Run the Numbers

 

 

When I’m on the hunt for real estate, I’m looking for visually interesting properties in locations and markets I’m willing to personally spend time in. But the place has to pencil out financially too, since this is a hobby that has to more than pay for itself. If you’re curious to know how I determine whether a property works for me, read on. And please note that, given that I’m figuring out things as I go, consider today’s post more a request for help than a guide for others to follow. 

 

Revenues 

Revenue is a function of the demand in a market and location for a particular type of product. Your guess is as good as mine, but in most cases there are comparables from which you can eyeball an educated guess. In the case of real estate, as with anything else, revenue is a function of two things: price and quantity. In the case of real estate, “price” means the price someone is willing to pay to stay at your place, and “quantity” means the unit of time you are renting it for. Generally speaking, there are four types: 

·       Daily – e.g. a condo hotel

·       Weekly – e.g. a beach rental

·       Monthly – e.g. executive housing

·       Annual – e.g. a long-term renter 

So annual revenue can be determined by figuring out what type you’re talking about, figuring out the going rate for the place, and estimating how many units of time the place is available and how often it will be rented. So, let’s do four examples: 

·         Daily - $150/night x 350 days/year (because I’m going to myself stay there two weeks) x 70% of the time the place will be booked = ~$37K a year. 

·         Weekly - $2,000/week x 12 weeks/year (because it’s summer only and I’m going to use it myself for two weeks) x 80% of the time the place will be booked = ~$19K a year. 

·         Monthly - $3,500/month x 10 months/year (because I’m going to use it two months out of the year) x 50% of the time the place will be booked = ~$17.5K a year. 

·         Annual - $1,500/month x 9 months/year (because I’m going to rent to college students) x 75% of the time the place will be booked = ~$10K a year. 

Before we move onto expenses, it probably makes sense to back out whatever portion of revenue you’re giving up to whoever might be helping you land tenants. In the case of condo hotels, it might be 50% or more of the revenue; weeklies and monthlies might be 12%; and long-term might be 1^st month’s rent. So take those amounts out and you’re left with the revenue you actually see. And now onto expenses. 

 

Expenses 

Typically I look at six categories: 

Interest on loan – Unless you’re paying cash, you’re taking out a loan to purchase the place, and your monthly payment has a principal portion and an interest portion. Think of the principal portion as paying yourself, since you pay a little in cash every month and when you’re done you own an asset that is the sum of all those principal payments; whereas the interest is essentially the cost of the money you’ve borrowed so can be considered an expense. 

HOA – Monthly condo fee can be small if a low-amenity building and quite large if there’s a pool and fitness center on-site. Obviously you times this by 12 to get an annual number. 

Property tax – This is publicly known and can be less than 1% of the property price in low-tax areas and 2% or more in higher-tax areas. 

HOI – Homeowner’s insurance is usually pretty low, especially for small units, but can get quite high in places like Miami where you’ll also need to tack on flood insurance. 

Maintenance – I typically budget 2% of property price for this, which can involve a monthly fee to a local property manager and/or the typical repairs and replacements that come up. 

Utilities – Usually these get passed on to your renter but not always, like in the case of daily or weekly renters. And, since you don’t always have a renter, there are some months you’ll have to eat this without getting reimbursed. 

 

Bottom Line 

Put it all together and the goal is for revenues to exceed expenses, unless you’re ok losing money every year (which you may be, if for example part of the reason you want to buy a place is to enjoy it yourself, in which case part of the return on owning it is the enjoyment of the place (and the money you save not having to pay to rent a place). 

The question, which only you can answer, is how much more do revenues have to exceed expenses for you to feel comfortable pulling the trigger. Because keep in mind that many of the numbers you’ve come up with above are uncertain. What if revenues end up being way lower, either because you have to discount the rent or don’t have renters as often as you’d hoped? What if expenses end up being way higher, because you have unexpected repairs or someone jacks up the price on something? Typically, the riskier something is the more you need to have a higher return to be comfortable bearing that risk. And figuring out what your threshold is is up to you to feel out. But hopefully this framework has been of use to you. Happy hunting!