How does short term/monthly rent affect cap rate/price?

Question

I've been practicing running numbers on various deals in town and I found this 22 unit apartment listed in Tampa, FL. The apartments are located in a central location in Tampa and the owner has converted them to short term, furnished monthly rentals that he labels as "luxury apartments". 1 of the 22 units is used as an office.

Craigslist Ad: http://tampa.craigslist.org/hil/off/5822629291.htm...

"Property and building is used as a Luxury short term corporate apartments/condos that consist of 22 units. 1 unit has been converted in to an onsite managers office and 21 unit 1 br/ 1 bath fully furnished luxury apartments. All homes come complete with elegant and comfortable furnishings, washer and dryer, full size kitchen with kitchenware, linens, wood floors, two flat screen televisions with cable and internet. Existing business has been successfully operated since 2006 boasting great revenue! This property is a must see! Possible owner financing up to 1 million.Apartment/Condos complex is minutes from downtown Tampa, Tampa General Hospital, Tampa International airport, I-275."

Previous Loopnet listing: http://www.loopnet.com/Listing/19737906/3418-W-North-A-St-Tampa-FL/

Here are some numbers:

Asking price: 2.7 million

NOI: 192,500

Cap rate: 7%

Monthly rents are $1600 a month for a 675 sq ft apartments.

Now this doesn't seem like a good deal to me and it's actually off the market but here's my question. He is seems to be getting 2x the normal rent by renting on a monthly rate and making his NOI much higher than you could get from a unit of this size.

Even though the overhead and management costs are higher, would this NOI still be usable /accepted in an appraisal?

Will the lender accept the NOI as the basis of establishing value, even if they come from monthly rentals instead of yearly?

This leads me to my next question - could you increase the NOI and thus the value of an apartment building by furnishing them and converting them to short term luxury rentals? (assuming there was a market for it). And I'm not talking about AIR BNB but more like corporate housing, 1-3 month leases, etc.

Russell Brazil · Answer

Most lenders are going to lend based off of a lease and not off of a short term rental. I've seen thousands of appraisals in my life and I've never seen one take into account short term rental income in the appraisal

Mike Lambert · Answer

Yes short term rental is a business with an investment. Maybe that had an impact on the taxes one has to pay. Most importantly, the rules around short term rentals are changing in many places and, when they do, they become more restrictive. if you buy a real estate investment only because it cash flows with short term rentals, what are you going to do if the law changes later and make it unlawftl? If it's the only way your investment cash flows, maybe you would be overpaying? Shouldn't you work harder to find a better deal? My two cents. Kudos for being creative though.

Joseph Gozlan · Answer

@Chris Smith This is an interesting question.

A few things to consider:

1) Short term rentals are NOT a real estate investment. It's a business purchase with a real estate component.

2) I would recommend that you highly scrutinize the seller's NOI. ask for 24-36 months back of leases, income statements and matching bank deposit to prove the income/expense used to reach the NOI. Many Airbnb owners will tell you it takes a lot of time and effort to keep the units clean, stocked and turned around fast enough to minimize vacancy.

3) Are you looking for a business? If not then who will run the property?

4) Did you add to your ongoing capex budget the costs of replacing the furniture, towels, mattresses, kitchenware, etc.?

5) Did you deduct commission fees (all the major sites take a cut off the top)?

6) Check the zoning. What others may be able to get away with might not hold true for you.

The bank shouldn't be much of a problem if you can prove all of the above. On top of that if you chose to move in you might be able to get a local bank to finance it as an owner occupied business loan (maybe even get an SBA portion of the loan) just like a B&B hotel.

just my .02

Marc C. · Answer

Most apartments are monthly rentals, right?  Some on annual leases, some one month-to-month. So I don't see why a bank would have a problem with that part. Where they will have a problem is the price for the building is higher than the NOI will support. And, what they will NOT finance is furniture and accessories...which is what the Seller is trying to get around by offering financing on the complete package. They also won't finance the building if it is based on inflated rents for monthly rentals to snowbirds from the north. They want to know that, if you default, and strip all the furnishings out, they will be able to hire a local manager to run the building as a traditional long-term unfurnished asset. THINK LIKE A BANK.

I would try to separate the two in the seller's mind: The value of the building, based on the NOI that would be obtained from rents for comparable unfurnished buildings in the market, and the value of the furniture/personal property. Once you know what the personal property is worth (depreciated to today's value), get the seller to finance THAT part, and let the bank do the building like they would any apartment. I bet this seller was hoping to get a premium for the complete package. In other words, "I've spent $x on this, so I want at least $x for the selling price." Except those flat screen TV's he bought 3 years ago, and all of the furniture, are worth fractions of what they were worth new.

Are weekly or monthly rentals of furnished luxury "executive" units, with all bills included, profitable? YES! You can get high rents for corporate housing, and there is demand for it in many markets. But it requires a lot more management and higher expense load. It is basically a BUSINESS, not just a piece of property. Could you find the right manager for that business? Maybe, maybe not. I'd be looking to hire a former hotel manager, not a property manager.

Personally, we are in negotiations for a terrific 23 unit that is in the hottest walkable neighborhood in town. The units are all 1BR renting on annual leases. My thought is to take 1 or 2, rehab them into "luxury" units, furnish them, and then try to rent them through AirB&B as corporate lodging at (very high) weekly rates. If it works for 1 or 2, then we could slowly expand to more units. But again, the management of that might be too intensive...it becomes an active business like a hotel.

Erica Muller · Answer

For the price it's not a very good deal. The NOI isn't high enough to support the price. The issue an appraiser with have with that from a short term rental perspective is how long have they been doing it? Do they have at least two years of STR history to support both busy and slow seasons to prove those numbers are accurate? Also the community doesn't seem to have any amenities which for luxury short term rentals is a must. Those will be hard to do anything else with other than airbnb for people traveling in town on short stays. I would NOT waste the money on making the interiors nicer with better furniture. The only way this is a deal is if they come down dramatically on price. If you want a successful STR community you need to think in terms of amenities. That is what rents to higher ticket STR renters.  Also the furnishings are never factored into the value of the property. Keep that in mind. Everything you put into furniture will just be depreciated and you can most likely write the depreciation off at best but it doesn't add value in the bank's eyes. Short term rentals are incredibly lucrative when done right.

Joseph Gozlan · Answer

@Chris Smith thinking that outside the box is where good deals turn to great.

There is no reason why the short term leases won't be taken as collateral by the banks however as @Marc C. said above, you got to think like a bank. Shorter terms means less stability which in turn means higher risk.

If you chose to peruse this deal I suggest you talk with some local bankers and figure out what they will do for you. One way to mitigate the risk is yo put 3-6 months of PITI in an escrow account. I found its a lot easier for the local banks to accept riskier deals with that in place.

Chris Smith · Answer

@Joseph Gozlan @Russell Brazil

Thanks so much for providing your feedback.

You mentioned that AIR BNB and short term rental type income would not be considered for an appraisal purpose, which makes sense. But what if you are using month-to-month leases with the minimum term being 1 month? So in theory you would have leases to verify income.

But overall, I agree with your viewpoints, this is no longer a passive income and you will need a much more active manager and higher capex and expenses to cover the costs of turnover every 1-3 months.

In this age of compressing cap rates and every increasing asking prices I'm trying to find a way to make deals work. Or even make a new build, small scale multi-family work. There are a few apartments in areas of town I've been looking at that might make sense if they can be rented out shorter term just like @Marc C. is considering doing.

Just trying to think outside the box here guys :)

Marc C. · Answer

By the way: For those of us in film industry towns like Albuquerque, New Orleans, and Atlanta, there is big demand for temporary lodging for film industry crews. Often, the rent is paid by the production company, not the resident.

Chris Smith · Answer

I doubt you will find any similar properties, and even if there were, it's unlikely there would be recent sales data and unlikely that they would be of similar size/value.

It makes me wonder if you could buy a decent apartment deal off of loopnet, convert it to monthly rental and increase the value. In most areas 30 day rentals are legal.

Kieran Jackson · Answer

These are some very good, yet tough questions to answer. I would like to see what an appraiser has to say about the appraisal aspect. Can you find other 1-3 month short term rental property sales in your market? You could look to those for truer comparable properties. Use those to evaluate the strength of this deal.

How does short term/monthly rent affect cap rate/price?

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