Finally. After nearly a month of negotiations, we’ve reached an agreement on terms to purchase our first vacation rental property. We have four single family homes in our portfolio today, but each of them are within a ten minute drive and rented to long-term tenants. The new place: A condo, located ten HOURS from us in northern Michigan. Airbnb experiment, here we come!
Vacation rental properties carry a bit more risk and reward than long-term rentals. You’re not locking-in rent for up to a year or more, as you would with a lease. Instead, you’re relying on market demand to fill a vacation property week after week, particularly during “high season”. So yeah, I’m a little nervous about this, but the potential for solid returns is, well, solid.
The thrust behind this is our own Airbnb experience as guests. We’ve done Airbnbs only a couple of times, but in each instance we enjoyed our stay and felt welcomed by our hosts. For my money, Airbnb beats the pants off just about any hermetically sealed hotel. What can I say? There’s something primal and altogether more sleep-friendly about windows that open to fresh air.
Why Rentals Are a Good Vehicle for Early Retirement
The Airbnb condo will be the fifth rental in our portfolio and my intent is that it positions us even better for early retirement. Using my handy rental property evaluation spreadsheet, I’m projecting a return on investment of about 20%. That’s a tad on the conservative side, as it assumes very minimal use in the low season (winter.)
The key thing to recognize is that the immediate ROI does not factor-in the tax advantages of rentals. With those advantages, we’ll gain even more return later, at tax time, thanks to depreciation and business expense write-offs. This bumps the overall ROI (or “cash on cash”) to a healthy yield of about 33%.
In a future post with updates on the experiment, I’ll share how the cash-on-cash spreadsheet works. Reach out via email if you’d like a copy of the .xls.
The financial analysis – summarized:
I just locked in the rate yesterday with my mortgage lender. 4.75% is pretty good for a 30-year fixed deal, considering the upward movement of the prime rate over the last couple of years. Keep in mind if you’re new to rental investments, that you’ll be charged an extra 0.5% over what you’d get for a rate on an owner-occupied property. I suppose that’s due to the added risk banks take on with rentals.
I’m fortunate to have my parents living in the same complex. They provided me with estimates based on their utility bills. More importantly, they warned me about the increase in association dues coming later this year (projected above at $1,660.)
This is another variable with condos that you need to consider. If the association is in a bad situation with its finances, you could see dues skyrocket. Fortunately again, this particular association is in good shape financially. The increase here was long overdue.
Vacation Rental Forecast – Crystal Ballin’
The big unknown with any rental is how quickly you can sign up a tenant and start getting cash flow. With an Airbnb, particularly one located in a popular vacation zone, you’re often competing with other Airbnbs, VRBOs, traditional B&Bs and hotels — all in the same general area.
The high-season in northern Michigan is June through September, with a bit of action in May and October. November through April could see some snow-shoeing types or cross-country skiers, but I’m not counting on them as much.
We’ll come back to this forecast in about six months to see how the low season panned out. I’m hoping to get at least a trickle during this first low season, to offset the monthly costs, until high season comes around again in June.
Other People’s Money
Here is the key nugget of wisdom I fully subscribe to: Unless you’re buying auction properties or distressed properties for cash, be sure to use financing to fund rental purchases. I’m reading more and more about folks in some kind of death race to pay off the mortgage on their rentals. DON’T DO IT.
The idea behind “other people’s money” (i.e., the bank’s) is leverage. Your money will work harder for you if you put it into more rentals as down-payments, or at least into stocks. If you want to pay off the mortgage on your primary residence as a cash flow play, that’s fine. But let the bank hold the risk on your rentals.
Prepping for Airbnb Prime Time
There’s a ton of work to do to get this place ready. We got a decent deal on it because it’s quite simply worn. The carpet has to go. The walls need patching and painting. Oh, and it needs to be FURNISHED. Yikes! That’s another big difference from long-term rentals…
Instead of the tenant bringing all their stuff along, with vacation rentals, we’re on the hook for beds, bedding, chairs, couches, TV, kitchen utensils, etc. etc. Luckily, my folks are willing to help us tackle some of the to-do’s on a very long list.
My philosophy with rentals is centered on customer service and having a keen sense what a tenant is looking for: good location and proximity to amenities, and a space that’s welcoming, clean, and timelessly appointed (e.g., wood floors, neutral tones, stainless appliances.) With the Airbnb experiment, I’ve just got to kick it up a notch. Pinterest, here I come!
So far, so good?
The good news is that Airbnb is (so far), an easy outfit to work with. Signing up to be a host was a breeze. It reminded me of Turbo Tax with its friendly step-by-step flow. Having a system to manage the reservation calendar is awesome. I’m excited to see how the market-driven pricing engine works out. Airbnb suggests a low and high figure for nightly rents, and adjusts up or down, based on area demand. Come high season, this will be interesting to watch.
Summing it all up: Remembering why the beef I’m doing this Airbnb experiment
The thing that really excites me about this new endeavor isn’t the money. If anything, we’ll be losing money until next spring, and I’ll be pretty anxious to get early commitments on high season bookings. I’m certainly excited to have a place my family can use when we visit my folks. This part of Michigan is stellar, and for the kids, there’s so much to do and see.
What really excites me in all this? The work. I’m amped-up to get over there after closing, to start tearing out the old carpeting, replacing fixtures, painting, and assembling furniture. Heck, I’m even geeked to decorate! My hope is that the pride I put into making this pad a gem of a home is what will make it a successful Airbnb.
Remember that early retirement is a means to maximizing happiness. This Airbnb could be a big fat epic failure. Regardless, I’m pretty damn jazzed to have yet another project on my growing list of post-cubicle things to do.