Vacation rental purchase

[Daniel Patrick]

Hey guys,

I am looking at purchasing a vacation rental in Hawaii (very early). I am out of state and plan on using a management company.

I am only interested in going forward if I am cash positive.

When I start crunching the numbers I am not sure what data is reliable. What is an accurate expectation of occupancy, income, and expenses? Where can I obtain an honest answer to these questions?

Any thoughts or shared experiences would be greatly appreciated.

[David Krulac]

Daniel Patrick

I've owned vacation property, so I'm speaking from the heart and real experience.

1. One of the first obstacles that you need to overcome in the vacation property purchase is that prices are sky high. After all this place where ever it is, the beach, the lake, Hawaii, Caribbean, etc is some beautiful place that many other people view as a very desirable place also. It a place that many people find desirable and want to got to, even if for a short time.

2. Financing is generally more difficult for than for a personal full time residence back home. Condos in general also a more difficult path to financing. FHA has pulled the approval of all condo association and essentially the development must be re-certified before a mortgage approval. Same rules apply to Fannie and Freddie and may make the easiest path to financing being portfolio loans. One of the Fed qualifying rules has to do with the financial reserves of the association and another rule has to do with a limitation on rental units in the complex and number of units owned by a single entity. And often times in vacation locations many if not most of the units are rentals.

3. In general the rate of return on vacation properties is low in comparison to non-vacation properties. Many at BP talk about a minimum monthly return of 2%, whereby the monthly rent is 2% of the purchase price. I'll go 1% and have had even 3%. At vacation properties the return is most often sub 1%. People think favorably about vacation property, who wouldn't want a place in Kona or Hilo, and therefore think that the return is great because the rents are high. They forget the other side of the equation, the expenses. While the rents may be high in vacation places, so are the expenses and therefore the returns are lower than non-vacation properties.

4. Property managers charge more in vacation areas. One manager that I'm familiar with charges 12% for year leases and 10% for weekly leases. I've seen in some ocean front condo projects where the management fee is as high as 25%, think Myrtle Beach, SC.

5. This does not apply to Hawaii, but many vacation areas have short seasons, Hawaii being basic a year round destination. But even the Caribbean has an off season. July through fall is hurricane season in the Caribbean and is the off season. The rental rates are much lower in the off season and the vacancy rates are much higher. One July I was in St. Lucia at a place that had 200 units, of which 180 were vacant, and generating zero income, while still generating expenses. Ski areas are often dead in the summer. In the mid Atlantic areas of NJ, DE, MD, VA, the ocean beach season is Memorial Day to Labor Day, 12 short weeks. As a LL you need to make almost all your income for the year is 12 weeks. Interestingly enough, the 12 week season rentals often produce about the same rent as the 12 month yearly leases at similar buildings. So its your choice of renting for 3 months and have 9 months of vacancy or renting for 12 months and the rents are about the same!

6. On the East Coast and the Caribbean, hurricanes and severe weather are an issue. You may not have damage this year, but if you own the property long enough there is a greater chance of having weather related property damage. Its just a fact of life. And a fact of life that the insurance companies are well aware of with the recent massive claims. And with massive claims comes massive insurance premium increases. At one town near the hurricane paths the insurance is 3 to 4 times what it would be in a non-hurricane prone area. In FL, a friend of a friend saw their yearly insurance bill rise to $12,000+ because of possible weather damage. when your monthly insurance bill is $1,000, its very difficult to have positive cash flow, by contrast I have non-hurricane property where the monthly insurance bill is $20 to $30.

7. Vacation properties are more of a luxury item, as opposed to an essential item like a personal residence. It is a discretionary expenditure for both buyers and renters. If the economy is good, people take more vacations. If the economy is bad people take less vacations, which results in more vacation vacancies, which affects your bottom line as an investment property owner in a vacation area.

8. Its no impossible to have positive cashflow with vacation property. But it is more difficult than non vacation property. But even if it is break even or slightly positive, do you want a property thousands of miles away where you are one vacancy or one weather incident from a very negative situation?