Saturday, June 20, 2009

Positive cash flow, does it exist?

I get tons of calls and emails from people looking for a "deal" on a beach property that will generate positive cash flow and offer a get-away spot for occasional trips to Cocoa Beach or Cape Canaveral. There is a pretty narrow set of requirements for realization of positive cash flow. Let's do some simplified math to help us narrow our search. Say we're looking for a condo in the $200,000 range. We'll assume a 30% down payment (Fannie Mae requirements for 2nd home condos) on a 30 year mortgage at 5.5%. Our fixed monthly costs will be (estimates but close to reality);

property taxes__ 250
condo fees_____ 350
utilities________ 130
insurance_______ 70

That means on this condo the buyers will need to net $1594 per month after management for all 12 months of the year. Subtract a couple of months for personal use and the net bumps to $1913 a month necessary to break even. Without even looking for examples I can tell you that there is not a single $200,000 condo anywhere on the beach that will bring $1913 per month rent year round even if it were possible to carve out 2 months for personal use and rent the other 10 months. Does this mean there are no cash-flow possibilities? No. If there were no mortgage in our example the numbers would slide into the realm of possibility but we're still faced with the impossible task of renting 10 months while carving out two months for our own use. In this case, with no mortgage, the only realistic possibility is to not use the unit ourselves and have a long-term renter paying at least $800 per month, a very feasible scenario.

The biggest (but often invisible if you don't ask) fly in the ointment for investors exploring condo investment is rental restrictions. I have written about this before. In a nutshell, Cocoa Beach and Cape Canaveral, unlike most Florida coastal communities, have very few condos that allow weekly rentals. Most here restrict rentals to at least one month and some have as much as a one year minimum rental. Even with a one month minimum, an owner is faced with the daunting task outside of the main snowbird season of January through April of finding tenants who want to rent for at least one month. Our summer and fall guests are primarily vacationers who are here for one or two weeks. That reduces the options to finding a long-term renter which kills the idea of occasional personal use of the unit. The obvious best solution to this dilemma is a weekly rental unit.

Let's explore the same scenario as above but with a weekly rental unit in the $200,000 range like Chateau, Ola Grande or Cape Winds. The units that are selling in this price range in these complexes are renting in the $600 to $900 per week range. It quickly becomes obvious that the no-mortgage scenario is only going to require about 50% occupancy to net enough after-management cash to break even. With no mortgage, positive cash flow is a very real possibility with halfway decent occupancy. By the way, a mortgage is not possible in most of these weekly rental complexes. Expect to pay more (20 to 40%) for good short-term rental management. Good long-term management can be had in the 10 to 12% range. If an owner is able to and does their own management the possible returns for weekly rentals become quite attractive. The other obvious plus of the weekly rental units is that owners can chop out a few weeks here and there for themselves without destroying the income stream.

For buyers who don't want or need personal use of the unit, one other way to tilt the odds in their favor is to find a unit at a price far below the assumed $200,000 purchase price. In our first scenario, dropping the purchase price significantly assuming the same desirability of the unit, the numbers begin to shine a little brighter even with a mortgage and a long-term renter. There are some other tweaks that will change the numbers like condo fees and utilities but those differences aren't big enough to change the tone of our hypothetical purchase.

As a potential condo buyer, your takeaways here are;

  • All other things being close to equal, a well-managed weekly rental unit will always generate more income and offer greater flexibility for personal use.
  • If you do stick with longer minimum rental buildings, don't think that because January through April rents and demand are high that you'll be able to find monthly renters the rest of the year. If you do, consider yourself lucky.
  • Be realistic with your expectation. Only considering positive cash flow scenarios might mean never using your unit yourself or could have you looking at units you don't like. The benefits of owning a condo that you use occasionally that is slightly negative on cash flow might make sense.
  • Ask your buyer's agent about rental restrictions. Not all of them will go out of their way to tell you why your dream of income/personal use won't work in many of our complexes. Many of them have never stopped to even think about the implications of restrictions.
  • And lastly, if you don't have to have the income, you'll probably enjoy your time here more in a longer-term building without all the transients. It's all about what you want and need.
"I merely took the energy it takes to pout and wrote some blues."
________Duke Ellington