The Money Mustache Community
Learning, Sharing, and Teaching => Real Estate and Landlording => Topic started by: DMAC on March 29, 2017, 03:06:41 PM
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Hi, I'm considering purchasing a vacation rental property and looking for some advice on the matter. I have 2 long term rental properties that do OK, but I'm not really interested in purchasing another long term rental. If this vacation rental doesn't make sense I'll just stick the 35k I was planning on putting down (proceeds from a vacant lot I just sold) into an index fund.
The property I'm considering is near a popular national park that has a busy season of 6 months, the remaining 6 months aren't nearly as busy but the property has good access to snowmobiling, skiing, and other winter recreation so it won't be completely vacant. The property is part of a group of properties that are managed by an agency that handles reservations, snow removal (in the winter), and cleaning for 20% of the gross rents. I'd reserve 10% of rents for maintenance.
The list price for the cabin is $175k and after my down payment of 35k an estimated mortgage would be about 800 per month, or 9600 for the entire year. The nightly rent would be between 200-250 per night depending on the season. Based on the availability of comparable properties I'd conservatively estimate 80 nights of occupation with average price per night at 225. That would give me annual gross rents of 18k, less the 800 mortgage payment and property management and maintenance of 30% that would give me a net of 3k. Based on my 35k investment that would put me at roughly 9% annual return.
With a return of 9% I'm not sure if it is worth the trouble, but my numbers are very conservative and I'd expect to have closer to 100 nights occupied which would make the return roughly 18% making it worth the extra time and effort compared to putting the extra money into an index fund. My analysis does not include tax benefits through depreciation that would further increase my return. I live about 4 hours from the property and would use it personally 4-5 times per year. Assuming all your other financial ducks are in a row (maxed out 401k, no consumer debt, etc.) would you consider a property like this?
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How much of the managing would you do yourself? Time is a huge factor in here.
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How much of the managing would you do yourself? Time is a huge factor in here.
Ideally I would not do any managing on a day to day basis. The only time I should be involved would be if a costly maintenance item needed my approval. But in reality I'm sure I'd spend a few hours a month involved somewhere in the process.
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Could you consider this a "retirement" home at a later time? I went down this road three years ago. I wanted to do it, but I bought a regular rental instead. I figure I can take the rent income and vacation anywhere I want. Check your insurance, loan rates, local zoning rules, and triple your repairs fund figures. People on vacation like to drink and have no attachment. Think about it like the difference between a lease car vs a rental car. Can this money return more elsewhere? Mine did.
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I live about 4 hours from the property and would use it personally 4-5 times per year.
How many days would you personally be using it, considering that both the arrival day and the departure day count as days used? At 5 times per year, and a minimum 3 days of use (Friday night, Saturday & Sunday), you have gone beyond the 14 days allowed for personal use of a vacation rental. Here's an IRS link about vacation rentals: https://www.irs.gov/taxtopics/tc415.html
Going over the 14 days means more recordkeeping and less deductibility of expenses. At 80 days of vacation rental and 20 days of personal use (assuming at least one of your uses is a 1 week stay), a max of 80% of your costs could be allocated to the rental business, and the other 20% would be personal, and potentially not deductible, among other things.
If you are willing to keep your personal use to 14 days or less per year, buying a vacation rental is not much worse from a recordkeeping perspective than a long-term rental. But using it 15 days or more adds complexity. Just something to think about.
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I live about 4 hours from the property and would use it personally 4-5 times per year.
How many days would you personally be using it, considering that both the arrival day and the departure day count as days used? At 5 times per year, and a minimum 3 days of use (Friday night, Saturday & Sunday), you have gone beyond the 14 days allowed for personal use of a vacation rental. Here's an IRS link about vacation rentals: https://www.irs.gov/taxtopics/tc415.html
Going over the 14 days means more recordkeeping and less deductibility of expenses. At 80 days of vacation rental and 20 days of personal use (assuming at least one of your uses is a 1 week stay), a max of 80% of your costs could be allocated to the rental business, and the other 20% would be personal, and potentially not deductible, among other things.
If you are willing to keep your personal use to 14 days or less per year, buying a vacation rental is not much worse from a recordkeeping perspective than a long-term rental. But using it 15 days or more adds complexity. Just something to think about.
We would definitely keep it under 14 days of personal use to avoid any issues with the IRS.
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Could you consider this a "retirement" home at a later time? I went down this road three years ago. I wanted to do it, but I bought a regular rental instead. I figure I can take the rent income and vacation anywhere I want. Check your insurance, loan rates, local zoning rules, and triple your repairs fund figures. People on vacation like to drink and have no attachment. Think about it like the difference between a lease car vs a rental car. Can this money return more elsewhere? Mine did.
This is not something I'd consider a retirement home just due to the fact that I don't think my wife will want to live permanently in a place that has snow on the ground 5 months out of the year. My loan rate would be 4.6% for a 30 yr investment property with insurance of less than 100 per month which I included in my estimated monthly loan payment. The property is zoned to allow transient rentals, I'd just need to fill out a single form to get a residential lodging permit. Do you really think I'd need to withhold 30% of gross rents for maintenance and repair? That might kill my margins to the point of no return.
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The most expensive part on monthly rentals is turn over. People expect to see a vacation level property. I am selling a rental 1 hr from my home. It is too far away to manage. Only you care about your property. A maintenance company is out for profit, you can get good companies, but never lose sight of who is out for who. Will you need 30% residual for success? Probably not. Are people held liable and accountable for their actions? Nope. A judgement requires court, 4 hours from your home. Collecting on that judgement is basically a joke. When it's good it's great. When it's bad... it is four hours away, needing repairs and money all while burning up a monthly payment. I viewed it as a break even way to end up with a great house later in life. The house I wanted was on an island... $60 ferry to get there. Ultimately I just decided there were other ways to make better money with less risk.
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The most expensive part on monthly rentals is turn over. People expect to see a vacation level property. I am selling a rental 1 hr from my home. It is too far away to manage. Only you care about your property. A maintenance company is out for profit, you can get good companies, but never lose sight of who is out for who. Will you need 30% residual for success? Probably not. Are people held liable and accountable for their actions? Nope. A judgement requires court, 4 hours from your home. Collecting on that judgement is basically a joke. When it's good it's great. When it's bad... it is four hours away, needing repairs and money all while burning up a monthly payment. I viewed it as a break even way to end up with a great house later in life. The house I wanted was on an island... $60 ferry to get there. Ultimately I just decided there were other ways to make better money with less risk.
Definitely things to think about, thanks for your input!
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I hope I don't sound like a total Debbie downer... I thought I wanted the island house. The taxes, and expense was really more than I wanted to deal with. People on vacation drink and party. When you rent a hotel, or cottage you have a grand vision of how great it will be. This requires a pristine appearance to get your top rent. Assuming that it would be furnished with beds and all, this can get expensive quick. I also came to realize that owning my own cottage was like a pre determined vacation to "get the return" on my investment. Then I realized that I would feel obligated to fix it all the time. Vacation would now be work. I bought another regular rental house. Got it for the right numbers and it is making some great returns for the investment. If it is something you want then go for it. I don't think you'd "lose" money, but I dont think it will make big returns. Remember that you will pay all utilities on it as well. Vacationers don't care about the bills. Like I pointed out earlier, you treat a rental car different than a lease. Always be conservative on your numbers and then you can be even more pleased when it out performs your expectations.
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I did a lot of research into vacation homes this winter. Questions I would still have from your numbers:
-Can you find better vacancy and pricing data than just a rough estimate? Given that there is a management company for the complex, they should be able to provide you with the pricing structure that would apply to that unit and potentially the historical occupancy data. I was able to find very detailed occupancy data for the small town I planned on investing in from the county tourism board- monthly actual occupancy data for trailing five years. When I took the time to make a spreadsheet of the monthly expected income (the nightly price information from the management company x the actual occupancy data from the city), the numbers ended up being quite different from an average season price x average season length. It also gave a much more realistic idea of cash flow.
-Don't forget taxes. A property with an average rental stay of less than 7 days has a different tax rate than one with an average stay greater than 7 less than 30. I didn't understand why there were some rentals that were only available for rent by the month during the down season until I saw they were trying to avoid the high taxes.
-Watch out for utility costs, particularly if it's an area known for hot summers or cold winters. Presume that a/c & heating will be 3-4x higher than a long term rental. And don't forgot to include cable, internet and water.
-I would consider raising the maintenance reserves. You are going to have a property full of furniture/linens/etc that will wear out faster than they would in a home.