W E A LT H A S A VAC AT ION
bedroom for $10,000, bringing the earning potential of the home up from $40,000/year to $60,000/year. Accounting for the additional construction cost for the new room into the home price means investing a total of $550,000. But with the increased earning potential, the cap rate becomes 10.9 percent ($60,000/$550,000)—a nice jump. If they are unable to negotiate, they will need to figure value beyond cap rate. For example, does owning beachfront property where they may someday retire make it worth it to buy a home with slightly lower earning potential on the rental market? Knowing what a cap rate is and why it’s important will help you make a more informed decision when buying a vacation rental. Cash-On-Cash Return
Cash-on-cash return is a related metric that considers mortgage fi nancing. This metric compares cash flows, less fi nancing expenses, with the down payment. As cash-on-cash returns just consider the difference between the income and the mortgage against the down payment, they can be sensitive to variations in performance. For example, for a property with a $600,000 purchase price, a $100,000 down payment, and a $1,800 monthly mortgage payment, the cash-on-cash return is only 2.4% when income after expenses is $24k in one year. It jumps to 20.4% when income after expenses is $42k. The difference in cap rate between those two examples? Only three percent.
7.3 The Negotiation Now the fun begins! As my mentor in real estate once said, “Don’t fall in love with bricks and mortar.” This is great advice for your VRP business. You will see many existing vacation homes, and likely fall in love over and over. You will be immersed in beautiful renderings, aerial views, 3D walkthroughs, and have fi nished samples of countertops, floors, tile, and paint color set before you until you feel you might drown.
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