Finding Your Balance Between Fun And Profit
Finding a balance between investment agendas and personal preferences when investing in real estate can be difficult. I recommend that you invest as much as possible in places where you want to spend time. Otherwise, ongoing management and administration of the asset can become a chore.
That baseline suggestion aside, I understand that the line between for pure investment and solely for personal use can easily blur, especially when investing in a vacation rental. I’m re-learning this lesson during this trip through Europe.
Six years ago, in Istria, Croatia, Kathie and I bought something we wanted rather than something we were comfortable would work as a rental investment. The truth is, we didn’t do enough research into the local rentals market in this region. We found a country house we liked and pulled the trigger.
This means we have a great place in a great location with a great view, but we’re remote by vacation rental standards for this area, even though we’re less than 30 minutes to the beach, 5 minutes to a town with an annual truffle festival, and 10 minutes to a town with an annual film festival. Because we’re also halfway up the side of a mountain at the end of a dead-end road.
We like the remoteness and will enjoy spending time here with the kids, but the situation will affect returns once we finally get the place ready for rental.
When buying a vacation home you plan also to rent out, you have to balance the yield potential with the pleasure potential. Depending on your personal preferences, this can be easy. For example, a one-bedroom resort rental works well for someone who wants the Caribbean, likes to scuba dive, and needs only one bedroom.
Property type and size are important rental factors. In most markets, a one- or two-bedroom property yields better than a three- or four-bedroom place. The incrementally higher rental rates you should be able to charge for a three-bedroom usually don’t compensate for the higher cost of purchasing the larger apartment.
And while a super-high-end property might suit your personal preferences, a higher-end (read: more expensive) property probably means a lower yield. To keep your occupancy up, you’ll likely have to compete on price with the general (not high-end) market.
The best way to start your search for a vacation rental is to decide what is more important to you–yield or personal preferences. If you decide that personal preferences should take a priority role in making your decision, then you simply tell the real estate agents you’re working with what you want in a property and go from there.
If you decide yield is of primary importance, then you want to start by looking at the market. Understand the answers to the following questions:
- Where do people want to stay? In Paris, the traditionally best arrondissements for rental are the 5th and 6th. These are also the most costly arrondissements. Good for rental but more affordable are the 4th or the 9th, meaning an investment in these areas could generate a better yield.
Take a similar approach when shopping for a rental in any city. Rather than focusing on the heart of the most rentable district, look around the fringes of the main tourist area and work your numbers to determine if the lower acquisition costs could result in a better yield, even with slightly lower expectations for rental price and occupancy.
When shopping for a rental in a beach location, the closer to the beach the better (to state the obvious). However, again, prices will be higher right at the beach so something slightly back with an ocean view might yield a better return.
- What size rentals are in demand? Again, generally speaking, one- and two-bedroom apartments are the rental sweet spot. However, a market can be overrun with rentals of this size, creating opportunities for either smaller (studios, for example) or bigger (three-bedroom) places. This was the case in Paris about seven years ago. Everyone buying for rental was focused on studios and one-bedrooms. The abundance of product in the category pushed yields down for smaller apartments. Meantime, bigger apartments (with three bedrooms) were few, meaning you could charge enough to generate a better yield, even given the higher cost of acquisition.
In Medellin right now, investors are buying two- and three-bedrooms even if that’s more apartment than they need because the prices are so low it’s hard not to be tempted to buy bigger. And, right now, rental yields for these apartments are high. That said, picking up a one-bedroom apartment in this city right now could generate the same or better yield. Again, it’s a matter of balancing investment agenda with personal circumstances and preferences.
- Is there a high season, and what’s the opportunity for occupancy beyond that time? Also, when considering the rental season, remember your plan (if you have any) for personal use. Would you want to be occupying the place yourself during the season when much of your rental return otherwise might be earned?
Punta del Este, Uruguay, is a good case study from this point of view. The high season in this coastal resort town is mid-December through February. Over this 10-week window, you can charge outrageous rental rates. In fact, it’s not uncommon to earn as much as 80% or 90% of the annual rental income during this peak-season period alone. The rest of the year, the going rental rates are a fraction of the short-term rents you can ask for in January and February. That’s ok, as you can earn enough during this period to make the investment worthwhile overall.
Unless that’s the time of year you’d want to use the place yourself. In that case, your intended rental investment could default into a holiday home for the family.
We plan to use the mountain house we bought six years ago in Istria during the shoulder season, meaning we’ll be able to make it available for rental for the high season. We bought big enough to accommodate our family (three bedrooms). Again, this should work in this market, as it’s a popular family holiday destination, and hotel rates in season can be high.
All things considered, the house in Croatia should net at least 5% to 8% annually, which is my general rental investment target. On top of this is the potential for personal use, which is at least half the equation in this case.
Lief Simon
