Underwriting STR - Looks promising but deeper evaluation shows poor return

[Dan H.]

This cabin is in the sierras near Giant Sequoia National Monument.

I identified a nice cabin in a nice area that I was going to offer $500k to STR it. Bonus I found a co-host with a presence in the area that would co-host it for 15%. He believes it can achieve $100k after stabilization. He has an STR that is smaller and not as nice that has T12 revenue over $90k. It is a very nice 4/3, 3100' with class A finishes.

It seems like it could be a sound investment so deserves more extensive underwriting. So I ran various scenarios with different finance options. They all show negative COC going out at least 5 years and I suspect for the life of the loan. I have purchased a negative COC property before but it had a value add and I made ~$1m in 3 years and had stabilized positive COC (so only first year forecast COC was negative). This cabin does not have a value add. I will likely be challenged to get a 1 to 1 return on adding the AC, adding an EV charger, converting a sound studio to an office, and furnishings. I refer to expenditures that return less than they cost as value subtract.

How bad is the COC? The first year my underwriting projects negative $33k in the best of my 3 finance scenarios. This is because I allocated $80k revenue (because not yet stabilized) and subtracted $10k for 2 months in off season to get STR ready (so only $70k revenue the 1st year). After the first year, I show negative $8k/year best case and negative $12k with worse scenario. You would think with a fixed rate loan the COC would improve over time but the other expenses are so large that the COC stays about the same year 2 to year 5. The primary issue is the expenses are high. It has high utilities. It has high insurance. Because it is large cabin with nice finishes, the maintenance/cap ex is high. Snow removal and fire prep add to the cost.

So my underwriting shows all return is via appreciation and equity pay down. Even including modest appreciation and equity pay down, the ROI is between 7% and 12% for a non passive holding (not good for an active holding)

I can easily afford this level of negative, but do I want to? Note this area is an area to get away. That is not my usual style of vacation. I want to do things, see things, etc. I can rest when I die.

So the return appears to rely on appreciation and equity pay down, but the sale price on this cabin is below building costs. Unlike my usual market, this area seems to have appreciation not far superior to CPI.

Complicating things is I like the property and have an itch to purchase. I have not purchased since Dec 2021 and have not gone this long without buying a property since we purchased our initial investment property.

Tell me why I should buy or not buy this property. I am leaning toward placing a competitive offer.

Thanks