by Brian Brady
Commercial Real Estate Finance Expert
Structured Debt and Equity
Licensed Real Estate Broker in AL, CA, and FL
While we earn most of our money from our mortgage brokerage business, I started helping investors buy real estate some 5 years ago. Working in San Diego, I have seen just how profitable vacation ownership has been for long-term investors. If you follow me on any of my social sites, you will see that we just traveled to the Florida Panhandle to look at some of the best areas to own a vacation rental property. Subsequently, we entered into a strategic partnership with Vacasa, the nation’s largest vacation rental property manager.
Here is an incomplete list of reasons why we think vacation rentals make sense for most investors:
1- Landlords get paid up-front. When this COVID panic hit, politicians in every level of government instituted eviction stays, denying landlords the right to remove tenants who couldn’t afford the rent. When you own a vacation rental, the typical stay is 7-30 days and you get paid by the renter before they occupy your property
2- The capitalization rates are better than long-term leases. Properly managed, vacation rentals produce between 1.6 and 2.1 times the annual income which a long term lease would produce. A vacation rental requires much more active marketing and management and, for that, vacation rental property managers take a healthy management fee but, after that is accounted for, the net operating income is still better than a long-term tenant.
3- Vacation rental properties are maintained better than those with long-term leases. This seems counter-intuitive but, because of the active management, the properties are kept cleaner and repairs are addressed immediately. The housekeeping service is usually passed on to the vacation renter and many of the repairs are covered by that renter if they break it. Routine maintenance is addressed immediately because the vacation rental needs to be in top-condition to be rented again– tenants don’t “hide” small problems (which can become big problems)
4- Owners can take a vacation in their property. While using the property can eat into profits, there are seasonal vacancies which can be expected and, if the property is within driving distance, the owner can use the property for leisure (and keep an eye on his/her investment).
5- Vacation rental properties can sell for more money. Verified capitalization rates demonstrate to would be buyers that the property has greater economic value than one used for long-term leases.
6- Most vacation properties can be financed with favorable terms. 5+ unit properties have loan amounts which are capped by the income of the property. Residential properties, which are purchased as investments, will have higher interest rates and higher down payment requirements than vacation homes. This can be tricky because lenders will want to distinguish that you intend to use this as a vacation home. That doesn’t mean that you can’t rent the property out some months but intent matters. Lenders will typically ask a buyer to sign a form which states that you intend to occupy the vacation property for a minimum period of time during the year. Do not lie– if you do not plan to vacation in the property per the lender’s requirements, it’s an investment property.
7- Vacation rental properties can become retirement homes. Buyers, 5-25 years away from retirement can “lock-in” today’s prices before they have the financial capacity to retire. The income from vacation rentals can service the debt to purchase the dream retirement home.
One of my clients bought a house in Palm Springs, in 2012, when he was 40 years old. His hope was to rent it out and have a property he could pay off (and live in) by the time he was 70. He chose to rent it out for “golf vacations” rather than to a long term tenant. That enhanced his net operating income which allowed him to pay off chunks of principal every year. We just refinanced the property into a 15-year loan and the vacation rental net operating income exceeds the new mortgage payment. Now, he thinks he can retire at age 62 rather than 70.
8- Vacation rental properties can be a solution for potential “boot“. Many times, when a real estate investor is trying to use a 1031 exchange provision, he/she can’t quite line up enough property to purchase with the proceeds from the sale of the appreciate property. That “amount” left over is called “boot” and becomes taxable.
Vacation property investments are plentiful and are available at all price points. An errant $40,000 of “boot” can be quickly applied to the purchase of a $200,000 resort condominium, deferring capital gains taxes and offering the investor and income-producing asset.
These are some reasons why vacation rental properties can be a great investment. Readers should understand that all investments carry market risk and not all real estate investments are suitable for every buyer. You could lose money. Care should be taken to select desirable resort communities, the right property types, and the right financing.
