Author Topic: Expensive Beach Rental Property  (Read 4471 times)

happyfeet

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Expensive Beach Rental Property
« on: November 12, 2014, 03:45:18 PM »
Tried to  find some info on this but no luck with my MMM forum search.  So apologies if this has been covered before. Post me the links if you have them.

DH and I have many interesting conversations regarding this topic.  Family member owns a beach front condo that is high rent.  We often discuss FIRE with said family member and he is anti stock market and pro real estate - beach front property because there is "only so much beach front"

Property cost $750,000 with additional $150,000 reno and furnishings.  Did I mention high end?  It's gorgeous.  We get to stay there once a year with them.

Relative says it costs him $7500 a year beyond what is collected in rents to operate condo. I think he put 30% down and it will be paid off in five years?  Not sure on pay off.

My DH says this is a good investment because the mortgage is mostly being paid for by the rental.  I say it is not a good investment because it is not rent positive.

Who is right?  Me or DH? Or neither or us? I ask this because DH might want to do something similar but on a much smaller scale.
« Last Edit: November 12, 2014, 03:46:54 PM by happyfeet »

MikeBear

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Re: Expensive Beach Rental Property
« Reply #1 on: November 12, 2014, 04:19:47 PM »
If the rents don't cover the costs, it's an alligator, because it's eating them alive. They might not recognize that, but that's what it is. Maybe he makes enough money that he doesn't care, or maybe he'll get lucky in the future and make money on the sale if it comes to that.

However on a rental property, FIRST RULE is: Make your money right off the bat on/at the purchase. All the rest is gravy. If you don't buy right, you really limit your options. You never want to be a "don't wanter"

NEVER, ever count on appreciation to pull your ass out of the fire in case you have to sell one day. It's just not a good thing for a rental property to EVER be an alligator...

Poorman

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Re: Expensive Beach Rental Property
« Reply #2 on: November 12, 2014, 05:48:59 PM »
Nobody can really answer this question for you.  It depends on what the actual future rate of appreciation is, which nobody can predict.   You will need a rate of appreciation well in excess of what you are losing in negative cash flow each month to make this worth while, which might be possible to achieve, but it also makes this type of deal much more risky.  If you are going to pursue this, try to get as much historical data about prices and rents in this sub-market as you can, then study and at least make an informed decision.  The residents of this area should not only have high incomes, but also be experiencing superior income growth if rents are to continue rising faster than inflation.  Try to make some conservative projections about the future and see if it makes sense on paper to pay the prices being asked.  Buying in a beach area because there's "only so much beach front" isn't a good enough reason to buy.

clarkfan1979

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Re: Expensive Beach Rental Property
« Reply #3 on: November 12, 2014, 07:18:50 PM »
I agree that positive cash flow is more likely to predict that appreciation. However, when appreciation happens, please do not pretend like it didn't happen. It did happen and please log it as reality. I like a little bit of both, a little positive cash flow and a little bit of appreciation. People who are 100% about cash flow pretend like appreciation does not exist and that is not reality.

TreeTired

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Re: Expensive Beach Rental Property
« Reply #4 on: November 12, 2014, 07:25:57 PM »
You said he paid $750 and put in another $150, so he has $900 in it.  You said he put 30% down,  so does that mean he borrowed $525,000?    If he can pay off that loan in 5 years with a net payment of $7500 per year,  I think he is doing quite well.  The property should generate plenty of cash once the loan is paid off.

marty998

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Re: Expensive Beach Rental Property
« Reply #5 on: November 13, 2014, 04:36:49 AM »
If the rents don't cover the costs, it's an alligator, because it's eating them alive. They might not recognize that, but that's what it is. Maybe he makes enough money that he doesn't care, or maybe he'll get lucky in the future and make money on the sale if it comes to that.

However on a rental property, FIRST RULE is: Make your money right off the bat on/at the purchase. All the rest is gravy. If you don't buy right, you really limit your options. You never want to be a "don't wanter"

NEVER, ever count on appreciation to pull your ass out of the fire in case you have to sell one day. It's just not a good thing for a rental property to EVER be an alligator...

Tell that to Australia!

Funny how we think we are the rational ones when it comes to Property investments :)

arebelspy

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Re: Expensive Beach Rental Property
« Reply #6 on: November 13, 2014, 11:39:56 AM »
If the rents don't cover the costs, it's an alligator, because it's eating them alive. They might not recognize that, but that's what it is. Maybe he makes enough money that he doesn't care, or maybe he'll get lucky in the future and make money on the sale if it comes to that.

However on a rental property, FIRST RULE is: Make your money right off the bat on/at the purchase. All the rest is gravy. If you don't buy right, you really limit your options. You never want to be a "don't wanter"

NEVER, ever count on appreciation to pull your ass out of the fire in case you have to sell one day. It's just not a good thing for a rental property to EVER be an alligator...

Tell that to Australia!

Funny how we think we are the rational ones when it comes to Property investments :)

While I've heard your first sentence a number of times, I haven't heard that second one.  Explain?  How is it more rational to buy a property that is cash flow negative than one that is cash flow positive from day one?  :)
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Poorman

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Re: Expensive Beach Rental Property
« Reply #7 on: November 13, 2014, 03:03:06 PM »
Here is a thread from somebody that bought a negative cash flow property and made $1 million in a few years.  The rational investor looks at both the opportunity to cash flow and the opportunity for growth, not just one or the other.

http://forum.mrmoneymustache.com/real-estate-and-landlording/keep-or-sell-rental-property-in-san-francisco/


StashDaddy

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Re: Expensive Beach Rental Property
« Reply #8 on: November 21, 2014, 07:00:51 AM »
Even if that $750k property appreciates only 1% per year, that is $7,500/yr.  Also, sometimes a rental property can be cash flow negative on the surface, but due to the magic of appreciation, tax deductions and equity buildup, it can be generating a healthy rate of return when you crunch the numbers in more detail.

arebelspy

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Re: Expensive Beach Rental Property
« Reply #9 on: November 21, 2014, 08:05:40 AM »
Even if that $750k property appreciates only 1% per year, that is $7,500/yr. 

And if that money was put into something that had a positive real return, instead of negative, you could have way more!

If you put that 750k into something earning 7%, you could have over 50k/yr and easily rent the house whenever you wanted plus have extra in your pocket.

Opportunity cost is the key thing to compare, not just an absolute dollar amount that you may be getting in return without looking at what else you could do with the money.
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StashDaddy

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Re: Expensive Beach Rental Property
« Reply #10 on: November 21, 2014, 08:10:31 AM »
I think you miss my point.  That beachfront rental property could very well be earning him 7% returns, even tho he is cash-flow negative at a surface glance.

Since he has a loan, he did not have to put up the full $750k for his property investment.  So no, its not as simple as multiplying $750k by 7% when comparing actual potential yield.
« Last Edit: November 21, 2014, 08:12:21 AM by StashDaddy »

Villanelle

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Re: Expensive Beach Rental Property
« Reply #11 on: November 21, 2014, 08:32:33 AM »
How much of that $7500 (or more) is he paying down in equity. 

If I got a 30 year loan and decided to pay it off in 12 months, for that year, I'd be cash flow negative, if you just looked at dollars in and dollars out.  But give that a ton of my money would be going toward equity, that's a very different picture than someone with the same cash flow as thy pay a 30 year loan over 30 years. 

I think your "not sure of the pay off" is more than a minor detail and would make all the difference in my answer.  If he'll have a fully paid off property making huge returns in 5 years when he's done aggressively paying off the property, that seems like a good set up.   I'd want to take out his principal payments out of his expenses, and then look at the numbers.  The interest he's paying is an expense, the principal isn't or at least not in the same way. 

arebelspy

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Expensive Beach Rental Property
« Reply #12 on: November 21, 2014, 08:42:24 AM »
I think you miss my point.  That beachfront rental property could very well be earning him 7% returns, even tho he is cash-flow negative at a surface glance.

Since he has a loan, he did not have to put up the full $750k for his property investment.  So no, its not as simple as multiplying $750k by 7% when comparing actual potential yield.

I think you miss my point. It's not as simple as looking at a straight dollar return from your rental, even taking into account all tax benefits, leverage, etc.

It's a matter of comparing what else you could have done with the money. And typically that opportunity cost of buying a cash flow negative vacation home is not at all close to being worth it when you run that calculation, taking everything into account.
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totoro

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Re: Expensive Beach Rental Property
« Reply #13 on: November 21, 2014, 08:52:34 AM »
Unless you are in an appreciating market cycle.  I have observed three RE cycles and participated in two.  The up cycle in all of them has resulted in very high appreciation rates for well-located waterfront. 

I own and operate a cash-flow positive vacation rental.  The market has been flat.  When it rises again I may sell.

As far as cash flow goes on this type of property, a lot of them are negative.  Mine has a suite which has made the difference.  In addition, we use it regularly and I can claim accommodation rates when there for work.  Airbnb has extended the shoulder rental season significantly.

I don't believe I could have obtained the same after tax returns on my investment in the stock market.

As for the question posed by the OP, it likely depends on appreciation.  As is, it doesn't seem like a fantastic investment, although we'd need to know the down payment, how much equity is being paid down each year, and what the actual net loss is if it constitutes a deduction from income.

Where I live condos aren't usually a good bet due to higher management costs resulting from strata fees, plus usually a lot of restrictions in the strata rules.

clarkfan1979

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Re: Expensive Beach Rental Property
« Reply #14 on: November 24, 2014, 05:08:08 AM »
Here is a thread from somebody that bought a negative cash flow property and made $1 million in a few years.  The rational investor looks at both the opportunity to cash flow and the opportunity for growth, not just one or the other.

http://forum.mrmoneymustache.com/real-estate-and-landlording/keep-or-sell-rental-property-in-san-francisco/

I second this logic.

The true answer to this will emerge when he sells. As of right now, I would argue that we don't really know. However, on average this doesn't appear to be a good rental because it is negative cash flow.

With that said, I think you need to look at the big picture. I would not ignore an investment just because it is currently negative cash flow. This example is a little different but Michael Jordan got a killer deal when he bought a majority share in the Bobcats because it was currently losing $20 million a year. Many investors would not touch it. This gave him the opportunity to score a really good deal. As far as I know, the team now makes money and is worth way more than he paid for it. His net worth went from around 500 million to 1 billion in about 6 years, mostly due to the Bobcats.

Most people do not make money on the vacation home thing. I would consider it, if I lived in the same area because I could manage it myself. However, then it wouldn't technically be a vacation home because I would live in the same area.