Every vacationer to the Outer Banks, has considered, if only for a moment – what it would be like to have their very own home in paradise. A place for a family retreat or perhaps to eventually retire to. Some go as far as considering relocating here. Yes, it is that special of a place.
Many investors feel you can’t make a vacation rental home investment property pay for itself. The idea being you can rent out your second home for a few weeks a year and help defray your expenses. But, the bigger question is, can you have your vacation rental home earn a profit like a traditional investment property would? No longer should buyers count on just appreciation for a profitable investment.
Buyers should purchase a rental home with positive cash value. Purchasing any home can be a complicated process. When one adds in the added considerations of renting the property, it can be overwhelming. How do you make that happen and how do you recognize a good deal?
Monthly Mortgage Payment –
Generally, the rule of thumb is – if your monthly mortgage payment on your vacation rental property is equal to or less than what your one week peak season rental rate is, and if you rent for 4 months out of the year, then you should be able to achieve positive cash flow.
The attached chart provides an example of a positive cash flow property at the Villas at Corolla Bay and compares the purchase as a second home investment and as a vacation rental property. The Villas at Corolla Bay seasonal weekly rental rate exceeds ($2111) the monthly mortgage, interest and taxes ($1727.63) and outperforms the general rule of thumb for vacation rental property. The example, even includes the cost of professional management fees and your returns will be higher if you self-manage the property. In addition, the community is new; to provide you years of enjoyment with lower maintenance and repair costs.
Break Even at 120 Days
At minimum, to break even on the vacation rental property, you need to keep it rented for about 120 days (during peak season rates) out of the year. The Outer Banks typically is almost 100% occupied for June, July and August. In the past decade, the shoulder season beginning in April (around Easter) through October has been very active with holiday and special event weekends getting renters even in the “out of season”.
Gross Rent Multiplier
The gross rent multiplier is simply the monthly rent divided into the cost of the property; without taking into consideration the mortgage, interest, taxes, insurance or any expenses. The result is the number of months it would take for the property to pay for itself. The lower the number, the better the investment. It is good for comparing investments where the costs are likely to be similar and are rented year round.
For vacation homes, the annual rent multiplier is a better tool since the typical vacation home is not rented year round. It can be used as a rule of thumb or first step screening tool. In the example for the Villas at Corolla Bay, the cost of $399,900 divided by annual gross rents of $38,000 is 10.5 years. Ideally, a multiplier less than 11 will provide positive cash flow and a profitable investment.
The items below provide details on what you need to consider to find your ideal vacation rental.
Positive cash flow is the total income minus the total expenses. Calculating the fixed expenses, like mortgage, insurance and taxes is easy because they are fixed and known prior to purchase. What becomes trickier is estimating the unknown expenses and estimating the net income and capitalization rate.
The Outer Banks has a mature vacation rental market and this helps to take most of the guess work out of your decision. If you are putting your vacation rental property into a property management program, the Property Manager can assist you with income and operating costs for like homes under management. The property management fee is typically 10% to 15% of the rentals.
Some owners manage and market the property themselves through services such as VRBO (vacation rental by owner). Renting the property yourself will save over $5,700 in property management fees included in the example below. Increasingly, the market is responding to owners who are managing the reservations for their property by providing “hosting” and maintenance services to the owners and their guests. This provides a local contact for guest questions or for emergencies. Xpert Home Services is a VRBO local hosting company in the Outer Banks providing home improvements, maintenance, repairs, responding to guest inquiries and providing check in services.
What can prove to be more difficult to discern is repair and replacement expenses. If you are purchasing an older house, carefully examine the condition of all major systems (electric, plumbing, septic, HVAC, roof) and structure. If you are not expert in these areas, consider an inspection service or tradesmen in each specialty as a contingency of your offer. A major system repair or replacement can wreak havoc with your cash flow expectations. If you discover a problem while negotiating, you can lower the offer to offset required repairs or replacement. Alternatively, you can make the offer contingent on the repair of the suspect system. The industry “rule of thumb” is to estimate 25% of the gross income will cover your total operating expenses.
One way to lower the risk of high repair and replacement costs is to purchase a new home under warrantee. An added advantage of a new home is also lower operating and energy costs due to energy efficient building practices not available to older homes. Installing “smart home” devices in your new home will allow you to monitor and control energy expenses and wear and tear to reduce your expenses for years to come.
Know the Market
One key to the vacation rental market is pricing the property properly. If your weekly rates are too high, you will remain vacant and if your rates are too low you will be foregoing potential income. Research area homes on the property management sites and VRBO to determine the rates across the season for a property that you are considering. Make sure you take into consideration the not just the size but amenities of each property. A home without community amenities or a pool, hot tub or distance to the beach are not equal in this market.
Consider having your vacation rental property professionally photographed. Rentals are booked based on first impressions when viewed on either the property management companies’ website, VRBO or comparable platform. Guest will see every detail of your property and compare to other properties available. Put your property’s best foot forward with durable but good looking and comfortable furniture and accessories. Of course, if the maintenance on the house seems lacking the decorating will not make up for it. You need to sell the whole package.
One way to get a head start in first impressions is with a new home in a new community. Guest will appreciate both the newness in the community amenities and your home. Just like that “new car” smell; folks will flock to be the first to find a new vacation haven.
The most important variable for rental properties are tenants. Vacation home rentals have lots of tenants; after all the typical rental is for one week. As a result, they tend to suffer more wear and tear than does a year round rental. Knowing this up front, can help you select the furnishings wisely. White furniture may look stunning initially but will not after the first season. Choose accordingly. Select durable furniture, bedding, carpeting and appliances. Minimize the amount of fancy gizmos that tenants may not be familiar with and unable to use.
If you are using a property management company, they will be renting on your behalf. Typically, in the Outer Banks market, the minimum age of tenants is 25. This reduces the likelihood of damage to due “spring break” like parties. A background check is not typically performed but a security deposit or damage waiver insurance is collected to offset risk of damage.
If you are renting the property without a property management company, you will responsible for screening tenants. In addition, you will also have to have plans to handle tenant calls during their stay. Having a local company, like Xpert Home Services, able to assist you with emergency or maintenance calls is necessary.
If you are considering purchasing a property for a year round rental, the selection of tenants is critical and a background check necessary. A tenant whom does not pay on time or has a lot of demands will eat your pocketbook. Should a dispute escalate and go to court for eviction you may find it costly. A good rule of thumb is to plan on a 10% vacancy rate for year round rentals.
Sale or Trade for Eventual Retirement Home
The most successful vacation homes do not always make the best retirement or year round homes. Sometimes, the size is too large or the amenities greater than ones needs. This is where selling your vacation home, specifically as a positive cash flow business, would have great appeal to prospective buyers. A turn-key business scenario with documented past results. Buyers generally will pay a premium for a property with proven rental income and a turn-key results scenario. When you can show a potential buyer your entire past rental records proving your rental history and expense records; including promotion efforts and all channels with guest comments and reviews, you can add value to your vacation home. It is also a very good idea to have a dedicated website for your vacation home (even if it is professionally managed) and transferring the personal website and domain with the property sale. In short, you are selling a business, not just another investment property.
The great thing about rental properties is they produce higher returns than monthly cash flow. Besides cash flow you will have equity pay down, tax benefits and appreciation. If you include the family enjoyment and memories of vacationing in your very own rental home; well, that’s just priceless. Contact Eillu to visit the Villas at Corolla Bay or learn more about the benefits of owning an Outer Banks vacation rental or relocating for your retirement years.