Not unlike your standard buy and hold properties, investing in vacation rentals can offer savvy entrepreneurs a great opportunity to capitalize on the one thing investors covet the most: passive income. If for nothing else, passive income is something a great deal of investors would love to add to their portfolio. It’s worth noting, however, that truly great passive income is the result of a lot of hard work and research. You must put in a lot of work up front to ensure the cash flow from your vacation rental is accurate and able to be counted on.
If you are considering investing in vacation rentals, you must have an idea of what kind of cash flow you can expect. And, of course, calculating the cash flow of a vacation rental is easier said than done. Fortunately, it’s not impossible, but it will require you to mind a bit of due diligence.
Instead of assuming you already know the cash flow for a vacation rental investment property, take the correct approach and account for everything. Investing in vacation rentals can be complicated, but as long as you familiarize yourself with the following, you should be in a great position to benefit from positive cash flow.
Calculating your cash flow when investing in vacation rentals isn’t as simple as guessing how much you can charge for rent and how much you expect to spend. There are, in fact, numerous things that you must account for, not the least of which include:
As their names suggest, vacation rentals are inherently subject to seasonal fluctuations. Whether it’s summer, winter or any season in between, vacation rentals serve a distinct purpose: to house those traveling to an area at a specific time of year. Vacation rentals on the beach, for example, are more likely to be in demand when the weather permits; peak season typically extends from spring to summer. Mountain cabins, on the other, have become synonymous with colder weather because of their close proximity to things like ski resorts. Case in point: no matter where your vacation rental is, it has most likely become ubiquitous with a busy season. Those vacation rentals with busy seasons inherently have slow ones, too. Therein lies one of the trickiest financial aspects of a vacation rental property that must be accounted for: vacancies.
You are only fooling yourself if you believe your own vacation rental won’t sit vacant for at least part of the year. In fact, it’s more than likely that each offseason will bring with it at least a few months of vacancies. And while it’s not impossible to find tenants for a beach house in the middle of winter or a log cabin in the middle of summer, it’s a practice in ignorance to think your property is immune to such inconsistencies. That said, you must account for vacancies when deciding whether or not investing in vacation rentals is for you.
I maintain that the safest assumptions are those that account for a vacancy rate as high as 25 percent. That should provide enough of a “buffer” when you go to calculate the annual cash flow of a property. And while assuming your property won’t house tenants for three months out of the year may sound like a recipe for disaster, the lack or renters must be built into your cash flow calculations. If for nothing else, falsely assuming you will be collecting rent over the course of your home’s offseason is more dangerous; it sets false expectations that can ruin your bottom line.
Peak Season Rates
It’s important to remember one thing: there are two sides to every coin. For every off season a vacation rental property owner must endure, there is a peak season that’s entirely capable of tipping the scale in their favor. So while it’s true that slow seasons can eat into a landlords bottom line, it’s entirely possible for busy seasons to offset their negative impact. If for nothing else, peak seasons represent the pinnacle of demand for vacation rental property owners. And when demand for a property rises, as we all know, so too does the rental rate. That means vacation rentals can charge a premium for their services at the right time of year — provided they are in an area with high enough demand.
Not surprisingly, vacation rental prices fluctuate over the course of the year. It’s safe to assume fall and spring will coincide with “average” rental rates, as demand is just that: average. It’s not until you get to the busy seasons, however, that those average rates can increase exponentially. In fact, well positioned vacation rentals can charge as much as one month’s mortgage for a one week rental. So while you must account for vacancies over the course of a year, all is not lost; it’s entirely possible for busy seasons to more than pick up the slack. You would be wise to factor in peak season prices when investing in vacation rentals.
Fees & Miscellaneous Expenses
Investing in vacation rentals requires owners to pay attention to a lot more than what they expect to make on a respective deal; it’s equally important to account for the expenses they will incur while owning the property. Owning any home — not just a vacation rental — has become synonymous with an exorbitant amount of fees and expenses. Owning and operation a home can be quite expensive, and investing in vacation rentals is no exception. Fortunately, vacation rentals are typically capable of offsetting said expenses with impressive cash flow. But what are those expenses? What do owners need to account for in order to better determine their own cash flow from a respective property?
While not required, it’s at this point I would recommend enlisting the services of a professional property manager. Their help will certainly come with a price, but I can assure you it’s well worth it. Under the right management, a good vacation rental can become a great one. A good property manager will take care of just about every aspect of running the property from finding tenants to collecting checks. It’s their involvement, in my opinion, that makes the prospect of investing in rental properties so attractive.
It’s also worth noting that a lot of vacation rentals come complete with things like homeowners association (HOA) fees. Fortunately, HOA fees are pretty straight forward, but just be sure to account for them when determine your own property’s cash flow potential.
It should go without saying, but it’s here where you should also account for the mortgage you will take on once you acquire the property — that’s an important one. The mortgage will represent your largest expense, but provided you have minded due diligence, there is no reason your rents shouldn’t offset it, and then some. In fact, most vacation rental property owners expect to set the weekly rental rate 10 to 20 percent higher than their expected monthly mortgage payments.
Few factors, at least that I am aware of, contribute to a property’s cash flow potential more so than nearby comparables. Otherwise known as the competition, comparables are just that: similar homes within a close proximity to your own. These homes can play a pivotal role in the performance of your own. That said, comparables are the safest barometer to gauge how well you should expect your own home to do in a given market.
Whether you want to believe it or not, comparables dictate the rate in which you will be able to rent your property for. It’s reasonable to expect your home to rent for a similar price to that of a nearby comparable. In the event you choose to charge more for a similar home, you run the risk of scaring away tenants. After all, why would they choose your home over the cheaper alternative?
When investing in vacation rentals, you must listen to what the market is saying. you can’t simply charge as much as you want — regardless of how many upgrades you have made. Your potential will essentially be limited to the local comparables, and your cash flow predictions need to reflect that.
Investing in vacation rentals can be a tricky endeavor if you don’t know what to expect. Fortunately, you don’t need to learn through trial and error. In fact, there are very important factors to account for when you want to calculate the cash flow of a respective property — namely, those things I listed above.