Primary Home + ADU as Vacation Rental in HI = Worth It?

13 Replies

So I've already started on a road that I don't know how to navigate.  Searched and read as much as I could but unfortunately am under a time constraint.  Was referred to BP as a great community for RE discussing ideas.  So here goes.... warning: definite newbie so please excuse my ignorance. 

Property:

Property is a piece of land that allows for a primary dwelling + ADU. My estimate for the total cost after construction is probably 1.02M. The location is in Hawaii, near the beach and within major tourist spots.

Goal:

The thought is to live in the primary dwelling for X number of years (we really enjoy the location). During that time, we'll rent out the ADU as a vacation rental. I don't mind doing the work to run the vacation rental but I don't want it to be a full time job. I want to still be able to enjoy my evenings.

Numbers:

IF I calculated ROI* numbers correctly... with me living in the main unit while renting out the ADU only at about 40-50% capacity (since I don't want to overwhelm myself), I'll be generating a ROI of -7%. I imagine if I move out at some point, I might be generating 4-7%. Of course, these numbers could be higher if I spend more time filling the rental capacity closer to 100%. Perhaps with the help of a PM.

Worth it?

I'm sure the "is it worth it?" question is hard to answer given that there is certain level of emotional investment also. I suppose I could reword it and ask, is there a certain ROI range that is acceptable for a lived-in vacation rental? I don't really see a positive ROI being possible unless I push to 100% rental capacity. The amount of initial capital required will also likely keep me out of any future investments for at least a year or two.

I'm not real estate savvy.  I've only know buy and hold and that it's better than renting, lol.  I'm sure there's no right answer to it but hoping to hear some seasoned insight and experiences.  

Thanks!

* I am calculating ROI as

  • Initial Capital = Down payment + mortgage fees
  • Expenses = mortgage (interest) + insurance + taxes + HOA + rental expenses (10% of income)
  • Cash Flow = (Rental Income - Expenses) / Initial Capital
Originally posted by @David L. can offer some local experience.   If Bob can't help, attend you local REIA and ask other investors in the area what they are getting for vacation rentals.  

I would also compare the returns with the unit being a vacation rental vs a annual lease with a regular tenant.

Thanks, @Brie Schmidt .  I took your direction and did some calculations on the property as a LT rental and a ST rental.  I just did a quick browse on craigslist for properties nearby and found some potential rental numbers.  I also took the list of expenses from the rental property expenses blog post and tried making a more accurate expense number.

With those numbers, here's what I think the ROI comes out as:

  • Living in main dwelling + ADU as vacation rental @ 50% vacancy = -6%
  • Renting main dwelling + ADU as vacation rental @ 50% vacancy = 9%
  • Renting main dwelling + ADU as separate LT rentals = 7%

From what I've read, more expensive units are considered decent if they have a solid 7-9% ROI? So, if I ignored the "living in" number and concentrate on the rented out numbers, this should be considered a decent deal?

Originally posted by @Brie Schmidt :
 That is so hard for me o answer because I know nothing about Hawaii.  So what is considered good there is totally different than with is considered good by me.  

Ah, ok. I wasn't sure if there was a general number / range that constitutes a good ROI. Thanks for clearing that up.

@Brie Schmidt Thanks for the shout!

@David L. recommended (when smart people like her make recommendations, I always listen!).  Be cautious on the expenses though -- very unlikely you will ever approach a 50% expense ratio in Hawaii since there are no heaters, air conditioners, and vacancy is non-existent.    

I invited a friend to help build it with me, and you can read more in a series of blog posts here.  I would recommend a couple things:

1.  if you are on a tight timeline, hire an expediter to pull permits.  It was the best $1200 I spent on the project.

2. Size matters - you'll get the most bang for your buck if you build a smaller ADU (like 300-350sf). I analyzed several size scenarios, and the smallest one had the highest ROI.

3.  Don't skimp on electrical or plumbing since those are required to be done by a licensed person, but all the other stuff you can do on your own if you are so inclined.  Also, you should be able to find some great materials on CL for cheap.  There's some suggestions for saving money in the link to the blog above.

Is 7% a good return? That's a different answer for every investor.  When you are projecting returns, you should have a benchmark to compare against.  It would not be a good return for me, because of the credit and liquidity risks of real estate.  I think (long term) the stock market (VTSAX) will do 7% with much better liquidity, no work, and no credit risk ... so I would not do a deal if it was only 7% return.  If it was a negative return, I would definitely not do it ... unless it was more of a flip and you were expecting a quick sale after you pick up the value boost from an addition.

Best of luck!

Big mahalos, @Johnny Aloha !

Interesting point on the TVR permit issue.  I haven't really looked into it that much.  The property I'm looking into is actually in a visitor designated area so I wonder if I would still have an issue getting a permit.

Your comment about the ADU size is interesting. I take it since you were doing a long term rental, you still manage to get a kitchen in there? For some reason my assumption was that a kitchen would necessitate more space but perhaps not. Thanks for sharing that experience.

I agree with you on the 7% mentality.  Stocks can definitely give that sort of return much more easily and quickly.  Some how I had that in the back of my mind but I think my desire for the property some how pushed it out of the way. 

I suppose my last thought is, what about appreciation?  I notice most folks here don't really include that into any of their evaluations.  And I can understand why - it's difficult to predict or analyze.  It really does seem like a gamble but I would think that this place will appreciate.  

I guess the hard part of this all is, I really like the location and really want to make it work.  But the truth of it all is, it's not really a good deal.  It's not a negative deal, but not a great deal.  But perhaps that might be "good enough" for a place that we really like.  Tough decision.  Thanks for your insight!

Actually, I just finished reading the MMM blog posts and answered some of my own questions.  What a great and informational piece.  Thanks for sharing that. 

I also am half way through @Brie Schmidt 's podcast where they talk about appreciation and the 1-2% rule. Seems like if I wanted to make this property worth it, I would likely have to do ST rental for both the main dwelling and ADU at as close to 100% capacity as possible to follow the 1% rule. Hopefully I'm calculating everything out correctly.

Learning a lot and finding I'm asking a bunch of questions that have answers sprinkled all over the place.  Lots to learn, so little time.  Thanks for the guidance thus far. 

@David L. You still need to do a lot more research before you do anything. You will only be granted an ADU if you are living there (have a home exemption) and have a minimum 6 month rental lease. If not it is illegal, so no vacation rentals are allowed. If you are building a duplex or CPRing the property that is different from a ADU. ADU are restricted on the size it can be depending on zoning. If you go this route you will be able to do a vacation rental, but you will have to pay regular taxes, hotel taxes, and because you stated the property would cost $1.2M market value will most likely be over a $1m putting you in a Res A tax bracket for property tax (about double the regular rate), unless this is in a commercial zoning. Also when you say kitchen, a kitchen is a place where you can heat, cool/store, and clean/rinse. A wetbar is any of those 2, so there is a minimal difference in size. What many people do is get around having 2 kitchens by having a wetbar with a sink and fridge then after inspection passes give the tenants a stove top or hot plate. Essentially it is an illegal rental but the structure is legal so you wont have any resale problems.

Hope this helps you in the right direction so you dont waste your time and money on something that you thought was possible but ends up not.

Awesome information, Royce.  Thank you.  From what I've found, the subdivision I'm looking at is zoned / cleared for ADUs as long as the build conforms to the guidelines.  There are several lots that have already built also.  From what I understand, the subdivision is within the Visitor Designated Area and this eases doing a vacation rental but I admit that it is something I need to research more on.  Not a whole lot of information out there so might need to call some folks.

As for the taxes, is there somewhere I can look up to dig into this further?  Briefly looked at the hawaii property tax site and I see tax rates but not sure how I figure what bracket I put myself in.  You said I would probably be put in the Res A tax bracket ... just trying to understand how you determined that.

Thanks for that wetbar tip.  I'll keep that in mind when / if we get to that point!  Great tips.  Thanks again, Royce.

Originally posted by @Royce Talbo :

@David Leung You still need to do a lot more research before you do anything. You will only be granted an ADU if you are living there (have a home exemption) and have a minimum 6 month rental lease. If not it is illegal, so no vacation rentals are allowed. If you are building a duplex or CPRing the property that is different from a ADU. ADU are restricted on the size it can be depending on zoning. If you go this route you will be able to do a vacation rental, but you will have to pay regular taxes, hotel taxes, and because you stated the property would cost $1.2M market value will most likely be over a $1m putting you in a Res A tax bracket for property tax (about double the regular rate), unless this is in a commercial zoning. Also when you say kitchen, a kitchen is a place where you can heat, cool/store, and clean/rinse. A wetbar is any of those 2, so there is a minimal difference in size. What many people do is get around having 2 kitchens by having a wetbar with a sink and fridge then after inspection passes give the tenants a stove top or hot plate. Essentially it is an illegal rental but the structure is legal so you wont have any resale problems.

Hope this helps you in the right direction so you dont waste your time and money on something that you thought was possible but ends up not.

Originally posted by @Kawika Burgess :

Keep in mind that the ADU law limits rentals to 6 months minimim?

 Yes, I saw that in the guidelines.  However, the subdivision is within a visitor designated area, which I'm learning might be more a Kauai thing only.  Supposedly it allows for vacation rentals.  Something I definitely need to look more into.

@David L. Im sorry I thought you were on Oahu, Kauai is a different county and has different tax rates and different rules.  But as far as Res A (which I dont think Kauai has) it is for non owner occupants that have an assessed value over $1M pay a higher tax rate.

Since you are in a designated visitor area do you really need an ADU? Could you just build a rec room with a separate entrance, throw in a bathroom and rent it out like a hotel room? If you looking for longer term rentals like monthly then maybe throw in a wetbar too.

Originally posted by @Royce Talbo :

@David Leung Im sorry I thought you were on Oahu, Kauai is a different county and has different tax rates and different rules.  But as far as Res A (which I dont think Kauai has) it is for non owner occupants that have an assessed value over $1M pay a higher tax rate.

Since you are in a designated visitor area do you really need an ADU? Could you just build a rec room with a separate entrance, throw in a bathroom and rent it out like a hotel room? If you looking for longer term rentals like monthly then maybe throw in a wetbar too.

Hi Royce.  I actually looked up the tax rates and yes, you're right - we are different. Thanks for that guidance. It actually helps me clarify another part of the ROI.

As for the ADU, you make a good point. An ADU just seemed like a cleaner, separate way of doing this... which I still think it is but if budget is strained, I could potentially do what you're saying. If I wanted to adhere to keeping distance between the room and the main dwelling, perhaps I could do something along the lines of a room connected to garage on one side, then main dwelling connected on the other. Might save a bit more again on a single structure vs two.

To touch on part of your comment, yes, I do want to keep the option of doing a LT rental if the ST route proves to be too much work for me.  I'm a little weary on the kitchen vs wetbar debate simply on the idea of "feeling" I want to portray.  i.e. I don't want them feeling they're in a high scale neighborhood with a ghetto hot plate, lol.  But hey, maybe it can be done nicely and I just haven't seen it.

Thanks for the brain storming session.  It's brought up some great ideas.