Do any agents or builders selling new construction STRs include proformas?

[Mike H.]

As a somewhat new GC here in Sevier county, I am building to hold and building to sell.  The market for sales has slowed down considerably here.  But the margins are still there if you're willing to price these right.  What I'm wondering though is if any agaents/builders in this area or any other areas include actual proformas with their sales materials.

As a long time investor, I look at the numbers on these deals - even at retail prices - and am amazed at how good of an investments these cabins are if someone actually looks at all the numbers.  

We've got a large 3 bedroom cabin with somewhat conservative rental projections for sale that I think if people actually saw all the returns on the investment over time, it would be a no brainer. But I think people tend to look at what a rental property is going to do in year 1 and just pass it by.

i.e. Cabin will appraise at a little over a million (1,050,000) and we could sell it for 950k and still be happy on our end.  Assuming they could finagle a 10% down payment loan and put up 95k, they'd owe 855k and have close to 200k in equity.  At a rate of roughly 7.25, they'd likely only make about 7k a year net after everything (property management, expenses, etc).  So I could see why they doesn't seem as appealing on a 95k investment.   But the reality is they'd also gain 42k in appreciation (assuming 4% which is conservative out there), and another 8k in principal paydown.  And they'd be able to use the additional depreciation to write off regular income and save about 5k on their taxes.

So what is the real return on their 95k investment.  Well one would be the equity capture they'd gain right off the get go by buying below market (100k), plus the 7k net rental income, 42k appreciation, 8k principal paydown and 5k from tax writeoff on regular income = 162k is what they'd technically gain.  But thats only in year 1.

Where things really work out in real estate investing is over time as the mortgage stays the same but the rents increase.
After year 6,  that property would be worth 1.33 million (again, assuming the 4% appreciation) and they'd have a remaining loan balance of 791k which gives them 539k in equity.  Their net rental income for that year 6 (assuming 5% rental increases per year but increases in management fees, utilities, taxes, insurance) would be 24k.  Their principal paydown in year 6 would increase to 11,500 per year, and their appreciation for that year along would be just over 50k. 

So in year 6, that same 95k initial investment they made is going to allow them to gain 24k net rental income (and the depreciation is still enough to cover that so it would be TAX FREE), 51k, in appreciation, 11,500 principal paydown = roughly 86k in total return in year 6.
So a 95k investment after 6 years would give them an asset that they'd have 539k in equity.  And they would have added 86k in total return in that year.

As an investor that built up a nice portfolio after the bust through covid where I got to 83 sfh's, the returns on these str's, are just silly. And whats even more impressive is that the numbers include property management built in so its much more passive then managing yourself. And you have no risk of evictions and, depending on your management company, you get most of your damages covered even.

So I'm wondering if maybe investors just need to see the actual proformas and what these numbers look like with some basic assumptions (i.e. annual rent increases, annual appreciation) to really hit home how good these numbers truly are.   To me the biggest risk to STRs is the municipalities shutting down the ability for owners to rent homes out short term.  And that is one of the reasons I really like sevier county.  The subdivisions are specifically zoned to allow STRs or they aren't.  

[Collin Hays]

Quote from @Mike H.:

As a somewhat new GC here in Sevier county, I am building to hold and building to sell.  The market for sales has slowed down considerably here.  But the margins are still there if you're willing to price these right.  What I'm wondering though is if any agaents/builders in this area or any other areas include actual proformas with their sales materials.

As a long time investor, I look at the numbers on these deals - even at retail prices - and am amazed at how good of an investments these cabins are if someone actually looks at all the numbers.  

We've got a large 3 bedroom cabin with somewhat conservative rental projections for sale that I think if people actually saw all the returns on the investment over time, it would be a no brainer. But I think people tend to look at what a rental property is going to do in year 1 and just pass it by.

i.e. Cabin will appraise at a little over a million (1,050,000) and we could sell it for 950k and still be happy on our end.  Assuming they could finagle a 10% down payment loan and put up 95k, they'd owe 855k and have close to 200k in equity.  At a rate of roughly 7.25, they'd likely only make about 7k a year net after everything (property management, expenses, etc).  So I could see why they doesn't seem as appealing on a 95k investment.   But the reality is they'd also gain 42k in appreciation (assuming 4% which is conservative out there), and another 8k in principal paydown.  And they'd be able to use the additional depreciation to write off regular income and save about 5k on their taxes.

So what is the real return on their 95k investment.  Well one would be the equity capture they'd gain right off the get go by buying below market (100k), plus the 7k net rental income, 42k appreciation, 8k principal paydown and 5k from tax writeoff on regular income = 162k is what they'd technically gain.  But thats only in year 1.

Where things really work out in real estate investing is over time as the mortgage stays the same but the rents increase.
After year 6,  that property would be worth 1.33 million (again, assuming the 4% appreciation) and they'd have a remaining loan balance of 791k which gives them 539k in equity.  Their net rental income for that year 6 (assuming 5% rental increases per year but increases in management fees, utilities, taxes, insurance) would be 24k.  Their principal paydown in year 6 would increase to 11,500 per year, and their appreciation for that year along would be just over 50k. 

So in year 6, that same 95k initial investment they made is going to allow them to gain 24k net rental income (and the depreciation is still enough to cover that so it would be TAX FREE), 51k, in appreciation, 11,500 principal paydown = roughly 86k in total return in year 6.
So a 95k investment after 6 years would give them an asset that they'd have 539k in equity.  And they would have added 86k in total return in that year.

As an investor that built up a nice portfolio after the bust through covid where I got to 83 sfh's, the returns on these str's, are just silly. And whats even more impressive is that the numbers include property management built in so its much more passive then managing yourself. And you have no risk of evictions and, depending on your management company, you get most of your damages covered even.

So I'm wondering if maybe investors just need to see the actual proformas and what these numbers look like with some basic assumptions (i.e. annual rent increases, annual appreciation) to really hit home how good these numbers truly are.   To me the biggest risk to STRs is the municipalities shutting down the ability for owners to rent homes out short term.  And that is one of the reasons I really like sevier county.  The subdivisions are specifically zoned to allow STRs or they aren't.  

A proforma right now is a total crapshoot. Rental revenues are down 15 percent from last year, and last year was down 12 percent from 2022. Who knows where 2024 goes.  

Same for "appreciation".  I lived through 50 percent depreciation cycles in that market. In 2010, there were "new" cabins - with indoor pools - that sold for $899K a year or two earlier going for less than $250K by the bank. 

There are many investors in the Smokies that would like to sell right now, but they cannot because they will have to bring money to closing.

I wouldn't be doing new construction in Sevier County under any scenario right now.  

[Michael Baum]

Yeah @Mike H., I agree with @Collin Hays. There are too many assumptions IMHO.

[Sarah Kensinger]

We offer rental projections on STR revenue for some realtors, but nothing as detailed as you outlined. Most realtors are not educated on how to really underwrite a STR, so they don't always give proformas of any kind.

[Mike H.]

Quote from @Collin Hays:

Quote from @Mike H.:

As a somewhat new GC here in Sevier county, I am building to hold and building to sell.  The market for sales has slowed down considerably here.  But the margins are still there if you're willing to price these right.  What I'm wondering though is if any agaents/builders in this area or any other areas include actual proformas with their sales materials.

As a long time investor, I look at the numbers on these deals - even at retail prices - and am amazed at how good of an investments these cabins are if someone actually looks at all the numbers.  

We've got a large 3 bedroom cabin with somewhat conservative rental projections for sale that I think if people actually saw all the returns on the investment over time, it would be a no brainer. But I think people tend to look at what a rental property is going to do in year 1 and just pass it by.

i.e. Cabin will appraise at a little over a million (1,050,000) and we could sell it for 950k and still be happy on our end.  Assuming they could finagle a 10% down payment loan and put up 95k, they'd owe 855k and have close to 200k in equity.  At a rate of roughly 7.25, they'd likely only make about 7k a year net after everything (property management, expenses, etc).  So I could see why they doesn't seem as appealing on a 95k investment.   But the reality is they'd also gain 42k in appreciation (assuming 4% which is conservative out there), and another 8k in principal paydown.  And they'd be able to use the additional depreciation to write off regular income and save about 5k on their taxes.

So what is the real return on their 95k investment.  Well one would be the equity capture they'd gain right off the get go by buying below market (100k), plus the 7k net rental income, 42k appreciation, 8k principal paydown and 5k from tax writeoff on regular income = 162k is what they'd technically gain.  But thats only in year 1.

Where things really work out in real estate investing is over time as the mortgage stays the same but the rents increase.
After year 6,  that property would be worth 1.33 million (again, assuming the 4% appreciation) and they'd have a remaining loan balance of 791k which gives them 539k in equity.  Their net rental income for that year 6 (assuming 5% rental increases per year but increases in management fees, utilities, taxes, insurance) would be 24k.  Their principal paydown in year 6 would increase to 11,500 per year, and their appreciation for that year along would be just over 50k. 

So in year 6, that same 95k initial investment they made is going to allow them to gain 24k net rental income (and the depreciation is still enough to cover that so it would be TAX FREE), 51k, in appreciation, 11,500 principal paydown = roughly 86k in total return in year 6.
So a 95k investment after 6 years would give them an asset that they'd have 539k in equity.  And they would have added 86k in total return in that year.

As an investor that built up a nice portfolio after the bust through covid where I got to 83 sfh's, the returns on these str's, are just silly. And whats even more impressive is that the numbers include property management built in so its much more passive then managing yourself. And you have no risk of evictions and, depending on your management company, you get most of your damages covered even.

So I'm wondering if maybe investors just need to see the actual proformas and what these numbers look like with some basic assumptions (i.e. annual rent increases, annual appreciation) to really hit home how good these numbers truly are.   To me the biggest risk to STRs is the municipalities shutting down the ability for owners to rent homes out short term.  And that is one of the reasons I really like sevier county.  The subdivisions are specifically zoned to allow STRs or they aren't.  

A proforma right now is a total crapshoot. Rental revenues are down 15 percent from last year, and last year was down 12 percent from 2022. Who knows where 2024 goes.  

Same for "appreciation".  I lived through 50 percent depreciation cycles in that market. In 2010, there were "new" cabins - with indoor pools - that sold for $899K a year or two earlier going for less than $250K by the bank. 

There are many investors in the Smokies that would like to sell right now, but they cannot because they will have to bring money to closing.

I wouldn't be doing new construction in Sevier County under any scenario right now.  

People told me the exact same thing when I was buying sf houses right after the bust.  They said I was absolutely nuts for buying real estate in 2009, 10, 11, 12, when I was adding rentals.  Then in about 2012 or 2013 or so when the bust was still going on, warrentbuffet was asked what he would invest his own money in if he could choose anything at all - and he said sfh's.  And the skies opened. 

And yes, I know what you're talking about numbers but you're not putting them in context.  The fire created a huge issue there. As for 2010, yet another cliff event with residential crash.  Same with covid and rental income.  Three years ago, occupancies were hitting 95%.  Thats just unrealistic to think that would continue.  And then you had a massive boom in building so even when covid was over, you had too much inventory and less people with all that money. Occupancy and rents had to come back down from them.  This idea that something is wrong because rents are dropping is just misplaced.  The reality is that rents were artificially too high because covid and people should have expected to come back down to pre-covid occupancy rates.  

As it is, I'm seeing one bedroom rentals hitting 55k to 60k gross in decent areas which is about 20% above what they were getting precovid. The 3 and 4 bedrooms seem to be coming in around 90k to 110k which is right at precovid levels so to me they've actually dropped a bit given they haven't gained for inflation. 

But I think thats a good thing.  There was simply too much building going on out there.  Now there's way too little and thats a good thing too.  If it keeps up, that should help soak up the excess that was built and bring everything back in order.  That will help keep occupancy at a more consistent level in that 70 to 75% level to make the returns much more predictable.

As a builder, I'll be looking to build only the smaller cabins (1 or 2 bedrooms at 1,000 to 1,400 sq ft) because they seem to still be selling. And then I'm keeping the smaller ones and doing some bigger ones (3bedroom 2,000 to 2,400 sq ft) that will remain as holds.

Keep in mind that as a builder my cost basis is better than people paying retail.  So I can cash flow with less rent.   But again. I still look at the numbers and I'm seeing solid returns even for people paying retail.

But I'm still looking at the returns people are getting that are paying today's retail prices and I just don't see how you can not want to buy these properties.  Not only are you getting excellent returns, but you're getting it with property management built in.  And much less risk in terms of collections because you don't have to worry about evictions or damages (assuming your property management has the right coverage).

And yes, you can easily point to the bust in 08 causing prices to drop or the covid rents coming back down as big changes.  But you can do that for stocks too.  Go look at historical numbers for any 10 year period and see what that looks like in terms of appreciation and rent increases and I'd be extremely happy with those numbers even if I was paying retail.  Far better than anything you could have done in a stock fund or just about any other real estate investment.

As someone who once had 83 sfh rentals in middle class american towns here in illinois, these str's here are without a doubt far better investments. The only reason i've cashed out of roughly half of my rentals since covid was to put my capital here instead.  Its a no brainer. 

Its really a shame that there isn't some way for investors to see the full return on their investment though. Had i not understood all the ways real estate makes you money, I would have never gotten to 83 rentals and over 10 million in net worth in a 15 year period. I'd still be working for "the man" in IT driving 60 miles each way to work and spending 3 hours in one meeting on one silly, meaningless report.    

 

[Mike H.]

Quote from @Michael Baum:

Yeah @Mike H., I agree with @Collin Hays. There are too many assumptions IMHO.

 I don't see that there are that many assumptions really. But I do wonder about the legal consequences of it. Once you put something in writing as a proforma, I could see some buyer complaining years later if one of the years the numbers don't hit. Yet if the numbers were to far exceed the proforma, you can bet they wouldn't be willing to give you any of that money back. :-)

I wonder if you could take another actual cabin and do a 5 year example of ownership on the actuals for that cabin and then put that those numbers can't be used as a guarantee for any other cabin's future returns. 

Don't mutual funds do the same thing? Don't they report on their historical returns and then say that past performance doesn't guarantee future yada yada yada? 

Again, I'm just looking at these investors and wonder why they think its better to put their money into cd's making 5% when STRs clearly make a far bigger return - especially when you put them in a 5 or 10 year model.  Its not even close. 

Then again as a builder and someone thats also looking to put together a very large portfolio of holds for myself, the other part of me likes that everybody is so scared off right now because of the rates. The numbers are still amazing - even moreso for me given my cost to build as a gc.  And if the rates ever do come down from 7.25 to say 5, I'm going to get a nice little boost in income when I refi. Plus, the less cabins there are to rent the better the occupancy/rent rates will be too.

I just look at this time the same way I did when I was buying up houses right after the bust and everybody told me I was crazy then.  To me, I don't see any risk in buying right now. You're going to cash flow positive right off the bat (at least a little) even if you're paying retail.  But your overall returns with appreciation and principal paydown make that even stronger of a return.  

[Josh C.]

@Mike H.

I think it’s funny you compare buying rentals in 2010 to today saying it’s apples to apples. It’s the absolute opposite. When a market goes to the floor like in 2010 people were scared it would continue to drop. Now the market went to the moon people are unsure if it’s the top or not. The huge difference was cash flow. Almost everything cash flowed in 2010. It’s tougher now. I personally wouldn’t sign a 850k mortgage after putting 100k down to make 7k if I have no problems. Too much liability for 7k. I would guess when you bought your 83 rentals worth 10 million you were NOT buying them with a 7% cash on cash return. Smaller investors aren’t getting out of bed for that. Possibly some large funds would buy that?

Typically when someone highlights all the other benefits besides cash flow my spidey sense tingles.

Now if you can build them for 650 then you should do that all day.

[Collin Hays]

Quote from @Mike H.:

Quote from @Michael Baum:

Yeah @Mike H., I agree with @Collin Hays. There are too many assumptions IMHO.

 I don't see that there are that many assumptions really. But I do wonder about the legal consequences of it. Once you put something in writing as a proforma, I could see some buyer complaining years later if one of the years the numbers don't hit. Yet if the numbers were to far exceed the proforma, you can bet they wouldn't be willing to give you any of that money back. :-)

I wonder if you could take another actual cabin and do a 5 year example of ownership on the actuals for that cabin and then put that those numbers can't be used as a guarantee for any other cabin's future returns. 

Don't mutual funds do the same thing? Don't they report on their historical returns and then say that past performance doesn't guarantee future yada yada yada? 

Again, I'm just looking at these investors and wonder why they think its better to put their money into cd's making 5% when STRs clearly make a far bigger return - especially when you put them in a 5 or 10 year model.  Its not even close. 

Then again as a builder and someone thats also looking to put together a very large portfolio of holds for myself, the other part of me likes that everybody is so scared off right now because of the rates. The numbers are still amazing - even moreso for me given my cost to build as a gc.  And if the rates ever do come down from 7.25 to say 5, I'm going to get a nice little boost in income when I refi. Plus, the less cabins there are to rent the better the occupancy/rent rates will be too.

I just look at this time the same way I did when I was buying up houses right after the bust and everybody told me I was crazy then.  To me, I don't see any risk in buying right now. You're going to cash flow positive right off the bat (at least a little) even if you're paying retail.  But your overall returns with appreciation and principal paydown make that even stronger of a return.  

 Are you trying to convince us?  Or yourself?  I say get out there and start building some cabins!  

[Michael Baum]

Right, you have a plan and want to go forward so go forward.

It isn't something I would invest in.