First, let’s look at CAN you do this… before we answer SHOULD you do this?
What are the association rules?
Some associations strictly prohibit some or any type of rental, while some associations bend over backwards to help you. It’s not unheard of (especially with resort/second home communities) for the association to have a manned front desk to facilitate short term renters’ needs like checking in and out, housekeeping and security. At the same time, more traditional condo buildings where the units serve as primary residences will have a higher probability of rental restrictions. Just read the docs…it should be clearly stated.
What does the zoning say?
My best advice on this one is to make a polite phone call to your city’s planning office. Tell them where your condo is or will be and what you are considering. Once you have an answer, ask where you can find the code that documents what they’ve told you. Don’t do it in reverse order…here’s why: the published code can be out of date (happened to me), you may live in an overlay district which makes the regulations differ for you despite living in a particular zone, the published zoning maps may be old, etc. Just call, then get it in writing. It’ll save time.
What’s the math?
The math is probably the first or second consideration, along with how this decision affects your quality of life. The equation is simple:
Revenue – Vacancy – Operating Expenses = Net Operating Income (NOI)
NOI – Mortgage Payment – Taxes = Cash Flow
Revenue: find this by searching Zillow, VRBO, Airbnb, CraigsList and classifieds. Find similarly sized/appointed units in your neighborhood. Ideally, you’d want comps from other units in your building. This is a pretty important number, so don’t skimp on the research for this one.
Vacancy Considerations for Short vs. Long Term Rentals
Vacancy: You should get a sense for this during your Revenue research. If you find a ton of listings with lots of openings, you should pencil in higher vacancy. Here’s how you should research vacancy differently for short vs. long term rentals.
|Long Term Rental||Short Term Rental|
|When do leases sign in this community? i.e. in college towns leases sign in August. If you miss, you may miss an entire year of revenue. May be NA.||What is the draw to my unit? i.e. events, landmarks, etc.|
|Are any new apartment projects coming on line?||Would this enterprise be seasonal?|
|What attributes of my unit are better or worse than the closest competing apartment project?||How are the local hotels doing?|
|Are any new hotels being planned in the neighborhood?|
Operating Expenses include, but are not limited to: COA dues, utilities during vacant periods, real estate taxes, management fees, insurance, anticipated repairs and maintenance and possibly housekeeping.
Do the math, and see how it pencils out. Everyone has their own standards for investments. For a low risk piece of real estate, we like to see around a 10% cash on cash return. “In investing, the cash-on-cash returnis the ratio of annual before-tax cash flow to the total amount of cash invested, expressed as a percentage.” (Wikipedia). Therefore, if you had $100k in cash invested, and the cash flow worked out to be $11k annually, you would have $11,000/$100,000 = 11%, which exceeds our return threshold of 10%. We would take that deal.
How will it be managed? If you plan to self-manage, do you have the time? At the very least, you’ll need to do the following:
Draft (find) a lease document
List the unit
Market the unit
Show the unit
Be available for unexpected/emergency repairs
Set maintenance plans for all the major systems
If this list seems achievable, and you have the time, you’re a good candidate for self-managing your unit. But if this seems like a lot, and you don’t have a lot of free time, you may be better suited to paying the fees, and let the pros do this for you. A reasonable management fee to write into your pro forma is 10% of revenue for long term rentals and 35% for short term rentals.
Do you intend to use the unit? If so, obviously a long term rental is not for you. A short term rental may be appropriate though. Carefully consider the potential conflict with your renters. If you are considering renting your beach condo and you have kids, you’ll more than likely want to use it during the summer when the kids are out of school, and that’s exactly when everyone else wants to use your beach condo; this will certainly hurt revenue. At the same time, most condo buyers don’t buy a condo solely for rental income…they buy it because it’s somewhere they want to be. In a situation like that, it’s really not a bad idea to use the condo when you want, and treat the income from your unoccupied nights like found money. The only catch is that some rental management companies will have maximums on the number of nights an owner may use their unit. They need to ensure the resources they invest for marketing and maintaining your unit can be potentially paid back with a little bit of a return. Be sure to explicitly ask if you are limited in using your unit when interviewing potential management companies.
If you are considering renting out your unit, take the following steps:
Make sure leasing your unit is legal and allowed by your COA.
Do the research; do the math. If the returns satisfy your investment criteria, that’s a positive indicator that you should rent.
Decide how you want to manage it. If you use a professional manager, make sure to include their expenses in your pro forma.
Make sure you don’t lose the ability to use your condo as you originally anticipated. If you can live with at least some access limitations, this is also a positive indicator.
The good news is this is not a permanent decision. Most rental management contracts and long term residential leases are year to year. Short term rentals are typically only a few days. There’s nothing wrong with putting your toe in the water to see if this is right for you. Good luck, and let us know if you have any questions by writing in the comments section below.