septic inspection and a full septic inspection if you do have a septic system. While a visual inspection can identify any obvious issues, a full inspection will reveal any blockages or drainage problems that could cause trouble down the line.
While most homes rely on city or municipal water supplies, some properties have private wells that supply water. If that’s the case for your vacation rental, then you’ll need to keep up with maintenance and testing to ensure the water is safe for consumption.
A thorough well inspection is necessary when purchasing a property with a private well. This inspection checks the water pressure, quality, and refill speed. It also looks for leaks and other issues.
Other Potentially Necessary Inspections
Aside from general home, pest, radon, septic, and well inspections, there are an entire host of other inspections that you may wish to invest in. Some of these are only necessary for properties in specific areas or with certain features. In many cases, your home inspector may recommend more specific inspections and can even put you in contact with companies that will complete them.
- Mold Inspection – Uses a moisture meter and air samples to check for potential mold growth
- Foundation Inspection – Identifies whether the foundation is faulty or the home is sliding
- Chimney Inspection – Ensures smoke discharges properly and cap is in good shape; looks for crumbling internal brickwork; checks for a flue liner
- Wood Damage Inspection – Looks for wood-destroying critters like termites and powder post beetles; checks for dry rot
- Electrical Inspection – Makes sure the electrical box is up to code
- Lead-Based Paint Inspection – Tests for the presence of lead-based paint
- HVAC Inspection – Checks for any issues or malfunctions with the heating, ventilation, and air conditioning systems
- Pool/Spa Inspection – Looks for leaks and provides an estimated life expectancy for the pool and spa
- Roof Inspection – Provides a roof certification and identifies any problems that need to be addressed
- Soil Stability Inspection – Looks at the stability of the soil for properties on hills; checks for soil contamination
- Landscaping Inspection – Ensures all bushes, trees, and other landscaping features on the property are healthy
- Water Systems Inspection – Inspects the construction of the system; reveals the depth of the water table; checks water sanitation
- Asbestos Inspection – Takes samples from the property to a lab to check for asbestos
- Document Inspection – Researches records on square footage, lot size and boundaries, permits and zoning, easements and encroachments, and more
- Disaster Inspection – Shows whether the property has endured a natural disaster such as a flood, tornado, or hurricane; determines how well it will stand up to potential disasters in the future
The Option Period
An option period is a span of time in which you, as the buyer, can terminate the contract for any reason whatsoever, without having to worry about any form of recourse from the seller, including losing your earnest money. This period takes place after the contract has been signed. However, an option period does not exist in most states. In fact, the term is specific to the state of Texas.
A few other states have similar periods, but they come with different names. There’s the Inspection and Due Diligence Period in Georgia, the Contingency Period in Massachusetts, and the Inspection Period in Florida. All of these are time frames in which the buyer can terminate the contract without consequences.
Option periods typically last between seven and ten days. However, as long as the buyer and seller agree on it, an option period can last any length of time. During this time, the buyer has the property inspected so they can ensure that there aren’t any major issues before they fully commit to the purchase. They may also take further steps to secure financing and hire a real estate attorney to look over the contract.
Usually, the buyer pays a non-refundable option fee of about $100. They don’t get this fee back if they decide to terminate the contract rather than purchase the property. But if they go through with the purchase, the fee goes toward closing costs.
You shouldn’t assume you can back out of a contract on a property without good reason if you don’t live in a state with an option period. If you do, you’ll likely lose your earnest money. Be sure to talk to your real estate agent about the laws in the area. Most places have an inspection period but no option period, and when this is the case, you can only terminate the contract over material defects found through inspections.
Valid Vs. Invalid Reasons for Contract Termination
You can almost always back out of a contract after signing, but the reason you have for backing out determines the price you’ll pay for choosing not to go through with the purchase.
To have a valid reason to back out of a contract, you’ll generally need to cite defects found during the home inspection. Maybe there are large-scale problems with improper drainage, or perhaps the inspection revealed dangerously faulty wiring that will cost several thousands of dollars to fix.
Unresolved claims, liens, or encumbrances on the property’s title can also be valid reasons for contract termination. If it looks like you’re not going to be able to get a clean title from the seller, then it’s possible that the purchase agreement can’t be executed legally.
There’s usually language in the contract that requires the property to be in the same condition when it’s delivered to you as when you initially signed the purchase agreement. If the vacation rental you intended to purchase sustained significant damage between signing the contract and finalizing the sale, that’s a valid reason to back out. Any other contract contingencies that aren’t met are also considered valid reasons not to go through with the purchase.
Let’s say you jump in and get under contract on a property, but after further evaluation, you’ve changed your mind about it. Perhaps you’ve realized that the furniture that came with the property is extremely worn and needs to be replaced, and you didn’t factor that into your budget. Or maybe you don’t like the floor plan and don’t think it’s conducive to what you wanted to offer your guests.
It could be that you found another property you liked better, and now you don’t think the property you’re under contract for has enough potential to bring in revenue as a vacation rental.
Unfortunately, all of these reasons are considered invalid. In fact, anything that doesn’t have to do with the contract contingencies and legalities or the property’s deficiencies (according to inspections) is not a valid reason to terminate the contract.
Potential Consequences of Contract Termination
Suppose you back out of a contract for a reason other than an issue that was uncovered during the inspection period or a legal or contract issue such as an unsatisfied contingency. In that case, there will likely be consequences.
Going under contract on a property and then terminating the contract is a considerable inconvenience for the seller. It can cause them to miss out on other offers and set them back time-wise. At best, you likely will not get your earnest money back. At worst, the seller may sue you.
Even forfeiting your earnest money can be a notable loss. Since earnest money typically ranges from 1% up to 10% of the purchase price, you could be saying goodbye to tens of thousands of dollars, depending on the property’s price and how much you deposited as earnest money.
Finding and working closely with an experienced real estate agent is a terrific way to avoid mistakes like getting under contract before you’re completely sure about a property. They can also help you identify valid reasons to terminate the contract if you decide you’re no longer interested in going through with the purchase. A good real estate agent will help you make a fully informed decision with all the necessary information.
Furnished Property Contracts
When purchasing a short-term rental in a regional or national vacation market, you’ll likely come across many properties that have already been used as vacation rentals and are being sold fully furnished. This can be extremely convenient since it means you won’t have to spend a lot of time picking out the perfect furniture and decorating the house. However, there can be a lot of confusion surrounding the way that furnished properties are sold.
Sometimes, inexperienced real estate agents and sellers will attempt to assign value to the furniture within the real estate contract. You’ll most often see this in metro markets where there isn’t as much familiarity with the sale of short-term rentals. The seller might state that the property is worth $400,000 unfurnished or $425,000 furnished, for example. The problem with this is that furniture is not real estate; it is personal property. Therefore, it cannot be mentioned in a real estate contract, and lenders won’t assign it any value.
It’s also worth noting that you cannot use furniture as a point of negotiation during the inspection period. Since it isn’t considered real estate, it’s not a valid reason to back out of the contract.
Many sellers will negotiate a higher price for the property and note in a separate document (which doesn’t go to the lender) that the furniture is included with the purchase of the property at no additional cost. The document must specify which furniture, decorations, light fixtures, and other items in the house are included in the sale. This is usually the best way to go about selling a fully finished property.
If you’re buying in a mature vacation market, where vacation rentals have changed hands many times over the decades, then it’s usually expected that furniture comes with the property in as-is condition.
Should You Honor the Previous Owner’s Future Bookings?
When buying a property in a vacation market that is already being run as a short-term rental, you’ll often run into various scenarios that have to do with the seller’s future bookings. Negotiating these types of situations is often one of the biggest challenges of the vacation rental contract process.
Scenario #1: You Want to Take Over Their Listings
If you’re new to vacation rental investing and hosting, taking over the property’s current listing site accounts may seem like a great idea. This may be especially enticing if the previous owner has accrued many five-star reviews and cemented their status as an excellent host. You may think they can just hand over their login information, and you can take over the management of the accounts from there.
However, there isn’t really a way to take over another person’s listings, and even if there was, it’s not as good an idea as it may seem initially.
You can’t take over listings managed by the property’s previous owner because they’re tied to a lot of sensitive information, like the previous owner’s bank account, tax ID number, and Social Security number. Even if you change the personal information associated with the account, it’s just not wise for the previous owner to allow anyone access to this type of information.
Another potential problem many newbie investors don’t realize is that good reviews don’t necessarily indicate that a property has been managed efficiently.
For example, maybe the property’s previous owner has had complaints or made cancellations in the past. Maybe they didn’t respond to messages very quickly. All of this can impact the algorithm on listing sites, meaning that even if the property has excellent reviews, it can end up in a terrible position on search results simply due to poor management. This isn’t something you can see just by looking at the listing.
So even though you might wish you could take on those five-star reviews as your own and continue to build on them, it’s better to start from scratch with your own account. If the listing appears on the seventh page of the search results because of how it was managed in the past, those reviews aren’t going to mean as much.
Scenario #2: The Seller Wants You To Honor Their Future Bookings
Of all the possible scenarios surrounding future bookings, this one isn’t so bad. It’s more of a pain for the guests than for you or the previous owner.
Let’s say the seller has several guest bookings that take place after you will have closed on the property, and they want you to honor them. The best way to go about this is for you to create new listing site accounts for the property before you close on it. Then, the seller can reach out to all of the guests and let them know that the property was sold. They can send the previously booked guests a link to your new listings so that the guests can cancel and rebook their stay. Of course, you’ll need to speak with the seller about all of the booking details, such as the dates and the specific pricing, so that you can maintain them.
But what if the seller refuses to go along with this method? Well, it most likely involves the deposits guests have put down. Using the cancel and rebook method, the deposits are refunded to the guests when they cancel, and they use the refund to pay their deposit on the new listing when they rebook their stay. So if the seller doesn’t want their guests to cancel and rebook, it’s most likely because they’ve spent the deposits and don’t have the necessary funds to provide refunds to the guests.
This situation is challenging to maneuver, but one thing you can do is to ask for the deposit amounts to be held in the escrow account out of the seller’s proceeds. Although writing this into the real estate contract with a lender is a bit tricky when you’re using a vacation home loan, it’s 100% possible. You don’t want to just hope that the seller will hand over a check for the deposit amounts after you’ve closed.
Now, let’s assume that the seller is happy to work with the cancel and rebook method. Before you agree to it, you’ll need to be sure of a couple of things. First, do not allow any previous bookings for 30 days or more. In many areas, guests can retain tenants’ rights after staying for this period of time. If they refuse to leave the property, you’ll have to do a full eviction, which can be frustrating and cause issues with other guests who have booked stays at the property.
You should ensure that the property has been booked at market prices as well; any lower, and you may not make any profit from these previously booked stays.
There’s also the question of whether you’re interested in honoring the seller’s future bookings at all. If there’s a discrepancy between how the seller screened their guests and how you plan to screen them, then that could cause issues. Maybe you plan to be very diligent with screening, but the seller was pretty lax with their requirements. In this case, it’s possible you could end up with problematic guests that aren’t interested in following your house rules.
The main benefit of honoring the seller’s bookings is starting your vacation rental business with a fully booked calendar. But when you really think about it, is this in your best interest?
If you’ve purchased a property in a good market and will be managing it effectively, you won’t need the seller’s bookings. The fact is that asking guests to cancel their stay and rebook it with a new owner is pretty much guaranteed to start things off on the wrong foot. And if you make any changes to the property that don’t match up with the original listing the guest decided to book, they’re not going to be very happy. All of this means you may end up with some not-so-great reviews, and it’s probably better to start out with a clear calendar rather than taking on the seller’s future bookings.
Scenario #3: You Want the Seller to Stop Booking the Property
Between signing the contract and closing on the property, many buyers will ask the seller to stop allowing guests to make bookings. This might seem reasonable, but what if you end up backing out of the contract and the seller misses out on income?
When the property hasn’t yet gone through the inspection and appraisal process, the seller and buyer haven’t come to an agreement on everything, or the buyer hasn’t qualified for a loan, it’s in the seller’s best interest to continue running their vacation rental as usual.
Put yourself in the seller’s shoes, and you’ll likely understand why they’d prefer not to stop booking the property, especially if you end up terminating the contract for one reason or another.
Scenario #4: The Seller Wants to Continue Managing the Property
Another situation that sometimes arises is that the seller wants to maintain the property manager role after closing the sale on the vacation rental. This is never a good idea as you won’t have any control over your return on investment. Plus, do you really want to be locked into a business agreement with the property’s previous owner and have to allow them to run the rental as they please, even though you own the property now?
Scenario #5: The Seller Wants to Transfer Their Bookings and Retain a Procurement Fee
Similar to Scenario #2 above, the seller may want to transfer their bookings to your new listings, but in this case, they want to earn a procurement fee of a certain percentage that basically functions as a finder’s fee. This never ends well for the buyer, and you shouldn’t agree to it.
The problem is that this often sounds pretty reasonable to inexperienced short-term rental investors. Isn’t it fair that if you’re accepting the previous owner’s bookings, they should earn a little bit of money for securing them in the first place?
Unfortunately, this scenario can result in situations where the seller operates outside of escrow, and you (as the buyer) agree to send money to the seller after you’ve closed on the property. Sometimes, this can even result in lawsuits when the buyer or seller doesn’t do what was written in the contract.
When you run into a seller that wants to keep the initial deposits that guests paid on their bookings, this usually means that they’ve already spent them and no longer have those funds available.
If you do want to take on the seller’s future bookings, we recommend using the method described in Scenario #2, where you create new listings, and the seller directs their guests to cancel their original bookings and rebook with you. This is the cleanest way to handle things because it doesn’t involve the exchange of money between buyer and seller outside of escrow. All of the deposits will be returned to the platform they were booked on, and neither person has to trust the other to hold up their end of the bargain.
Scenario #6: The Seller Wants You to Stay with the Current Management Company
Finally, another common scenario in vacation markets is that the seller will request for you to keep the property with its current property management company for a certain period of time after closing.
The reason a seller might ask you to do this is that they have an existing agreement with a traditional property management company. This agreement likely states that the seller will have to pay a huge fee if they don’t keep the property with the management company for a specific period of time.
If you agree to this, then you’ll typically receive the standard owner/company split on profits, and you’ll also need to pay for various fees and maintenance during the specified time period.
In most places, it’s not legal for the seller to require you to stay with their management company, but you can find out for sure by asking a real estate attorney about the local laws and regulations. Still, spending the time and money to hire an attorney regarding this type of situation might not be worth it; you may just need to decide if you’re willing to deal with the management company for a while in order to obtain the property.
If it’s a property that’s in an excellent market and is getting several offers, then refusing to stay with the property management company will probably mean you won’t win the bid. However, you might be able to negotiate with the seller by offering to pay a higher purchase price in return for not having to stay with the management company. This way, you’ll essentially pay off the fee they’ll incur for breaking off their agreement with the company.
Do Vacation Rental Property Appraisals Take Earning Potential Into Account?
When looking to invest in vacation rental properties, beware of sellers and real estate agents that attempt to argue the property they’re selling is worth much more than anything else on the market due to its incredible potential for revenue. While, yes, vacation rentals are cash-flowing businesses, they’re still residential properties rather than commercial ones, and that’s how they are appraised.
Appraisals are objective, unbiased, professional opinions of the property’s value based on current market trends and recent sales of comparable properties. Key factors include the functionality of the property’s floor plan, the number of bedrooms and bathrooms it has, its amenities, and its square footage. Any necessary repairs can negatively influence the appraised value of a property. But the amount of income a property can bring in as a rental has nothing to do with its appraised value. Therefore, it makes no sense for sellers or real estate agents to claim a property is worth more because of its earning potential. Still, the income that can be made on a vacation rental affects the property’s desirability, so investors may be willing to pay more than the asking price in some cases.
Making the Investment Worth It
A few final words of advice regarding the vacation rental contract process: In the end, it’s all about whether or not the investment works financially. It is not about you “winning” and the seller “losing.” It’s not about trying to get more from the seller than they’re getting from you. Don’t stand in your own way and lose out on a fantastic property just because the contract isn’t exactly the way you want it. If the numbers still work, then some small, inconsequential items should not hold you back.
Decisions made due to ego, competitiveness, or principle should be avoided in favor of decisions based on return on investment. During any negotiation process, there is plenty of give and take on both sides that you’ll need to be ready for and willing to participate in. Although it can be an emotional process in many ways, don’t fall prey to an “us versus them” mentality or a power struggle; try to remain logical and rational, and always come back to the numbers.
A few years after closing, you’ll no longer be thinking about how frustrating it was when the seller wouldn’t agree to each and every request you had. You’ll be much more focused on your successful income stream and its positive impact on your life.
Here’s a quick recap of everything you need to remember as you navigate the vacation rental contract process.
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In this video, our correspondent Margeaux has explained the different aspects of the vacation rental contract process with illustrations: