Considering Buying an Investment Property?
by Merri Ann Simonson
Now would be a good time to purchase property held for investment and due to market conditions, a rental home in the San Juans would be the best investment.
Once you have made the decision of the type of investment property to purchase, then how you intend to use that property is the next consideration, vacation rental or long-term rental. To assist you with this process, I have compared the different aspects of each below.
Vacation Rental General Description
The most successful and thereby most desirable properties include waterfront or view homes, homes with docks, hot tubs, pools and those that offer gaming tables such as a ping pong or a pool table. Flat usable land and having good internet connectivity is a must; your tenants must stay connected while on holiday. Allowing at least small dogs will increase your occupancy numbers.
Buying a home with an existing permit, customer list, website and income history is the most efficient avenue. The permit for a vacation rental runs with the land. It is annually renewed automatically but can be voided by the County should the home not be used as a vacation rental within the last 12 months.
The cost to obtain a vacation rental permit includes the county fee and I recommend using a consultant. The fee range is $3300-$3800. Of this amount, the consultant charges around $1000-$1500, subject to complexity.
It is possible to process a vacation rental permit directly with the County but in the long run, it is more beneficial to work with a professional who does them on a regular basis.
The process requires the corners of the lot be well marked, which may require a survey if you are not able to locate them. The application requires a current water test, if on a private well and recent septic inspection. The owner must evidence adequate parking and access roads to allow for fire protection and emergency vehicles. Floor plans are required so a designer may be needed to create those.
The owner or manager must publish rules of conduct for the individual home as well as a telephone list of emergency and contact numbers. The owners must have an on-island person for the tenants to contact at all times. Providing details of operation is advisable, especially for appliances and systems.
Further, many homeowners have developed their own set of rules, such as being respectful of the neighbors, garbage, recycling and water use conservation suggestions. The County does restrict head count based on a maximum of three people per bedroom for occupancy and a total allowed for gatherings. Some homeowners have a pet restriction as well.
Most any property is eligible for a vacation rental permit however there are some exceptions.
If you are in town and on town water, vacation permits are not allowed unless you are commercially zoned.
If you are in the County and hooked up to town water, vacation permits are not allowed.
Many plats contain a provision in their Covenants, Conditions and Restrictions which prohibit vacation rentals.
If you have a home and guest house on one parcel, one of the structures must be owner occupied or be a long-term rental, you may not have individual vacation rentals in both structures.
You do not want to operate a vacation rental without the proper permit. The County has regulations that must be complied with and notable fines and penalties for failure to operate your business properly.
Long Term Rental General Description
A non-transient rental property is described as a rental occupied by a tenant on at least a month-to-month agreement or a term lease. The typical lease is for 12 months and may expire but convert to a month-to-month until terminated. Notice of termination is normally given in the range of 60-90 days prior to lease expiration.
Many of these homes are rented direct by the owners without the use of professional management firms. However, if one decides to go that direction, they must be knowledgeable about the Washington State Tenant Landlord ACT plus the owner must have a separate trust bank account.
Some plats have Covenants, Conditions and Restrictions that restrict against occupancy by a long-term tenant, but very few. The Oaks manufactured home park on San Juan is an example, but they also have an exception for homes on the market.
Income and Expense Review
Most property owners will consider the net income calculation for each type of rental as their decision maker. For the example shown below, I used a three-bedroom, two-bath waterfront home with approximately 2000 sf. The home is across from English Camp and has a tidal dock. The home is valued near $1.5 and has a well and septic. Per the vacation rental calendar on a similar home, the rent range is from $275 to $575 per night subject to the time of year. I used the VRBO calendar schedule of varying nightly rates and 130 days of occupancy which was generally the end of May through September. I have noted over the years that most of the homes produce at least $25,000 gross income per year and some produce as high as $90,000. Of course, the homes at the high-end of the range offer more amenities than the low end and the amount of owner occupancy will have a direct impact.
Expenses Comments
Of course, if the home you intend to purchase has HOA dues, water and sewage usage fees, those fees need to be added into this proforma. Similar, if the home didn’t have propane, it would need to be excluded. Typically, the long-term tenants pay for their utilities, but it all depends on the negotiations at the time of the lease. This chart can’t take everything into consideration and is not intended to be relied upon. In fact, it doesn’t take into account COVID, it assumes a normal occupancy year.
Further, the long-term rental fee for property management that is equal to the first month’s rent is just for the first year. It remains at 10{d4d1dfc03659490934346f23c59135b993ced5bc8cc26281e129c43fe68630c9} per month thereafter, until there is a tenant turnover. Or in the second year, $3600 less.
Maintenance and Repairs
The overall property maintenance will be more for a vacation rental as the property grounds must be mowed and tidied up regularly. Repairs will also be higher for a vacation rental as the tenant is less likely to be familiar with the various systems and operation of the home versus a long-term tenant so damage may occur, requiring regular maintenance. The property management firms arrange for repairs at $75 plus per hour and cleaning at $50, which is close to market rates.
The general types of repairs would be similar, although a long-term tenant may be more accepting of a broken microwave versus a vacation tenant. It is not possible to include the analysis for maintenance and repairs in this article unless I had the data on a home that was a vacation rental for one year then a long-term rental for the next.
Proforma
In the proforma above for this type of home, it is more favorable to rent under a short-term rental situation. As mentioned above this is a waterfront home with English Camp easily accessible and a dock, although tidal; so, the rental is very popular. As this is a very general proforma, a person considering their options needs to process a comparison spread sheet based on the home they own or the home they intend to purchase based on the actual income and expense.
Other differences include the following:
Property Management
Vacation
The management for a vacation rental is very complex. They are running the home similar to a hotel and are on call 24-7. The management fees vary subject to the level of service, but the range is 30-35{d4d1dfc03659490934346f23c59135b993ced5bc8cc26281e129c43fe68630c9}. Roche Harbor charges 49{d4d1dfc03659490934346f23c59135b993ced5bc8cc26281e129c43fe68630c9} however they originate most of the clients directly due to their wedding and events business and they offer more services and amenities.
The management firms operate a website that showcases the property, most feature it on Air B&B and/or Vacation Rental by Owner (VRBO), make reservations, collect rent, deposits, and prepare the home for each tenant. They must make immediate repairs as needed and have repair persons and cleaning people on staff or 1099 contractors at their beckon-call. The firm is not required to have a Washington State Brokers license or Trust account for the deposits.
Long-Term
The long-term rental management can be a phased management. You can hire them to run ads, screen and credit check the tenant, write the lease and collect the first month’s rent, damage deposit and last month’s rent, and then end their services. This first phase of the service charge is typically equal to the first month’s rent. If you want full service, then they would also collect the monthly rent and provide any notices and administer final departure services required with the tenant. They monitor the condition of the property during the tenant’s occupancy. Typical the full-service fee is equal to the first month’s rent plus 10{d4d1dfc03659490934346f23c59135b993ced5bc8cc26281e129c43fe68630c9} monthly thereafter. The firm must hold a broker’s license and have a trust account for funds.
Self-Manage
As a property owner you may self-manage a property and avoid the management fees. However, you must be willing to complete the necessary functions. The lure of a lucrative investment is strong but the romance of it ends quickly once you must go out and unplug a toilet in the middle of your own dinner party. I have interviewed many property owners who started off as self-managed and soon changed their approach to hiring the professionals that have regular connections with service providers and the knowledge of the industry. VRBO and Air B&B are common websites that owners join to self-manage.
Whether you self-manage or hire management, a business license is required for the vacation rental operation, which requires payment of B&O taxes, if due. Proof of filing of B&O tax is what the County may require as evidence of an active rental which is required for the vacation permit renewal.
Options for property management firms are very low on San Juan Island. We have more options for vacation rental management firms as the regulations are less; no brokerage license required, or state regulated trust accounts. It is easier to manage vacation rentals from a regulatory standpoint but more difficult in reality. There are only a few long-term management firms on San Juan. Generally, property management is a difficult field to work in; very demanding and very competitive.
One large benefit to using the professional firms is they most likely have Errors and Omissions insurance which may cover the liability should an event occur.
We often suggest that our clients looking for long term rentals view the online newspapers or use Facebook; San Juan Buy and Sell and San Juan Island Rental/House Share. Posting on those sites may be advantageous to a property owner.
As it is more difficult to find a long-term property management firm on this island than a vacation rental manager, this may be the decision factor for some of the property owners.
General Information
The tax assessor no longer adds value to the home if it has a vacation rental permit. The value to buyers can be recognized or discounted. The vacation rental or long-term lease will narrow the size of the buyer pool for the property as many buyers hope to occupy their new home immediately after closing. Further most lenders require occupancy by the borrower within 60 days of closing if the loan was intended for a primary residence.
Some lenders will not accept a vacation rental property as collateral and will only grant a commercial loan with less attractive rate and terms than a conventional loan. Generally, not disclosing to your lender that you intend to operate a vacation rental business out of the home is considered fraud. Make sure you discuss this issue with your loan officer.
More buyers in our market are looking to purchase for second home or primary residence versus a rental property. However, many are willing to purchase the right home subject to the rental agreements or reserved vacation rentals, but transactions have been lost due to tenant’s rights.
Cancelling vacation rental reservations is not a simple process and most management firms have a 120-day notice provision if the property is on the market for sale. In order to cancel, the vacation rental client may need to be reimbursed for their air flights and other travel arrangements that they have made. Can you imagine making that phone call to the coordinator of the up-and-coming July family reunion?
Technically, the property management firm has earned their fees for the transaction so those may be due as well. Agents will comment in the remarks section of a listing if the property is subject to any form of lease or vacation rental and whether they have a delayed closing date.
It is very difficult to have a home on the market while being an active vacation rental. An agent must arrange the showings around the vacation rental tenant so the showing activity will be less. For many homes, you can only show during a day with a turnover, after checkout, after cleaning but before the next check in. That time frame doesn’t always work with your buying client’s schedule.
Impacts to the Neighborhoods
Impacts to a neighborhood are very difficult to measure. For a vacation home, a tenant may travel on the roads four times a day for the 130 days the home is occupied. During long-term occupancy, the tenant may travel on the roads two times a day for 300 days a year, taking the weekends off: minor differences.
For those homes on community water systems or sewer, most communities have a provision for excessive use which is billed to the owners, or tenants if long term.
There may be a gathering at the vacation home that results in noise beyond what the neighbors would determine is acceptable. The sheriff is available to respond to this type of disturbance. The neighbors can also contact the property management firm or the on-island person in the case of those noisy events. Based on the number of vacation rentals as compared to all homes, the sheriff is more likely responding to a primary residence disturbance.
Impacts to the Economy
Homes offered into the long-term rental pool provide local housing for islanders. Residents living and working here over the long term tend to have pride in community which results in maintenance of the home and may result in a home purchase in the future.
Vacation homes offer economic gain into the community and to the owner. While visiting, tenants enjoy retail therapy, restaurants, kayaking and whale watching. Some may end up deciding that purchasing a home here is in their future.
B&O tax is generated back from the state into our local government. However, most of the vacation rentals properties pay little or no tax as they generate less than $90,000 in annual gross income so a small business credit applies to reduce the B&O tax liability to $0.
Depending on the home and its amenities, deciding to use your investment as a vacation rental MAY reduce the number of homes in the long-term rental pool and may drive up the rental rates for the remaining long-term properties due to high demand and less inventory. However, having said that, only the higher end homes with many amenities “pencil out” and favor the short-term rental arrangements. The homes that are rented for less than $2500 per month typically “pencil out” to favor the long-term rental arrangements as they have fewer amenities.
The vacation rental isn’t often the type of home that the long-term tenant is typically seeking. As mentioned, the most successful vacation rentals are waterfront or water view homes and perhaps a dock. If these were offered as long-term rentals, the rents would be over $3000 per month which may be out of the range of most of the islanders seeking a long-term rental.
The vacation rental homes are mostly occupied in the summer months, and this coincides with when the second homeowners return and desire to hire staff or service providers to help with their property maintenance. These service providers may be the very ones seeking long-term housing.
Bottom line Points:
Very few homes on this island “pencil out” as an investment when you take debt service into consideration. If you own the home free and clear you may enjoy some cash flow. Our rents are not high enough to balance with the price of the homes. The investor needs to rely upon their Schedule E for tax write offs and appreciation to come out ahead on a rental property here.
The vacation rental investment is replacing the second home purchase. Buyers have figured out that when they are not using the home, it can be rented and most buyers of second homes only use them for a few months out of the year anyway. Great tax benefits as a rental, owner use when desired; best of both worlds.
Having the home be a rental for 130 days in the summer then a long-term rental during the rest of the year is possible; but may be difficult to accomplish. You would have to change management firms as the services needed are different for each type of rental. Timing is everything; you won’t get top dollar for your long-term rental when trying to find an occupant in October versus June.
Long-term rentals are in demand in our community. Not a week goes by that a prospective tenant doesn’t contact our office looking for a rental house.
In last week’s Journal, 7 of the 8 public notices were for vacation rental permits. I assume this is attributed to the future changes in the vacation rental permit regulations. Property owners are trying to beat the clock for the new regulations.
Solutions to Creating more Rental Housing?
If a hard-working resident must work two jobs to afford a rental or camp, we have an issue. Ask any of the general contractors looking for skilled labors, the turnover is too high.
Allowing detached guest homes on parcels that are less than 5 acres may create inventory in the rental pool. The homes would most likely be smaller so they could be lower end rentals (Currently you may have a guest house on less than five acres only if it is attached to the main house)
Zoning and the cost of construction including hookup fees all need to be considered. Most investors have no interest in building an apartment or other multifamily units as they do not ”pencil out” on island, the capitalization rate is below a good investment return. The town fees for water and sewer hookups per unit and the monthly fees are too high for a typical investment proforma, so there is no incentive. At the present time, it is more cost effective to purchase existing than it is to build. It has been many years since an apartment was constructed in town by the private sector and this is a reason why.
As an author, I have tried to remain neutral in this article but as a REALTOR I find it difficult. In a perfect world, an owner of a home producing under $30,000 per year rental income will decide their home doesn’t “pencil out” as a vacation rental and should be offered as a long-term rental.
In most situations, the numbers make more sense at this level as a long-tern rental. The owners of high-end homes with amenities should continue to offer them as a vacation rental as it is good for our economy.
Each investor needs to do the math and make their own decision.
As for my disclosure, as usual, this article is meant for informational purposes and not intended to be all encompassing of the details. My proforma of income and expense comparison is not perfect.
Once again, I apologize for being lengthy, I am a wordy gal.
