It’s no secret that Charleston SC is an ideal vacation spot on the east coast and with that, a lucrative property investment market for vacation rentals. At its most basic, there are 3 ways to fund an investment property – cash, personal mortgage, commercial mortgage or some combination of two. If you are building a portfolio on this basis then here are some points you may do well to consider to increase your chance of the bank saying, “YES. ”
The path to success in acquiring a Charleston SC vacation rental property means understanding some of these key elements of the transactional process.
“Leverage ” or bank borrowing allows you to maximize returns on your available cash where the income achieved exceed the cost of that capital. Now mathematics would indicate that the greatest “Cash on Cash ” return is achieved by the greatest leverage. However you also run the risk of a downturn in the market wiping out any equity you may have and leaving you effectively owing the bank more than the value of the property. In other words, you are “upside down ” as experienced by very many homeowners in the last downturn. Our own internal rule is no more than 70% cash on long term rental properties and 60% on vacation or short term rentals. If it’s your first venture then do not push it, ask for 50% or so to provide comfort to the bank that their funds are safe. You can increase this once a track record is established on closeout of the first two or so seasons.
Banks lend money on the basis of an “asset class. ” Think of this as a silo that contains all loans of a certain type or class. Single-family residential or owner occupier would be one such class. Most loans made by a bank are suitable for the secondary market. In other words, they may consolidate a number of mortgages and resell them to secondary lenders thereby improving their balance sheet and allowing the bank to make additional further loans. Investments in short term rentals as an asset class is fairly new and often the bank must hold the loan as there is no secondary market. For this reason you are best approaching local or statewide banks as opposed to the national networks.
What is your debt coverage? As a rule of thumb, the projected or actual income must be at least 120% of all finance costs. Higher than that will help your case considerably (we prefer greater than 150% for our own assets). That is net income after all operating expenses have been deducted. It is also advisable to project what the income would be as a long term rental assuming that the vacation market temporarily evaporates. For downtown Charleston, the highest and best use is probably on a “per room ” basis. On the islands you will be looking at single family or maybe monthly rental for transient visitor or “Snow Birds. ” A project that returns 120% debt coverage on a long term rental basis will be viewed more favorably than one justified solely by short term rental rates as it retains a fallback position.
Telling your Bank that you “feel good ” about something or you “think it’s a great idea ” will not cut it. You will need a good financial model of costs vs income and justification for the predictions. Do not underestimate the costs involved in operations which can often total to >50% of your income once insurances, refurbishment, taxes, repairs and management are considered. A big, but surprisingly common, mistake is to seek funding for a property that is incorrectly zoned for the application (aka illegal!) and such a request will make no friends at the bank. Some banks need income projected on a “per room ” basis as this fits their “silo ” for hotels. This makes it easier for them to present internally, assisting them in delivering that sought after “YES ” decision.
Everyone has to start somewhere so don’t let a lack of experience stop you. The workaround is to engage a good management company with a strong track record and experience in your target area. They will be able to help with an income model based on known examples and provide your bank with the spreadsheets you need to instill confidence. They will be able to consult with you on how to target your investment, what works, what does not and also provide introductions to local banking partners if needed. This won’t guarantee success but certainly helps a great deal.
More importantly, sometimes the simplest guidelines to follow are also some of the most basic:
- be informed
- be accurate
- be realistic
- be honest
If you are cautious and successful in attracting funds, then short term rentals as an asset class is very rewarding often bringing in 1.5 – 2x the income from any other source. Local banks are willing to fund but you have to pitch in a way they will be receptive and be mindful of their own restrictions.
Note: Once you’ve gone through the process of acquiring your vacation rental property, find the right company to manage it for you. A good property management company knows you’re entrusting them with a significant asset so it’s their job to maintain and secure it while you’re out of town. See why Luxury Simplified Retreats is a top property management company in Charleston and what they can do for you …