Would You Do This Deal? NC Vacation Rental (Outer Banks)

[Troy Hebert]

Hi all,

I am finally buying my first property. It's a SFH under contract right now for $1.1mm. In the Outer Banks in North Carolina (Corolla specifically).

I've posted here before where I've looked in various regions of the country, namely CT, NY, NJ, FL, AZ, and have had real difficulty finding a good "turn key" rental property that actually produces real cash flow (after actually factoring things like capex, etc.) What I ultimately arrive at is that assuming no property price appreciation, the returns are typically 4-6% IRR unless I go class D or look at other deals that require significant owner involvement. At that point, I've just said why not buy REIT's and get similar returns and have the liquidity. It all seems to be speculation based on the price appreciation, which I haven't been comfortable with.

I do co-invest in a large real estate PE fund that focuses on value-add multi-family and other similar projects, but those are an entirely different ball game. Returns are pretty strong there with that firm, but I also want to own a property myself.

Anyways, a family member of mine invested in a SFH in the outer banks, ocean front. He is getting some crazy rental numbers from May-September, and he has a good amount of real estate rental experience in various parts of the country. He believes the area is one of the few areas on the ocean that you can still buy "cheap" (this is relative, say $1mm on the ocean for a nice 7BR house) and is growing and gaining more awareness. They rent well, and he actually likes to vacation there.

So I've looked at quite a few in person and modeled out probably 25 properties, and most don't work great. But there are actually quite a few. I currently have one under contract that seems pretty solid, but I may be missing something.

It's a 7.5% cap rate, and this is Class A (Class A plus if it existed). So that alone is pretty exciting. $1.1mm purchase price on $140k of 2020 bookings / $75k of annual NOI (including $8k of capex spend/reserves). I have the option to do a 10% down no-PMI loan at 3.51% blended rate. Throws off $1,900/month in FCF after paying down the full mortgage/P&I. It is a 10BR/10.5BA, 3 story house with ocean views, 2 lots off the ocean. Maybe 10 min walk to the beach, pool, elevator, movie theater room, etc. The story on it is that is was (one of the very few) properties that went into foreclosure last year, and the existing owners picked it up at $720k. They put $150k into the property, are collecting the rents for the season, and exiting. Good return for them. I saw it personally and it was clearly the best looking property we looked at. The dynamics, I was told by my agents, are that in the area investors look at the 10% rule, where you want 10% rents/purchase price. That seems to be the sweet spot for the area to get real cash flow after the mortgage. This one is 12.7%.

Property management is 11% and they are a traditional on-site manager with 300 houses on the island and have done very well with this one. A lot of managers here have not evolved and do not use any of the online booking sites. This manager does, and just handles a mix of traditional bookings and VRBO. The manager tells me he doesnt believe there will be a lot of volatility with the rents, he thinks it could do $133k for example one year, but he said at the same time you'll probably do $150k down the road. That is definitely a huge risk, just given this one does so much more in rental revenue than any of the other ones I look at. I fear it gets normalized compared to other properties.

Insurance diligence is ongoing, but the hazard insurance is ~$7k a year and covers loss of rental income. Lots of wind and hurricane risk in the area. In an X flood zone, which is good, but still requires flood insurance. All of that is factored into prior and current expenses.

New metal roof, new water and pool heaters, new furniture and TV's, etc. So I modeled $8k/year in Capex / repairs & maintenance. Management thinks $5k would be OK, but will vary.

Overall, IRR is 23% assuming I sell it at $1.1mm, what I entered at. If I sold for $930k, in 5 years, that is my break even point by which I lose money. But I have to think that a house like that on the water that is doing $140k in rental revenue during a 20% unemployment economy and a pandemic, should hold its value or even sell for more.

This is my first one, so I apologize for the length. Any advice would be greatly appreciated, and I'm happy to return some help as well (I can send folks my model to use if that helps in their analysis, for example. I was a prior investment banker, private equity and corporate credit person so I spent a lot of my junior years in finance modeling).