Impossible to profit on Vacation Rentals with a Mortgage?

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Impossible to profit on Vacation Rentals with a Mortgage?

Chase Cline
Investor · Corpus Christi, TX-Texas · Member since 2015 · 81 posts · 56 votes

Hey Everyone!

Sorry for the clickbait title... 

I own a successful vacation rental (successful meaning it pays for itself) and close on another one at the end of this month. We also bought another one in August of this year that we will be moving out of in March and it will become our 3rd vacation rental.

So I use QuickBooks self-employed to track my first rental and I have a bank account dedicated only to that property. At the end of this year I saw a $1,000 profit which means the property was "successful" in that it fully pays for itself, which is the goal while there is still a mortgage on the property, right?

(by the way we paid $4,000 in extra mortgage payments throughout the year so we could have had $5k profit, but my point still exists)

Well, I met with my new accountant for the first time two days ago and a bomb was dropped on me that I hadn't thought about it. I was expecting to be taxed ONLY on the ~$1,000 profit I showed, but apparently that's not how it works (I'm not a newbie, but this was a newbie mistake that I only became aware of because I finally started using a real accountant and not H&R block). I am taxed on the Net Income which does NOT include any mortgage principal payments. So this took my taxable income on the property from what I thought was ~$1,000 up closer to $8k. Getting taxed on that amount will just about eat up most of the profit. 

Are all of you dealing with the same issue? This was a very shocking realization and is making me re-think having a mortgage on vacation rentals. How are all of you handling this?

What are your monetary profit goals on VRs that still have a mortgage?? Even without making extra mortgage payments this year we will be left with maybe $1k profit after taxes. Is the work of managing these places worth a $1k profit every year?  

Thanks for any feedback!

Chase

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Tim Schroeder
Rental Property Investor · Castle Rock, CO · Member since 2017 · 335 posts · 387 votes
7y

Personally, I disagree with your definition of a "successful vacation rental". A successful vacation rental is NOT something that "pays for itself", it's something that makes a ton of money.

A property that makes you 1,000 per year before taxes is, at best, a free second home. But it's not really that even. What are you going to do when it needs a $2,000 refrigerator, a $5,000 furnace, or a $15,000 roof?  If what you want is a 2nd home for yourself -- a place to go sit in the sun and relax -- great. Good for you. You MIGHT just break even, until that furnace goes out anyway.

I have two properties mortgaged to the hilt, and they net me a disgusting amount of money. The mortgage isn't your problem, your property is. Do the ROI math on a mortgaged property vs a non-mortgaged property. Often, when you look at the profit numbers on a non-mortgaged property, you'll see much higher profit and you'll get excited. But divide that number by the capital you invested to buy the property outright and you'll see your ROI is terrible, because in order to get that profit up to an exciting level, you had to invest too much capital. And for most people, capital is the limiting factor for further investing. Personally, I would not be interested in an CoC ROI under 20%. Hell, historically I can get 8% in stock market index funds with less risk (over time) and zero effort.

Do the numbers for what you have now, then re-run them pretending you paid off the mortgage. Compare the ROI. Choose the scenario that yields a higher ROI. Consider sharing the results if you like. People here love talking about this stuff.

Then call your agent and put that thing up for sale and invest the proceeds in a better money-maker.  :)

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  • John UnderwoodPro Member
    Investor · Greer, SC · Member since 2014 · 13k+ posts · 17k+ votes
    7y

    @Chase Cline so you netted 8k. That's not too bad. What you choose to do with that 8k is up to you. You are saving on mortgage interest by paying down the loan faster. Remember that you still profited 8k and someone else is paying off the mortgage for you. You will also still have tax benefits from writing off expenses and taking depreciation. So the tax deductions might keep from eating into your net profits all that much if any.

    3Reply
  • Michael Greenberg
    Investor · Denver, CO · Member since 2016 · 533 posts · 433 votes
    7y

    @Chase Cline I think the bigger issue might be what your goal is for the property.  Is it cash flow (make a living)?  Property Appreciation?  Tax Savings (Depreciation).  Or something else?  @John Underwood has a good point, you can write off a LOT, maybe more than you have dug out so far.  I have always (until now) found that CPA's are VERY conservative, which isn't really a bad thing, but I changed to a new one who also personally owns VR's and he is really, really good.  Do a web search for SharedEconomyCPA (all one word) and reach out if you want a 2nd opinion.  I use Miguel Centeno who is a Partner in the firm.

    Best,

    Mike

    4Reply
  • Tim Schroeder
    Rental Property Investor · Castle Rock, CO · Member since 2017 · 335 posts · 387 votes
    7y

    Personally, I disagree with your definition of a "successful vacation rental". A successful vacation rental is NOT something that "pays for itself", it's something that makes a ton of money.

    A property that makes you 1,000 per year before taxes is, at best, a free second home. But it's not really that even. What are you going to do when it needs a $2,000 refrigerator, a $5,000 furnace, or a $15,000 roof?  If what you want is a 2nd home for yourself -- a place to go sit in the sun and relax -- great. Good for you. You MIGHT just break even, until that furnace goes out anyway.

    I have two properties mortgaged to the hilt, and they net me a disgusting amount of money. The mortgage isn't your problem, your property is. Do the ROI math on a mortgaged property vs a non-mortgaged property. Often, when you look at the profit numbers on a non-mortgaged property, you'll see much higher profit and you'll get excited. But divide that number by the capital you invested to buy the property outright and you'll see your ROI is terrible, because in order to get that profit up to an exciting level, you had to invest too much capital. And for most people, capital is the limiting factor for further investing. Personally, I would not be interested in an CoC ROI under 20%. Hell, historically I can get 8% in stock market index funds with less risk (over time) and zero effort.

    Do the numbers for what you have now, then re-run them pretending you paid off the mortgage. Compare the ROI. Choose the scenario that yields a higher ROI. Consider sharing the results if you like. People here love talking about this stuff.

    Then call your agent and put that thing up for sale and invest the proceeds in a better money-maker.  :)

    11Reply
  • Tim Schroeder
    Rental Property Investor · Castle Rock, CO · Member since 2017 · 335 posts · 387 votes
    7y

    @John Underwood He only netted 8k from a tax perspective. From a cash-flow perspective he netted 5k (1k plus the 4k he paid in extra mortgage payments). That's just not a sustainable level if cash flow is the goal. Not knowing what the purchase price was (or better yet, the total cash investment in down pmt & costs) it's impossible to say.

    @Chase Cline I think the last line in your post is key -- Is all the work worth $1000 a year?  Do the numbers and share. maybe I'm wrong :)

    2Reply
  • Jon Crosby
    Investor · Roseville, CA · Member since 2016 · 893 posts · 1k+ votes
    7y

    Hi @Chase Cline, sounds like you got some good (and lively) feedback already.  My personal investment model is a 'vacation house for free' so I'm actually trying to stay cash flow even or slightly positive as the rental pays for itself over time.  

    As others said, you do need to factor in those capital expenses but here's the thing.  I bought my VR to use it...not as strictly an investment property.  I would just buy a regular rental if I want a pure investment property as they are WAY easier to manage and cash flow from.  

    I invested in the VR so my family gets to enjoy the ancillary benefits of using the VR up to 2 weeks per year (plus maintenance trips) while others pay it off. That 'value' should be considered when figuring out your return on investment. If you are not using it and enjoying it's other non-financial benefits, then yes you might want to re-evaluate it's ROI.

    Best of luck on taxes, I would make sure you are accounting for every last deduction you can scrape up.  It's sad that you are taxed on your passive income but don't get the benefit of passive losses until you sell the home.  

    2Reply
  • Jeff Moore
    Real Estate Agent · PCB/30A Florida and St. Thomas USVI · Member since 2015 · 36 posts · 18 votes
    7y

    Hey, What Tim Schroeder says is spot on. I sell vacation rentals to clients all day long who are happy to have second homes that pay for themselves. But, I already live at the beach. Mine need to make MONEY. My accountant's head explodes every year when I go to do my taxes because I need to show a profit on my rentals so I can qualify for financing to buy more properties. But, he always wants to show a loss. So a good accountant is key to match with your financial goals. You didn't say how much you paid for the property. If it is a $100K condo and you netted $5K that is pretty good. But, if it is a $400k beach house, you need to move your money somewhere else. 

    2Reply
  • Luke CarlPro Member
    Rental Property Investor · Tennessee Florida · Member since 2016 · 4k+ posts · 5k+ votes
    7y

    @Chase Cline  Lots of wonderful advice here already!! There is NO way I would be in this business to break even it's way too much work. Which presents the question... How are these being managed? If you're paying a PM and breaking even that's fine but it seems like a waste of one of your conventional mortgages if you ask me. 

    I need my VRs to gross 1.5%+++ of PP per month or I'm not going to bother. 

    If you're paying a someone or a company to manage that's the missing piece of the puzzle. Everyone on here self manages and that's really the only way to go if you want to make cash in the VR business. It's very easy to do from anywhere in the world. Just call me I'll teach you how. Grab a pen it takes about an hour. No charge. 

    If you're self managing and breaking even why are you buying more? Sell all of those things and get into a market that makes CASH!!!!!!

    Podcast Guest on Show From Surviving on $30/Day to 30+ Properties Thanks to Blue-Collar Skills
    5Reply
  • Tim Schroeder
    Rental Property Investor · Castle Rock, CO · Member since 2017 · 335 posts · 387 votes
    7y

    @Jeff Moore I have that dilemma as well. Showing less income is great to reduce taxes but then you can't get financing!  My plan is to show the income and pay the taxes for another year or two, buy a couple more properties, THEN circle the wagons, reduce taxes where possible, quit my soul-killing cubicle job, and do this part time.

    3Reply
  • Chase Cline
    OP
    Investor · Corpus Christi, TX-Texas · Member since 2015 · 81 posts · 56 votes
    7y

    @John Underwood yea great point on depreciation. It turns out we discovered the depreciation was only being 50% counted as that's how it was the first year because we lived there half the time. That's what you get going with national chain accountants who don't really have a clue who you are and what you're doing. I wonder how much that update alone will impact everything. 

    @Michael Greenberg thanks for the input. All the benefits you mentioned are what I want ha. The issue with a lot of the write-offs is we actually live on the same island just a few miles down the road as our property so there isn't really any mileage or anything significant to write off. 

    @Tim Schroeder well this a condo with an HOA so the huge cap-ex issues like a roof won't happen. A refrigerator wouldn't cost more than a few hundred for the standard white ones so that's not much of an issue either. The only thing that could happen would be the A/C (and we will actually be replacing it soon) and that's $1,800. So really with ~$4k-ish profit when not making extra mortgage payments we are covered for any emergencies.

    Can you elaborate on a 'disgusting amount of money?' Are those LTR or STR? Considering we put about $10k-$12k all-in for the down payment and fixing it up ourselves and haven't spent a dime since, I'd say we are still in a good place. but you are correct about finding a better money maker which is why I posted in the first place. I want to know how people solve that issue and what better options could be.

    @Jeff Moore good point. I also live here at the beach so want it to make money. But since I live so close there isn't much I can write off other than supplies for the actual property or repairs, etc. This was purchased for $135k with around $10k-$12k out of pocket including a remodel we did ourselves. I was a huge newbie when I bought it 4 years ago but we've actually used it ourselves quite a lot too. It did $29k in rental revenue this year which is huge for a property that cost $135k. 

    1Reply
  • Chase Cline
    OP
    Investor · Corpus Christi, TX-Texas · Member since 2015 · 81 posts · 56 votes
    7y

    @Luke Carl yea I manage it myself as well using AirBnb and VRBO. 

    What does 'PP' stand for when you say need VRs to gross 1.5% of PP per month?

    I've been casually managing this property but as I am now planning on leaving my day job I want to figure out the cash/cost of these down to the dime before I make any rash decisions. We bought another one because we are paying $25k less for it than our first one so its a steal. At the very least we can sell it and make ~125% cash return. 

    2Reply
  • Luke CarlPro Member
    Rental Property Investor · Tennessee Florida · Member since 2016 · 4k+ posts · 5k+ votes
    7y

    @Chase Cline   PP = Purchase Price per month. 

    A 250k property in my market will easily gross 40k per year self managed.  And no regulations. 

    Podcast Guest on Show From Surviving on $30/Day to 30+ Properties Thanks to Blue-Collar Skills
    2Reply
  • Chase Cline
    OP
    Investor · Corpus Christi, TX-Texas · Member since 2015 · 81 posts · 56 votes
    7y

    @Luke Carl in that case this property absolutely meets and exceeds that criteria. Grossed $29k this year on a $135k property. so we are 1.7%+. AND we are closing on another one in the same complex in two weeks that we are buying for $109k so assuming it rents the same we are talking about 2.2% PP for that one. So since these meet the criteria what am I missing?

    Seems like mine should be in the 'disgusting amount of money' criteria but something is missing. 

    1Reply
  • Luke CarlPro Member
    Rental Property Investor · Tennessee Florida · Member since 2016 · 4k+ posts · 5k+ votes
    7y

    @Chase Cline That's pretty close 135k (if you can find it) should do 30-33k in my market. I have no idea what your numbers are. Are you paying HOA and heft property tax? My first guess anyway. We don't have either of those.

    Monthly Mortgage WITH home owners insurance and Property tax around here is going to be about $650 assuming 20% down payment-ish.

    Podcast Guest on Show From Surviving on $30/Day to 30+ Properties Thanks to Blue-Collar Skills
    1Reply
  • Chase Cline
    OP
    Investor · Corpus Christi, TX-Texas · Member since 2015 · 81 posts · 56 votes
    7y

    @Luke Carl yep they are condos so we have HOA and pretty high property taxes. How do you not have property tax?

    1Reply
  • Luke CarlPro Member
    Rental Property Investor · Tennessee Florida · Member since 2016 · 4k+ posts · 5k+ votes
    7y

    @Chase Cline we of course have property tax it’s just very low. 135k property is about $450 for the year. Probably less. Click the vote button for me ;) 

    Podcast Guest on Show From Surviving on $30/Day to 30+ Properties Thanks to Blue-Collar Skills
    6Reply
  • Chase Cline
    OP
    Investor · Corpus Christi, TX-Texas · Member since 2015 · 81 posts · 56 votes
    7y

    @Luke Carl damn that's crazy! Hell if you took out our HOA ($275/month), property tax ($3,300 this year), and extra mortgage payments this thing would be making $10k+ even WITH a mortgage and $18k+ per year without it. THAT is what I am looking for!

    0Reply
  • Luke CarlPro Member
    Rental Property Investor · Tennessee Florida · Member since 2016 · 4k+ posts · 5k+ votes
    7y

    @Chase Cline  that is what I have. :). 

    Glad we were able to solve your problem!! 

    Podcast Guest on Show From Surviving on $30/Day to 30+ Properties Thanks to Blue-Collar Skills
    5Reply
  • Joe SplitrockPro Member
    Moderator
    Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
    7y

    @Chase Cline yes we are all dealing with the same issue, known as tax laws haha.

    You get taxed on profit. On your loan, you can only deduct your interest, because your property value shows up as depreciation. If you got to expense your principal payment and depreciation, it would be double dipping. Depreciation is no free lunch either. When you go to sell the property, you will be taxed on depreciation recapture. Only way to avoid this is to do a like kind exchange into another investment property. That only defers the taxes until you finally sell or die.

    I would rethink your loan pay down strategy. If you converted a personal residence to vacation rental, my guess is you have a very low interest loan. Say your loan is in the 4% range, that is cheap money. You are better to save the cash to invest in new properties. You said you are closing on a new property, so for example if the loan on that is 5% and your old property is 4%, you just lost 1%.

    Just some food for thought. You are off to a great start.

    1Reply
  • Julie McCoy
    Real Estate Agent · Sevierville, TN · Member since 2015 · 1k+ posts · 1k+ votes
    7y

    Everything @Luke Carl and @Tim Schroeder said.  My $135k purchase is making me $36k gross in 2018... and I bought it in March '18.  If my STRs aren't netting me at least $1k per month I'm going to consider it a losing proposition - self-managing is too much work to settle for less, and hiring a property manager would suck up all the profits.  

    It is 100% possible to profit on VRs with a mortgage (I have three of them with mortgages, one without) - but as has been pointed out, you've gotta have the right property in the right location.  

    0Reply
  • Paul Sandhu
    Investor · The worst town to live in, KS · Member since 2016 · 4k+ posts · 4k+ votes
    7y

    In my market you can buy a 3BR 1BA house with CH&A in a decent neighborhood for less than $10k (bank foreclosures). You can't do it every day, but you can do it 2-3 times a year when the opportunity is there. You can rent it out for $600/week as an STR. 6 months of gross rent will pay for the purchase price of the house.

    But nobody comes to this town on a vacation. My STR renters are contractors. The big burly scary looking guys with neck tats you see working at a petrochemical refinery. Welders, pipefitters and the like.

    0Reply
  • John D.
    Rental Property Investor · La Quinta, CA · Member since 2014 · 1k+ posts · 779 votes
    7y

    Your definition of success is "pays for itself"?  Time to set your sights much, much higher!  Our average $700k property does $200k a year in rents.

    0Reply
  • Luke CarlPro Member
    Rental Property Investor · Tennessee Florida · Member since 2016 · 4k+ posts · 5k+ votes
    7y

    @John D. I believe  @Paul Sandhu  is saying your 700k property needs to make 700k in six months. Please clarify uncle Paul

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  • Paul Sandhu
    Investor · The worst town to live in, KS · Member since 2016 · 4k+ posts · 4k+ votes
    7y

    @John D. and Reverend @Luke Carl  What I'm saying, is that my properties pay for themselves with 6 months of rent.  It may take 6-9 months on the calendar to get 6 months of rent.  

    You can look at the payback period.   It is less than a year, any cash flow after that is profit.  Your payback is 3.5 years.

    You could look at the net present value.  Yours are higher, but you have about 80x the money invested in an average property.  

    You can look at the internal rate of return. Mines about 60%.  A $700k property that nets $150 is around 20%.

    All of these are good numbers, but both markets are different.  There is no $700k house in this town.  There are less than 5 appraised around $350k, and those are the highest.

    0Reply
  • Tim Schroeder
    Rental Property Investor · Castle Rock, CO · Member since 2017 · 335 posts · 387 votes
    7y

    @Chase Cline Well after more information has come out I can see it's not as bad as I thought at first, mostly because of the low purchase price you got. But most of what I said still stands. Always figure your ROI and don't be fooled into a non-mortgaged situation just to get yourself in the black. If you have to do that you're probably not far enough into profitability. I'm going to hit 50% ROI this year, which is just fantastic and certainly not something I'll always be able to duplicate.

    1Reply
  • Sam Shueh
    Real Estate Agent · Cupertino, CA · Member since 2016 · 4k+ posts · 1k+ votes
    7y

    What is your goal?  Tax write off or profit?  I am surprised that vacation rentals cash flows.  Need a strategy for each.

    0Reply
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