Chapter 4 – Buying a Vacation Property
In Hawaii, investing in a rental property catering to vacationers can double your income compared to renting to local residents.
Vacationers are in it for the short term. They may be willing to pay a rate for a weekend or one or two weeks that would break someone living there year-round. If your tenants are flying out to Maui, they have money and they’re willing to spend it to enjoy a great vacation. If you can deliver the experience they’re looking for, you can do very well with a vacation rental. Success requires picking a property you can rent out profitably and investing enough to make it an attractive place to stay.
Finding the Right Place
You can scour the entire island for promising, profitable rentals, but it’ll be easier if you can narrow things down. If you plan to use the property yourself, even if it’s just a couple of weeks out of the year, ask what’s important to you in a Hawaiian vacation. Would you prefer somewhere in downtown Lahaina or an isolated villa with no one around? Is it most important to you to have a rental close to a national park, great restaurants, mountains or the beach?
Once you have a rough idea of what you want, the best next step is to fly out to the island yourself. If you’ve no real idea of what sort of rental you want to invest in, visiting and touring around may help you decide. In-person visits are also essential for making a good buy.
It’s possible to learn a lot of information about locations and rental properties online, but a dishonest seller can cover up a lot of problems that way. There are also subtle details you can only pick up if you’re there in person. Is the neighborhood surrounding a particular property attractive or run-down, for instance? If you’re thinking of buying into a condo hotel, how is the resort’s room service? Does the time-share resort bustle with vacationers or is it largely empty? Is it peaceful and quiet or party central?
You can also use your trip to find the support team you’re going to need. A licensed Hawaii real-estate agent with experience in Maui is a must if you’re not familiar with the real-estate market. If you know anyone who’s invested in real estate in the same area, ask them for recommendations. Check that any agent you do business with has a valid license and look for any negative information about them online.
Price and Financing
If you’re going to take out a mortgage, talk to an island lender or mortgage broker about what you can qualify for. Many lenders require a down payment of 20% to 25% on a rental property, so you’ll need to have the money ready before you go shopping.
Don’t just look at the down payment and the overall cost of the property. Look at your monthly PITI—Principal, Interest, Tax and Insurance — and decide if it’ll strain your budget. You don’t want to pay so much that you have trouble handling other debts or long-term financial plans.
If things work out well, your rental income will cover your monthly maintenance or PITI payments and then some. That’s not a guarantee, so be careful. Forbes says that when lenders factor your rental income into their calculations, they assume a 25% vacancy rate. This may give you a more realistic idea of what to expect. While you can deduct expenses — maintenance fees, repairs, mortgage interest — from your rental income, but the purchase price and losses from having your rental stand empty aren’t deductible.
Forbes also recommends that you set the rental rate so a month’s income, if fully booked, is 10% to 20% above your monthly payments. If that makes your rent too high to be competitive, you may need to look for another property.
The VRBO — Vacation Rental by Owner — website can help you appraise properties. If you find a rental you like, look at VRBO’s website for other rentals in the same town or area. Find properties with a comparable number of bedrooms and similar amenities and see what they rent for. This gives you a feel for what you can charge to stay competitive. If the property is already a rental, the owner or the resort can also provide you with figures on rental prices and occupancy rates.
If you’re looking at several properties with different prices and rental rates, the gross rental yield and the capitalization rate make it easier to compare them. The gross rental yield is the estimated annual rent income divided by the property cost; the cost includes purchase price, closing costs and any improvements you pay for. With a 27% rental yield, it’ll take you roughly four years to recoup the property cost, no matter how much the purchase price is. The capitalization rate works the same except you subtract annual expenses from the annual rental income before doing the calculations.
When you figure your monthly expenses, don’t forget landlord insurance. This will cost you more than a regular homeowner policy, but it’s essential to protect you against losses from storms or destructive tenants. It also pays for lost income if you have to close the rental for repairs. You also want a policy with plenty of liability coverage so that whether your guests suffer injuries or cause them, you’re protected. A million dollars in coverage isn’t out of line for landlords.
Types of Ownership
Buying a house or a condo and renting it out is one way to become as a landlord, but there are alternatives. Other options may make it easier, and sometimes cheaper, when you’re dipping your toe into the rental market in Kula or Haiku.
Condo hotels are run like hotels, but you can buy individual suites as if it were a condominium. Suites typically range in size from a studio apartment to two bedrooms. Any time you’re not using the unit yourself, you can put it into the hotel program and rent it out, splitting the revenue with the hotel. Many condo hotels are established chains, however, be aware that a hotel that’s under one name brand this year can switch to another in a couple of years.
As hotels, the resorts offer amenities for your guests—restaurant meals, room service, a tennis court, depending on the hotel—so you don’t have to worry about that. Maintenance fees are relatively high compared to buying into a time-share resort. If you plan to use your unit yourself, be aware that some hotels restrict how much time you can spend in a unit yourself.
Time-shares let you divide up ownership with multiple other investors. One time-share may have, for instance, 52 owners, each with a week of time they can use themselves or rent out. In some time-share plans, you actually co-own the unit, in others the resort is the owner and you only buy the time. Beyond that, there are a bewildering variety of plans available. Some allow you to use different weeks in different years, for instance, while others keep the week constant but move you around different units at the resort. If you own the deed, you pay a share of the mortgage and property taxes. If you only buy time, you pay maintenance fees. Units range from studio apartments to four-bedroom villas.
Fractional ownership sounds a lot like time-sharing, and the two terms are often used interchangeably. Like a time-share, you co-own the rental with several other people. Typically, a fractional property has only six owners or less, each with a right to at least two months’ worth of time there. The properties are usually bigger than time-shares, often large homes. You pay a share of the mortgage and a share of the maintenance costs, based on how much time you control the property for.
These alternatives have advantages. With fractional ownership and time-shares, you only need to fill a couple of weeks or months to make money, instead of trying to draw tenants year round. Time-share resorts and condo hotels already have a management company in place to run the property.
On the downside, co-ownership of a rental that stays busy most of the year means less income for you. You also have less control over the property and amenities than if you own 100% of the rental.
Laws and Rules
Short-term renters aren’t welcome everywhere. They’re in town to have fun, then go home, so they have no idea of local rules—noise ordinances, for instance—and no need to care. Some communities and neighborhoods solve the problems by banning short-term rentals.
You may think that’s unfair, but thinking so won’t help you avoid fines if you rent out a house where the zoning or the homeowners association covenants forbid vacation rentals. Do your research before you buy; your real-estate agent should be able to help.
Even if the neighborhood allows renting, renters still have to comply with the rules. Loud parties that violate local noise ordinances, or garbage sitting on the street three days before pickup will alienate your neighbors and could end up getting you fined. Make sure renters know the rules, either by telling them when they contact you or leaving a flier in the rental.
Vacation Rental by Owner
The Internet makes it relatively easy to advertise a rental to vacationers anywhere in the world. You don’t even have to set up your own website. Advertising through the VRBO website, for instance, lets you promote your rental to more than 12 million monthly visitors. The site lets vacationers search geographically, so they can check any part of Maui for places to stay. You can pay a higher advertising rate to have your property turn up more prominently in search results.
VRBO’s rate system allows you to set regular rates, higher rates for a particular season — winter is the peak tourist season in the islands — or for particular events such as Christmas week or the Fourth of July. You set the rental rates, handle the bookings and communicate with customers.
VRBO makes it easier for vacationers to find you, but it can’t close the deal for you. Use the site to promote your rental with lots of first-rate photos and a video tour. Walk through your rental once it’s ready for market and note down all the features you want to highlight. These may be the new flat-screen TV you installed, the view of the surf from your kitchen window or the native Hawaiian art on the walls. You may want to show yourself or your family enjoying the property, to add a little personal presence. If videography isn’t in your skill set, hire a professional.
Preparing to Rent
If you want to charge your guests the highest possible rate, you have to offer them a prime experience. Amenities and furnishings should be the best you can afford.
If you invest in a time-share or a condo hotel, you may not have a lot of wriggle room in what you can offer the guests. Resorts of this type often standardize individual suites to keep the quality consistent. Before you make an offer, check out the property yourself and see if it’s the level of quality you want to associate with. If a condo hotel has mediocre meals and sub-part room service, you’re probably better off looking elsewhere.
If you’re buying a house or a non-hotel condo, either alone or through fractional ownership, check out the competition. If you’re competing with a half-dozen rentals in the same area that offer flat-screens, cable television and central air-conditioning and you don’t offer any of that, that’s going to hurt. You want to look at least as appealing as the other rentals, and preferably better. The beach may be the main draw, but comfortable beds, attractive furniture, fresh linens and kitchens with modern appliances all count with guests. If the house needs major remodeling or upgrades to stay competitive, factor that in when you’re figuring the gross rental yield.
You can also stand out from the crowd with little things. If you know the area well enough to tip guests off to the best restaurants or fun activities for children, share the information. When you work through VRBO you can find out what the guests want to know, and tailor the rental by providing helpful extras such as a stock of diapers for families that need them.
Being a landlord can take a lot of work. If renters have complaints, they expect to have them resolved, ASAP. If they cause problems for the neighbors, the neighbors want things resolved just as fast. Any damage to the house—a party that gets out of hand, a child writing in lipstick on the wall—has to be fixed up fast so you’re ready for the next renters. A rental that’s closed for cleaning generates zero income for you. Repairs that aren’t made, such as a leaky roof, can lead to more damage and more expensive repairs down the road.
Managing the property can require answering tenant complaints late at night, regular visits to the rental, negotiating with contractors or rushing out at short notice to replace stolen towels. If you live near the rental, you can handle the job yourself—assuming you want to—but it’s next to impossible to pull that off from the mainland. To keep your rental marketable, you need a property management company. The manager serves as your stand-in, dealing with contractors, renters and any unexpected problems.
This takes a lot of the burden of owning a rental off your shoulders, but it won’t come cheap. It wouldn’t be unusual to spend 30 percent of your rental income on manager fees, which cuts into your bottom line. You can’t afford to pick a company that’s not worth the money—your success may depend on it.
Ask your real estate agent or other owners you know for recommendations, then vet any strong candidates thoroughly. Interview the manager in person. Find out what you get for your money. Ask for references and actually call them. Check on the DCCA website and look up the company online to see if there are lawsuits against them, or Better Business Bureau complaints on file.
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