There
are two obvious profit centers available to short-term rental
vacation homeowners. First, there is money to be made on the actual
rental of the property to vacationers. Secondly, there is the
eventual realized appreciation profit if the property is sold.
Naturally, the return on investment is affected by financial factors
such as deposit, interest rate, closing costs, etc. We will discuss
those in the finance
section. There is also a third return on investment, which is
huge, that I will spotlight at the end of this chapter.
Let's
now examine the rental profits. If vacationers pay the same rates
to rent your home that they pay for a suite in an upscale hotel
(roughly $90.00 to $250.00 per night, depending upon season),
the total would be at least $630.00 per week. This amounts to
more than $2,500.00 per month. Consider that Walt Disney World
draws tourists every week, 52 weeks a year. Of these, 25 weeks
are particularly active and command the highest rent. This is
a profitable business, right? So, what percentage return on your
money invested will you derive from the rental income? OK…stop
here and sit down. The answer is "zero"!
I
am glad you are reading this chapter before you buy a house. Return
on investment is calculated after expenses. It is certainly possible
that you could profit from the rental if you plan on doing part,
or all, of the rental advertising and booking. However, most vacation
homeowners prefer to have a management
company take care of that. The management
company is going to get a percentage of the rental income
for its services. If you can just cover the expenses, mortgage,
taxes,
and insurance
with your portion of the income, that is great. That is real.
That should be your goal. Don't worry. You should reap a return
to brag about in years to come if you ever sell the property.
For now, be content to allow the hard working management
company to profit from the rentals. There is security in knowing
that if they are profitable, the management
company will be around to take good care of the goose laying
the golden egg…your vacation
home .
If
you are not going to profit from the rental of the home, then
is there any return on your investment at all? You'd better believe
it! My next statement may sound like a contradiction to the last
paragraph, but bear with me. The vacationers that will rent your
home will be putting money in your pockets. The better description
is that the vacationers will keep you from taking money out of
your pockets, but it means the same thing. A penny saved…is
not having to pay for the mortgage,
the taxes,
the insurance,
the association dues, the utilities, the housekeeping, the lawn
care, and the general maintenance. In fact, that should account
for saving millions of pennies per year. This means that you are
no longer investing in the property. If it all works out as planned,
your only investment will have been your initial deposit and closing
costs.
Before
we calculate the projected return on investing $50,000 in a vacation
home , let us first look at that same amount of money in
a different investment. Let's say that most individuals would
be satisfied with a 10% return on their money. $50,000 producing
10% per annum will earn the investor $5,000.
|
investment
|
$50,000
|
|
10%
return
|
x
.10
|
|
|
$
5,000
|
If
that same $50,000 were used to purchase
an income producing vacation
home , where would the money be used and how much of a return
would there be? For this example, let us say the original purchase
price of the home is $200,000 (See fig.1). I'll keep it simple,
primarily because it is. The initial 20% deposit will be $40,000.
Closing costs, a one-time expense, usually vary between 0 and
5%, depending on your mortgage
and whether you purchase
from an individual or a developer (a developer may offer to pay
all, or part, of your closing costs). For this example, factor
in 5% for closing costs ($10,000). You now have invested a total
of $50,000. Say the home appreciates 8% in value over the first
year. How do we calculate the return if you were to sell it for
that increased price? Would it be $50,000 multiplied by the annual
appreciation rate (8%) ? No. To accurately calculate the return,
first determine the current market value of the home. Multiply
$200,000 times the annual appreciation rate ($200,000 x 8% = $16,000).
Add $16,000 to the original $200,000 sales price and you have
a new market value of $216,000. Now divide the $16,000 of appreciation
by the money invested ($50,000) to get 32% (see fig.2). So, if
you sold the home for $216,000, you would realize a 32% gross
profit. Naturally this example is very simplistic and does not
take into consideration several factors that may reduce the sales
profit. For this example, we are imagining the unlikely occurrence
of a quick resale. Real
estate is considered a better long-term investment.
When we subtract the additional expenses of having to negotiate
a reduced sales price and the costs associated with selling the
home (closing costs, real
estate commission, and capital gains tax)
the return will be less, but still attractive over a number of
years in comparison to other investments.
Think about it. Your vacation
home only needs to appreciate 2.5% per annum for you to realize
a 10% return on your money invested, provided that your monthly
expenses are all covered by the rentals. This is the big advantage
of investing in real
estate. You invested $50,000, but your appreciation is calculated
on $200,000. Now do you understand why investors are satisfied
just to break even on the monthly expenses?
figure 1
| Home
purchase
price |
$200,000
|
| 20%
Deposit |
-
40,000
|
| Amount
to be financed |
160,000
|
| |
|
Closing
cost
($200,000 x 5%) |
$10,000 |
Total
investment
(Closing cost + Deposit) |
$50,000 |
figure
2
| Home
purchase price |
$200,000
|
| Rate
of appreciation (8%) |
x
.08
|
| Amount
of appreciation |
$16,000
|
| |
|
Return
on investment
( $16,000 ÷ $50,000) |
32%
|
Finally,
what is this significant, third return on your money invested
that I promised to tell you about? It is the memories that you
will deposit as you enjoy your vacation
home with your friends and family, year after year. It is
home away from home. It is that place in Orlando, where fun, sun,
and relaxation are the daily priorities. It should be the real
reason that you buy your vacation
home , because it is certainly the most important.
Example appreciation rate (8%).
Example based on 8% real estate appreciation with expenses,
mortgage payments, taxes,
and insurance
being paid by the rental income. Naturally, as the appreciation
figure varies, so does the return. If the expenses,
mortgage payments, taxes,
and insurance are not covered by the income, then the total investment
number increases by the amount not covered.
