How much to put down for first short term rental property?

Question

First time poster here!  I've been working through all the Bigger Pockets calculators and I need help answering one more question.

I'm looking at scooping up a mid century condo in Palm Springs, which I would then enjoy myself while renting out about half the time on Airbnb (when things safely open back up again, of course).

I've worked the Rental Property Calculator over and over and, of course, Cash on Cash return is higher if I put down LESS cash. (Duh!) But if I have have the cash, should I put more down *to avoid paying more interest over time*?

I hate the idea of paying interest to the bank if I have the cash - but on the other hand, I realize the point of short-term rentals is to let others pay that interest for you - and then use that cash in other investments that yield a higher rate of return than your mortgage interest. Is that right?

Let's use 220k for purchase price, and 40k down on the low-end, 80k down on the high-end as an example.

Thanks in advance for your help!

Erik W. · Answer

@Sean Conroy, hi and welcome to BP!

Careful with AirBnB/STR.  In addition to what previous advisors have offered, keep in mind that we could likely be seeing "Coronavirus Round 2" in the Fall, Winter, and maybe into next year.  It could be 2+ years before that chicken flies the coop.

I'd make sure that whatever strategy you use, there are multiple possibilities to profit regardless.  If it works as a regular, single family rental, very good!  If you could value add and flip it for a profit, excellent! If you can also AirBnB it and make 3-4x the money, even better!

In short, don't rely solely on one model that is, as we have seen, very fragile given the state of where we are today and in the foreseeable future.

As far as how much down payment, I realize the conventional wisdom on BP is leverage as much as possible: however, leverage is a two-edged sword as many investors are finding out today with tenants not paying rent.  If you are going to take the risk of high leverage, be sure to have ample reserves in case you end up going 3-6 months with no rent but still having expenses and mortgages to pay.

Ruth Blue · Answer

@Sean Conroy

I would out down enough to not pay PMI. If you have this fee your just paying the bank more money for the loan.

A lot of investors recommend 10% down or qualify as second home but anything less then 20% and you have PMI. Not worth it in my book.

Good luck!

Love love Palm Springs. My father in law lives there and cousin have a place there. Great place for Short teem rentals!

Sean Conroy · Answer

Thank you @Erik Whiting - this advice is really invaluable to me! Just for final point of clarification, when you say "I would probably be even more conservative," you mean less leveraged and more down, correct?

Erik W. · Answer

@Sean Conroy, if you're going to use it approximately 40% of the year then I would probably be even more conservative, since that is much less time available for the asset to generate cash flow to cover your expenses.  This sounds like a destination/vacation condo, and I assume you will be taking some of the prime rental time to enjoy yourself.  Unless it has a year-round high occupancy rate, typically those types of investments should factor in a much higher than average vacancy rate.

I know some folks who "invest" in condos, time shares, ski lodges or a lake house (or whatever) realizing they aren't going to make money renting it out, but their main goal is to lose less.  So for example if it costs them $3,000 / month to own they only plan on making $1,000 / month average net profit, and they are okay with spending the additional $2,000 per month on average vs. the entire $3,000 to own the asset.  I consider property like this more of a toy to enjoy vs. an investment, but in this case someone is helping you buy your toy.  I've seen people succeed with that strategy.

Sean Conroy · Answer

@Erik Whiting You're spot on with multiple approach strategies. What I should have clarified - we're looking to use this condo for personal use, as well. So even if we just break even each year on STR, that's a big win. (But previous Airbnb numbers from property, although yes, before CV19, project to have us making a few thousand a year.)

This is spot on:

"I realize the conventional wisdom on BP is leverage as much as possible: however, leverage is a two-edged sword as many investors are finding out today with tenants not paying rent.  If you are going to take the risk of high leverage, be sure to have ample reserves in case you end up going 3-6 months with no rent but still having expenses and mortgages to pay."

I definitely, definitely am planning for a year+ of zero rental income and pure personal use, so holding plenty of cash in reserve.

Erik, if I can ask you one more question: knowing this condo is partially for personal use (say 40% of the time), would that change your calculus on down payment percentage? Again, I have the cash either way - for higher mortgage or for down payment.

Thank you!

Sean Conroy · Answer

Thank you both @Jingru Sui and @John D. ! John, I may be in touch about further desert specific questions.

Jingru Sui · Answer

Sean, take advantage of leveraging lenders. You can use the extra cash you have to invest in something else and scale quicker.

Beside the checking with HOA I would also mention that STR has higher expenses. utilities, supplies, cleaning fees etc. make sure you add all the expenses when you do calculate your number. During COVID our STR get hits bad. I would also recommend you to make sure your investment will work for long term scenario.

Good luck

John D. · Answer

Interest rates are low, I would put down the minimum and finance it as a second home.

Doublecheck you are allowed to vacation rent the condo, most you cannot.

How much to put down for first short term rental property?

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