How To Improve Your Condotel Rental Income

Summary:

• Income statements are meaningless without proper context.
• Some rentals perform better than others. Implement what needs to be done to optimize performance and join the ranks of the highest producing comparable properties.
• Verify all fixed and variable expenses. Consider properties with the highest CAP rate potential. Ignore incomplete metrics and avoid emotional decisions.

“The more we think we know about, the greater the unknown…”  ~ Rush

— A new mad rush is on condotels. STR bookings bounced back in a remarkable Springbreak turnaround. Summer bookings are clocking in at a rate that could turn 2021 into a year for the record books.

Whoever has been watching from the sidelines during COVID now realizes that the most motivated sellers already sold. At least in the condotel buildings we recommend. – Pandemic discounts have evaporated.

Economists are revising upwards their tourism and economic recovery predictions. Vaccination successes are improving the outlook.

See related article:  Condotel Opportunities – COVID And The K-Shaped Recovery

Curious buyers inquire about the uniquely alluring combination of the best of both worlds:

1. Maximum rental income potential – Short-term vacation renting (less than 30-days per tenant) has the potential to generate significantly more rental income compared to longer-term 30-day minimum rental terms.
2. Maximum rental flexibility. – You control the booking calendar and can block days to best fit your vacation plans. Enjoy the unit for your personal use between guest bookings.

See related article: Guide To Condotels

For many buyers, the cash flow consideration is paramount. It’s no wonder that buyers eagerly scrutinize available income statements only to get confused. They discover with bewilderment:

“How come there is such a huge spread in reported income between one unit and a seemingly similar unit?”  

That’s because income statements are meaningless without the proper context. They don’t tell us why the income is high or low.

________________________________

Income Statements Don’t Tell The Whole Story

Buyers like to peruse statements for peace of mind and to extrapolate potential future returns.

But that’s like wanting to drive a car forward by looking only in the rearview mirror.

There is more than just reviewing income statements.

E.g. COVID negatively affected 2020 rental income. Are the 2019 statements more suitable as performance proxy? How reliable are these statements as a benchmark for what you are trying to achieve? Could they be entirely irrelevant?

See related article:  Cashflow vs Lifestyle

Income statements only reflect the temporary past performance of the property. They are sufficient if you plan to stick with the status quo. But is that all you are aiming for?

Recognize the hidden factors that affect rental performance. “What you see is what you get” is a standard thinking error.

Owners Have Different Goals

• Some owners don’t rent their unit and strictly use it for personal enjoyment.
• Others only rent part of the year.
• And yet others are satisfied with substandard existing income, not bothering to explore ways how to maximize it.
• That includes owners that kept their unit in outdated condition with the same property manager for the last 50 years. “I don’t want to spend any money on remodeling since the current cash flow is enough.”

See related article:  Waikiki Condo – Remodel Journal

________________________________

If you are a buyer seeking to maximize your rental income potential, then consider the following factors…

Ocean View vs. Mountain View

It’s easy to imagine that visitors prefer an ocean view and gladly pay a rental premium for it. Especially when it takes a 6-hour flight to get here. But how big is that rental premium in relation to the sales price premium?

The spread between the ‘ocean view’ vs ‘mountain view’ rental income varies between buildings. And the same is true for the respective sales price.

E.g. the ocean views and the mountain views from the Waikiki Banyan can both be impressive. Hence, the ocean view premium is comparatively small.

Instead, at the Ilikai, the ocean views are breathtaking, and the mountain views should be more accurately described as merely ‘street views.’

Here, the larger spread in rental income and sales price between the ocean side vs the mountain/street side reflects that.

During COVID, some of the price spreads were temporarily compressed. However, recently the price spread reverted back to the mean. In the case of the Ilikai, the spread has even increased beyond normal levels before COVID. Ilikai ocean view units are now selling at a disproportionate premium over mountain view units.

That’s typically what happens when the market heats up in anticipation of improving future revenue.

Whenever the spread in the sales price between ocean view and mountain view gets larger than usual, then either the ocean view is overpriced or the mountain view is selling at a bargain.

In a strengthening market, such as now, the latter is the case.

We monitor those trends and and find undervalued opportunities: “Which is the better property to buy today?”

Views are what we call incurable. You can’t change it. You either have an ocean view, or you don’t.

But you can determine by how much the rental potential justifies a premium purchase price if any.

Don’t pay a premium price unless the rental potential justifies it. 

Sometimes, a top-floor penthouse trophy property might sell at a premium with impressive ocean views. But the same unit only a few floors below will rent just as well without the premium price. – Don’t let emotions cloud your purchase decisions.

The view is fixed, but many other curable factors are well within your control and can greatly improve your rental income potential.

These factors, if implemented correctly, could propel your rental to join the ranks of the highest producing comparable properties.

See related article:  How To Zero In On The Right Property  

________________________________

Better, Faster, Cheaper Always Wins

That’s how Netflix bankrupted Blockbuster. Currently, Uber and Lift are eating cab companies’ lunches. A similar disruptive trend is shaking up the travel industry. Who manages your unit makes or breaks your investment.

Property Management

Some property managers use outdated business models and are reluctant to change. Others embrace new technology and efficiently utilize the latest tools to maximize revenue by streamlining operations and lowering costs.

Some property managers with a large overhead charge 50% of the gross revenue collected. Other nimble operators can charge 20% or in some cases even as low as 14%.

You need to consider both, the revenue and expenses because net cash flow is a function of Gross Revenue minus Expenses.

Which property manager delivers the better net result?

• A. Gross revenue: $100K, management fees: 50%
• B. Gross revenue:  $90K, management fees: 20%

Property manager B. produces $22K more to the owner after management fees compared to property manager A. ($72K vs $50K).

What about other ownership expenses?

• A. Gross revenue:  $80K, total expenses: $40K
• B. Gross revenue:  $120K, total expenses: $80K

Both properties net the same $40K, after expenses. But what if some of the expenses are fixed expenses? And what if your gross revenue then were to drop to $35K? Would your fixed expenses exceed your gross revenue and flip the property into negative cash flow?  No fun.

See related article:  Confessions Of A Real Estate Investor 

Dynamic Pricing

That’s what airlines and hotels do to maximize revenue by filling the remaining vacancies.  

• If your booking calendar is half empty, then you are charging too much.
• If you are completely booked up, then you might have charged too little.

Aggressive property managers quickly adjust pricing to capitalize on supply and demand changes. Dynamic pricing can optimize occupancy and squeeze out maximum revenue. Other property managers just let it ride and miss out. 

For Springbreak and Summer 2021, some property managers completely booked their rentals. Others are left behind wondering when tourism is going to recover.

Presentation – Pictures And Ad Copy

There is a world of a difference in how different property managers showcase your property. Professional photography and ad copy can make a huge difference in the number of bookings, daily room rates, and the gross revenue that your unit can get. Don’t skimp on photography. Investing in top-notch photography can yield huge returns.

Privacy And ‘Social Distance’

Advertising platforms like Airbnb, VRBO, and others have become popular among travelers to easily book online. Just like Amazon has become the cyber-shopping darling that disrupted retail, so have vacation rental platforms taken business from traditional hotel chains.

Amazon shoppers prefer the social distance during COVID by shopping from the comfort of their living room. And some travelers prefer the perceived social distance of vacationing in an individual Airbnb unit rather than in a dense hotel.

What the guest may not realize is that the individual Airbnb condotel unit might be located within the same dense hotel that they thought to avoid. This perception inadvertently helped some nimble property managers get an early lead and outperform large hotel operators during COVID.  

Trust And Credibility – Superhost?

Today’s property managers capitalize on the broad exposure these online platforms offer. And property managers have become real human hosts with a trustworthy verified online profile and hundreds of positive personalized reviews.

The trust barrier has been lowered and the process has been humanized. Rather than booking from an established hotel chain, some visitors are seeking a new travel experience and flock to book from proven and successful Superhosts.

Superhosts aggressively work to solicit top guest reviews. 100 top reviews are better than ten. And one bad review can spoil the bunch, tarnish the reputation, and affect future bookings. Any booking review less than stellar is to be avoided at all costs.

The most effective property managers are experts in public relations and damage control.

“A single cockroach will completely wreck the appeal of a bowl of cherries, but a cherry will do nothing at all for a bowl of cockroaches.“ ~ Paul Rozin

Condition And Amenities

Visiting guests are doing their research by scrutinizing the ad copy, the pictures, and the guest reviews to establish the unit’s condition and the included amenities.

• Does the unit have a full kitchen with a range/oven and large fridge or just a kitchenette with a microwave and mini-fridge?  
• Does the unit feature a whisper-quiet Split AC and ceiling fan or just a 20-year old window AC?
• Does the unit have modern clean hard-surface flooring or a worn wrinkled carpet from the 1970s?
• Does the unit include a spiffy-rich furniture package or ancient flower-print bamboo furniture that was popular 40 years ago?
• Has the unit been freshly painted with a bright and happy feel or instead still exhibit gloomy dark brown carpet and peeling wallpaper from a 15-year old remodel?   

Capacity – Bed Configuration

As a rule of thumb, the more people that can comfortably sleep in the rental, the better the income potential. Some rentals have two twin beds, some have two full beds, some have a King bed, and some have two Queen beds. Every living room should have an additional pull-out couch.

A small investment in improving your bed configuration to two Queen beds could improve your annual cash flow by $6,500.

But be careful. I have seen individuals that increase capacity beyond what the fire code allows. A 500 sq ft condo is supposed to sleep 5 individuals max. Don’t be tempted and fooled by creative ways that get you operating in the danger zone.

That also applies to paying the appropriate taxes. I know some that think they can cheat the system and get away with it. Then they look for help after they get caught. – Always stay within the law.

See related article:  The Risks Of Short-Term Vacation Renting 

In summary, to improve your rental returns, focus on what matters:

• Select the most efficient qualified reputable property manager for legal short-term renting.
• Don’t get hung up on past income statements. Instead, implement the above ideas to optimize your cash flow potential.
• Be mindful of the fixed expenses. All else being equal, consider properties with relatively low fixed expenses.

________________________________

Meaningless Metrics

What can’t be measured can’t be improved. But are you using the right metrics to measure and improve rental performance? Does partial information lead to faulty decisions? All the time. Yet, many buyers are asking the wrong questions and drawing half-baked conclusions.

See related article:  Define The Purpose Of Your Purchase 

How can we reframe the question to get better results? Here are some popular questions that fall short. Follow the thought sequence below and eventually, we can get the relevant data to make better decisions…   

• “What’s The Occupancy Rate?”

That measure by itself is meaningless. We already discussed dynamic pricing above.

Would you rather get 100% occupancy at $100/day or 50% occupancy at $200/day?

The revenue is the same. Therefore, occupancy is irrelevant as a single measure without knowing the daily room rate.

• “What’s The Daily Room Rate?”

Room rates can fluctuate by a large margin based on the season. That is the essence of dynamic pricing. The daily room rate is meaningless without the occupancy rate. You want to set your rental rate by aiming for 90% to 95% occupancy. 100% occupancy is an elusive unicorn due to turnover logistics.

Since occupancy rate and daily room rate by themselves are meaningless, the better question is:

• “What’s The Gross Revenue Per Month?”

Gross revenue is how much total rental income the unit generates. That’s the room rate multiplied by how many days are booked. But even that measure is meaningless unless we know the operating expenses. That’s the flip side of the coin.

What matters is how much money you get to keep after expenses. $500K in annual gross revenue sounds impressive but no longer when the expenses exceed the income. Oops.

Property sellers might be truthful when showing off dazzling gross revenue numbers. However, the true expenses are sometimes under-reported or entirely omitted.

See related article:  Real Estate Risks, Rewards & Responsibilities

Recently, in response to a request for P&L statements, a condotel seller shared their 1099 misc income statement showing some fantastic income figures. But that’s posturing showing only partial data. Income is only part of the equation. Show me the true expenses.

Since gross revenue is also insufficient information, the better question is:

• “What’s The Net Revenue Per Month?”

As mentioned in the beginning, net revenue is gross revenue minus all expenses. We also call it Net Cash Flow. A P&L statement should show that. Except, some tend to show only part of the expenses.

If the seller’s P&L statement looks too good to be true, then request a redacted Schedule E of the seller’s tax return.  That’s where the seller itemizes all expenses related to the investment property. Granted, the seller’s mortgage deduction and the depreciation expense are of little interest. But the rest of the Schedule E expenses should match the P&L statement. If not, then one or both have been fudged.

Buyer beware. In doubt, assume that the more conservative figures from Schedule E might be more credible. Especially with self-managed rentals, the accuracy of reporting could be conveniently off.

Also, self-managed means that the owner chose an active hands-on approach. Management fees are reduced in exchange for personal time and energy invested. Many self-managed rental P&L statements show no management fee.

Some of our self-managing clients do phenomenal. But self-managing is not for everyone. How much do you value your time and energy? Are you willing to save on expenses and tackle the three terrible Ts: Tenants, Trash, and Toilets?

Yet there is more. We are still missing something important. It’s called Denominator Neglect.

Even the net revenue aka net cash flow is meaningless unless within the context of the purchase price.

Which is the better cash-flowing investment property?

• A) Net annual cash flow:  $35K, purchase price: $700K 
• B) Net annual cash flow:  $35K, purchase price: $900K 

The net cash flow is the same, but paying only $700K produces a relatively better return.

If we divide the net annual cash flow by the purchase price, we determine the relative performance, aka CAP rate.

CAP rate = Net annual cash flow divided by the purchase price

Therefore, in place of all the questions above discussing incomplete and mostly irrelevant metrics, the better question is:

• “What’s The CAP Rate?” 

CAP Rate

It’s a simple measure that incorporates all of the above questions into one measure that allows for directly comparing different properties at various price points.

“Cap rate is the most popular measure through which real estate investments are assessed for their profitability and return potential. The cap rate simply represents the yield of a property over a one-year time horizon assuming the property is purchased on cash and not on loan. The capitalization rate indicates the property’s intrinsic, natural, and un-leveraged rate of return.” ~ https://www.investopedia.com/terms/c/capitalizationrate.asp

CAP rate calculations exclude mortgage leverage and tax benefits. It is on purpose a simplified approach to quickly compare property performance.

However, CAP rates are only a reflection of the current performance.

Unique Unfair Advantage? – Actualizing CAP Rate Potential

If you haven’t noticed by reading our blog, clients that work with us have a unique unfair advantage. Lucky you found us.  

What if you were to utilize the tweaks and tips from above, leverage our knowledge, and forge forward with improving the performance of your real estate investments? Do you think you could benefit?

That’s the actualization of the CAP rate potential. And that’s exactly how we should be analyzing investment properties.

Knowing what we now know, then the better question is:

• “What’s The CAP Rate Potential?

________________________________

Don’t Overpay – Look For Relative Bargains

The main point of this article is to focus on optimizing the CAP rate potential.

We already discussed avoiding paying a premium for trophy properties, unless

1. The rental income justifies it (rarely the case), or
2. Your ‘desired lifestyle’ requirements override the cash-flow / CAP rate shortcomings.    

Because the acquisition cost is the denominator of all CAP rate calculations, paying a relatively lower price is the better value proposition. Identify the most motivated seller and buy properties below today’s market value, all else being equal.

Remember that the market value today might be higher than last week or last month. Don’t hang yourself up, on having missed the recent market bottom. Otherwise, you’ll never buy.

See related article:  3 Things To Remember When Waiting For ‘The Right Deal’

Consider Properties That Require A Lower Cash Outlay

The cash outlay when you buy also includes any required improvement costs to maximize the income. The value of money today is higher than tomorrow. That’s due to the erroding effects of inflation.

Perhaps a $15K partial remodel can get you 90% of the highest income potential. That might make more sense than buying a property that requires a full $70K remodel to get you 100% of the highest income potential.

It’s beneficial to weigh the upfront expense in comparison with the time to recover. E.g. a $180 ceiling fan can save $20-$30/mo in AC electricity usage. That initial cost is recouped in electricity savings within a few months. Also consider how a ceiling fan increases the longevity of the more costly AC system which guests presumably will crank up less often to the max.

Focus on what gets you the biggest return on your money with relatively little effort.

‘Excellent’ and ‘good enough’ are better than ‘perfect overkill.’

“It is better to be roughly right than precisely wrong.” – John Maynard Keynes

But it’s not just the cash outlay. Unless you are a contractor, interior designer, or looking for a project that occupies your time, always consider the scarcity of your HBUT – your Highest and Best Use of Time.

Time is your most precious non-renewable resource. Don’t waste it. You can never get it back. Avoid lost opportunity costs and focus on your HBUT. Ask yourself: “What else better could I do with my time and money?” – Then do that.

See related article: The Psychology Of Buying And The Three “Ps” That Are Holding You Back

Conclusion 

Life is less complicated once you are clear on what you want. Improving condotel rental income requires simple deliberate steps that yield immediate results and compound over time.

You either talk or you do. Avoid analysis paralysis, get started, and adjust as you go.

________________________________

We don’t just write about this stuff. We are expert realtors specializing in representing buyers and sellers of real estate in any market condition. Committed to providing the most excellent service available on the planet, we love what we do and look forward to assisting you too!

Contact us when you are serious and ready to buy or sell. We are here to help.

________________________________

Also…, we want to make this The Best real estate website you visit. We love to get your feedback. Let us know any comments or ideas on how we might improve. We are humbled by your support and remain committed to constant learning and growing with you.  ~ Mahalo & Aloha

The post How To Improve Your Condotel Rental Income appeared first on .