Author Topic: Talk Me Out of This Investment  (Read 1393 times)

Telecaster

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Talk Me Out of This Investment
« on: October 05, 2019, 05:12:49 PM »
So, for various reasons I've been looking at vacation rentals in Maui.    My experience with any business is there are always more cost than you think, and you don't gross as much as you think.   So I'm using solidly conservative estimates.  I've crunched a ton of numbers and looked at a bunch of real data, and for the most part the picking are pretty slim.   Property after property has been going into the "not worth it" pile. 

But there have been a few home runs.  We're talking double digit cap rates, and double digit return on the down payment.   Again, using conservative estimates.   However, as you might expect, there is a catch.  And the catch is a doozey.   These are leasehold properties, with leases expiring in the next few decades.  That means you own the building but not the ground.  When the lease expires one of three things can happen:  1) You lose control of the building, 2) you may be able to renegotiate the lease, at a presumably higher rate, or 3) you may be able to buy the fee.   But you don't necessarily get to pick which one of those things happens.  So you must assume the value of the property goes to zero by the end of the lease term (at least that's what I'm assuming).  And there is another catch.  Banks don't want to finance a leasehold property unless the loan term extends several years beyond the lease term.  So if the lease expires in 30 years, you can't get a 30 year mortgage.  And so as times goes on, the harder and harder it becomes to exist the leasehold. 

The pros on BiggerPockets recommend not messing with leaseholds.  But leaseholds sell a whopping discount compared to comparable fee simple properties.  So why not?  You could recoup your down in say, 5-10 years, and then enjoy straight profits for another 15-30.  So why not? 

Jon Bon

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Re: Talk Me Out of This Investment
« Reply #1 on: October 06, 2019, 11:11:25 AM »
Ok Ill bite.


First off I know nothing about investing in Hawaii, all I know is that there are some really specific local weird rules. This leasehold seams be one of them. Know nothing of the numbers because you did not post my gut tells me this is going to be a bad investment for you. At best you would break even and be forced to take all your vacations to Maui only.

This is what I have named an "Ego Investment" people make these so called investments just so that they can say that they have it. They like casually dropping the topic in conversation (and who would not want to do that!) but as a result there are more buyers for this class of asset and they will accept a much lower return (if any) just to own a piece of salt life or whatever catch phrase you want to use.

If you want to own a vacation home because you think it would be fun and cool, yeah go do it! But if you are buying a property like this to grow your stache I am not sure it would be a winner.

Oh and the pros on bigger pockets, yeah not so much. Find yourself a bad-ass realtor or RE lawyer on the island. Find the guy who owns 30 properties and offer to buy him a fantastic dinner and pick his brain.

Good luck and let us know what you decide.








BECABECA

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Re: Talk Me Out of This Investment
« Reply #2 on: October 06, 2019, 12:14:31 PM »
...
Banks don't want to finance a leasehold property unless the loan term extends several years beyond the lease term.  So if the lease expires in 30 years, you can't get a 30 year mortgage.
...

This would be the concern for me: if a bank doesnít want anything to do with it, I donít either. You shouldnít think about this like real estate, since the land isnít included in this deal. Iíd think of it like buying a double wide with a couple of years lease in a trailer park. Youíre only purchasing the depreciating asset part of the real estate. And it needs maintenance upkeep that often takes a few years of rent to recoup, but might run into the end of your lease before you can recoup. When big investors buy whole trailer parks, they often gift the actual trailers to the existing residents because the investors realize that the cost and hassle of maintaining the actual trailer ďassetsĒ isnít worth it.

Telecaster

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Re: Talk Me Out of This Investment
« Reply #3 on: October 06, 2019, 01:17:33 PM »
Here's a back of the envelope.  I don't know how to post a table, so I'll summarize.  I can break things down further if you like

Price $719K
Down $210K (30%)
Yearly nut $70,884*
Gross estimate $140,000**
Net after Management  $20,000**
Simple ROI 9.7%

*Nut includes mortgage, insurance, taxes, HOA fees (which include utilities), and the lease fee.
**Based on 70% occupancy, based on spring, early summer rates.
*** includes 25% management fee and assumed 10% maintenance costs on the gross

A couple words on the assumptions.  This unit is in a vacation rental program, so you can look at the rates and availability on the calendar.  I'm going by spring-early summer rates, essentially assuming peak season does't exist, when rates and occupancy are much higher.    Nearby units have occupancy rates of 80% and above.  Unit is sold turnkey (common in Hawaii).   If I make even slightly rosier assumptions, like say 75% occupancy, it becomes much more attractive. 

The catch is that with each passing year, it becomes more and more difficult to sell, with the lease expiring in 27 years.  So the down payment is likely making a one way trip.

My motivation is that I'm selling a property locally (for a number of reasons), and would like to buy something else.  But I can't find anything locally that makes sense to buy, so I'm looking out of state.   

@BECABECA I think your comment is spot on.  This really isn't a real estate deal.  It is more like buying a business.   One that has a guaranteed closing date. 

BECABECA

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Re: Talk Me Out of This Investment
« Reply #4 on: October 06, 2019, 02:01:08 PM »
...
So the down payment is likely making a one way trip.
...

So then on the assumption that you'll hold this investment for the full 27 year term, youíre making 20k each year, but the first 10 years go to paying back your down payment. Then the next 17 years you make 20k a year. Assuming all your numbers end up holding true, that nets you 340k after itís all said and done. Or maybe you put that 20k a year into index funds and itíll grow to $729,005.

Contrast that with putting your down payment into index funds. $210k growing for 27 years at the S&P500 historical annual return of 8% would net you $1,467,493.

Is there something Iím missing in my calculations? The easy index route seems way better. Unless you think thereís a high enough probability of being able to extend the land lease or sell for more than you purchased that it can overcome the >$700k opportunity cost. Personally, for that high of an opportunity cost, Iíd want to see that probability well above 90%

After all that, this is just a nitpick, but do you have experience with maintaining a property in a tropical environment? From the bits Iíve seen, they require a lot more maintenance than most US real estate market estimates. Iíd be worried about your 10% assumption.

Telecaster

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Re: Talk Me Out of This Investment
« Reply #5 on: October 06, 2019, 03:17:13 PM »
So then on the assumption that you'll hold this investment for the full 27 year term, youíre making 20k each year, but the first 10 years go to paying back your down payment. Then the next 17 years you make 20k a year. Assuming all your numbers end up holding true, that nets you 340k after itís all said and done. Or maybe you put that 20k a year into index funds and itíll grow to $729,005.

Contrast that with putting your down payment into index funds. $210k growing for 27 years at the S&P500 historical annual return of 8% would net you $1,467,493.

Is there something Iím missing in my calculations? The easy index route seems way better. Unless you think thereís a high enough probability of being able to extend the land lease or sell for more than you purchased that it can overcome the >$700k opportunity cost. Personally, for that high of an opportunity cost, Iíd want to see that probability well above 90%

After all that, this is just a nitpick, but do you have experience with maintaining a property in a tropical environment? From the bits Iíve seen, they require a lot more maintenance than most US real estate market estimates. Iíd be worried about your 10% assumption.

Nitpick away!  The name of this thread is "Talk me out of it"  not "make me feel warm and fuzzy."   I want to hear the problems with the idea. 

Agree with your numbers.  Here's the logic:  My wife and I are getting ready to retire in about 2 years-ish.   Using a 4% SWR, that $210K gives us $8K/year.   Or that same $210k could throw off $20K/year--which is the equivalent of $500K in a traditional portfolio.   Of course it expires in 27 years, but in the meantime we could have presumably consistent-ish income which would reduce the SOS risk in the early years, combined with a somewhat lower WR from our traditional portfolio.   So in a lot of ways it could actually reduce our risk of running out of money late in retirement, even though it vanishes in year 27.   

re:  Maintenance.   In this case, the HOA takes care of everything outside the building, and major damage comes out of the deposit.   I'm budgeting $14K/year for interior maintenance/replacements, which I believe is conservative.  I would be surprised if actual maintenance was that high and it allows some reserves for future upgrades.

My main concern is lack of liquidity.   If I were to pull the pin on something like this there is no putting it back.  What if I need/want the money for something else? 

Loving the feedback.  Again, I want to hear the problems.  Nit picking welcomed. 

waltworks

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Re: Talk Me Out of This Investment
« Reply #6 on: October 06, 2019, 06:02:29 PM »
I'll nitpick - I think you might be looking at an asset which is VERY correlated with the larger economy/stock market. The first thing people cut in a recession is vacations - remember how bad the Vegas hotels did for a few years after the financial crisis?

So your SOR risk might go *up* here if suddenly you're at 30 or 40% occupancy and you have to drop your rates a lot to stay competitive with the other rentals in the area.

-W

BECABECA

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Re: Talk Me Out of This Investment
« Reply #7 on: October 06, 2019, 08:27:57 PM »
Nitpick away!  The name of this thread is "Talk me out of it"  not "make me feel warm and fuzzy."   I want to hear the problems with the idea. 

Agree with your numbers.  Here's the logic:  My wife and I are getting ready to retire in about 2 years-ish.   Using a 4% SWR, that $210K gives us $8K/year.   Or that same $210k could throw off $20K/year--which is the equivalent of $500K in a traditional portfolio.   Of course it expires in 27 years, but in the meantime we could have presumably consistent-ish income which would reduce the SOS risk in the early years, combined with a somewhat lower WR from our traditional portfolio.   So in a lot of ways it could actually reduce our risk of running out of money late in retirement, even though it vanishes in year 27.   

re:  Maintenance.   In this case, the HOA takes care of everything outside the building, and major damage comes out of the deposit.   I'm budgeting $14K/year for interior maintenance/replacements, which I believe is conservative.  I would be surprised if actual maintenance was that high and it allows some reserves for future upgrades.

My main concern is lack of liquidity.   If I were to pull the pin on something like this there is no putting it back.  What if I need/want the money for something else? 

Loving the feedback.  Again, I want to hear the problems.  Nit picking welcomed.

Excellent, Iíll dig in some more. First, comparing this to the safe withdrawal rate of 4% isnít a fair comparison, since 4% never erodes the principal whereas we are expecting your $210k down payment to be unrecoverable after 27 years.

So then letís consider a more comparable comparison: $210,000 put into an annuity calculator where you withdraw $20k per year (taken in equal monthly installments) and assuming an 8% average return would last 22.5 years. But if you put it in indexes now and then didnít draw on it until 2 years from now like youíre planning, then itíd grow for two years and be at $244,944 when you started drawing and that would last 45.5 years according to the annuity calculator. Or if 27 years is the key part of this equation, then $244,944 would allow you to withdraw $22k per year. And if your retirement date delays at all, itíll just improve these numbers.

But this wouldnít help reduce your SORR, although you could still mitigate SORR with a bond tent in your main portfolio. And with what @waltworks  pointed out about vacation rentals being very correlated with the economy, a bond tent would be a more reliable mitigation of SORR.

Telecaster

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Re: Talk Me Out of This Investment
« Reply #8 on: October 08, 2019, 02:19:52 PM »
Agent got back to me with actual numbers for the past year and half:

Basically, the actual net would have been $18,333, which wasn't all that far off from my estimate of $20K, so that gives me some confidence my numbers aren't totally whacky.   And gives a simple rate of return of 8.73% on the down payment. 

I'll have to ponder some more if that number is high enough to make it worthwhile to vaporize my downpayment. 

--------

Whoops!  Scratch that.  The net would actually be $13,698, which is a simple 6.5%.   That's starting to looking marginal. 
« Last Edit: October 08, 2019, 03:24:38 PM by Telecaster »

Kierun

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Re: Talk Me Out of This Investment
« Reply #9 on: October 08, 2019, 04:27:01 PM »
I don't follow Maui county stuffs but vaguely remember talk about property tax rate increases (something like 3%), something you may want to look into if you haven't already.

AMandM

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Re: Talk Me Out of This Investment
« Reply #10 on: October 10, 2019, 08:09:52 AM »
Agent got back to me with actual numbers for the past year and half:

Basically, the actual net would have been $18,333, which wasn't all that far off from my estimate of $20K, so that gives me some confidence my numbers aren't totally whacky.   And gives a simple rate of return of 8.73% on the down payment. 

I'll have to ponder some more if that number is high enough to make it worthwhile to vaporize my downpayment. 

--------

Whoops!  Scratch that.  The net would actually be $13,698, which is a simple 6.5%.   That's starting to looking marginal.

Since you welcome nitpicking.... It seems to me that the agent's numbers show that your supposedly conservative estimates were in fact too optimistic.

Car Jack

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Re: Talk Me Out of This Investment
« Reply #11 on: October 10, 2019, 09:19:11 AM »
https://www.hawaiilife.com/blog/leasehold-hawaii-real-estate-ownership/

Nice, simple explanation of leasehold.  Don't forget that you're paying the land owner rent during the lease period.  At the end of the lease, the property and all improvements go to the land owner, which has been covered pretty well.  Also note that non-Hawaiian native owners pay higher property tax.