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case study: the return of €300k holiday homes in Gran Canaria, Fuerteventura, Lanzarote - NO MORTGAGE
if you are looking for a case study with a 20Y mortgage, check this other post
Factors to consider when investing in real estate
Investing in foreign real estate can be an exciting opportunity that offers the potential for diversification, profit, and personal enjoyment. However, buying property in a foreign country requires careful analysis and consideration to ensure a successful investment. It's essential to understand the unique dynamics and factors at play in the international real estate market to make informed decisions. This introduction will highlight some of the main factors to consider when analyzing foreign real estate investments.
Economic and Political Stability
One of the fundamental factors to assess when considering foreign real estate is the economic and political stability of the country. Stable economies with sound political systems generally provide a favourable environment for real estate investments. Factors such as GDP growth, inflation rates, currency stability, government policies, and legal frameworks are crucial indicators to evaluate the investment climate.
Market Conditions and Trends
Analyzing the local real estate market conditions and trends is essential to understand supply and demand dynamics. Factors such as population growth, urbanization rates, employment opportunities, and market trends can significantly impact the profitability and potential for capital appreciation of your investment.
Legal and Regulatory Framework
Every country has its own legal and regulatory framework governing real estate transactions. It is crucial to understand the laws and regulations related to property ownership, foreign investment, taxation, and repatriation of funds. Engaging the services of local legal experts can help navigate these complexities and ensure compliance with all applicable regulations.
Location and Neighborhood
The location of the property plays a vital role in determining its desirability and potential returns. Factors such as proximity to amenities, transportation links, schools, healthcare facilities, and infrastructure developments can significantly impact the property's value. Additionally, understanding the neighbourhood dynamics, safety, and quality of life indicators is crucial for assessing the long-term prospects of the investment.
Currency Exchange and Financing Options
When buying foreign real estate, currency exchange rates can affect the overall investment return. Fluctuations in currency values can impact purchase costs, rental income, and potential profits when repatriating funds. Additionally, exploring financing options, such as local mortgages or international lenders, can help optimize your investment strategy.
Local Culture and Lifestyle
Understanding the local culture, lifestyle, and preferences of the target market can influence the demand and rental potential of the property. Analyzing factors like tourism, expatriate communities, and cultural attractions can provide insights into the property's viability as a rental investment or a personal retreat.
Risk Assessment and Due Diligence
Conducting a comprehensive risk assessment and due diligence is crucial before committing to any foreign real estate investment. This includes evaluating factors such as property title, construction quality, insurance coverage, environmental considerations, and potential legal disputes. Engaging professionals like local real estate agents, property inspectors, and surveyors can provide valuable insights during this process.
Most of these aspects of investing in the Canary Islands have been extensively reviewed in our previous post 9 Safe Reasons Why to Invest In Holiday Homes in the Canary Islands. Check it out!
Case Study
Introduction
As shared on our website's FAQ number 7, there are many factors that determine the return potential of a vacation property in the Canary Islands, but for the simplicity of this post, we will work out the calculations for three different properties within the same price range in three different islands, Gran Canaria, Fuerteventura, and Lanzarote. In this case, the investors are not financing through a mortgage. If you are interested in the same case, financed through, for example, a 20-year mortgage, please check out that specific blog post here.
The three properties are on the €300 000 sale price mark, and they all have at least two bedrooms, being able to host a minimum of 5 guests. They all have a terrace/garden space and access to their own or shared swimming pool. They are all located within the range of all expected amenities nearby, and no more than a 5 to 10-minute car ride away from the beach. They are all very much rent-ready, recently renovated with quality finishes.
Terminology
Cap rate
The Capitalization Rate is calculated by dividing annual net operating income by the cost of the asset (or its current value). As cap rates go up, the return on your investment goes down. Between 4% and 12% is typical and considered to be a good cap rate.
Cap rate = Annual net operating income (NOI) / property value or cost
Cash-on-Cash Return
Also known as cash yield, it is a common metric in the commercial real estate industry. The rate of return measures the annual pre-tax cash flow divided by the total cash invested. This figure measures the investment’s performance. Although there is no rule of thumb, investors seem to agree that a good cash-on-cash return is between 8% to 12%.
Formula
CCR = annual before-tax cash flow / total cash invested
Return-on-Investment
Return on investment (ROI), also called rate of return or yield, is a measure of the performance and efficiency of an investment. Real-estate ROI calculations attempt to capture amortization and appreciation to determine the return on different real property investments.
Formula
ROI = TOTAL RETURN (cash flow + appreciation + debt payment + depreciation) / TOTAL INITIAL INVESTMENT (downpayment + loan costs + acquisition + rent ready costs)
Return-on-equity
Return-on-equity (ROE) ratio calculates the amount of return generated in a particular year on the total amount of equity invested (or trapped) in a property. ROE gives you a more accurate return than ROI in years after the purchase because it's taking numbers from the current year for both the numerator and denominator. Every year, the numerator and denominator are changing. The big question that real estate return on equity (ROE) allows you to answer is “When is it time to sell?”
Formula
ROE = ROE = TOTAL RETURN (cash flow + appreciation + debt payment + depreciation) / EQUITY (down payment + Appreciation + Debt Paydown (Principal Reduction))
Comparison
Vacation Rental Property A: Gran Canaria
Located in Maspalomas. 2-floor, 2-bedroom renovated with own terrace, outside parking, and shared pool. 10 min bike ride to the beach. It is priced at €295 000, and the new owner invested €6000 to upgrade the facilities with a private hot tub and BBQ area. The initial cash investment (30% of the mortgage, 8.5% in closing costs, loan costs, taxes, and rent-ready expenses) adds up to almost €117 000.
Thanks to the upgrade on the property's amenities, the property keeps a high vacation rental occupancy rate (OCC) of 22 days per month, and gets rented at a 20% higher price than its closest competitors, setting the average daily rate (ADR) at €117 per night.
At this level, the property generates a gross income of €2831 per month or €33 972 per year. Including the Airbnb management services, the total operational costs of the property add up to 48% or €16 577.
Based on this real-life scenario, Vacation Rental Property A in Gran Canaria will generate the following types of returns in a 20-year period:
The capitalization rate for the total time is 6.02% for the total time, or 5.58% for the first 5 years. Note that a rate that falls between 4% - 12% is considered to be good.
Cash-on-cash return for the total time is 17.08%, or 15.73% for the first 5 years. Note that in general investors agree that a good CCR is between 8% to 12%.
Return on investment for the total time is 25.78%, or 23.89% for the first 5 years. Note that most real estate experts agree anything above 8% is a good return on investment, but it's best to aim for over 10% or 12%.
Return on equity for the total time is 22.88%, or 28.47% for the first 5 years. What is a good ROE? Think that the stock market has returned 8-10% on average over the long term. Also, private equity real estate deals should be able to make you 12 to 15% over the long term. Investing in real estate that can provide adds ROE above that, making it totally worth it.
Ok! But what if the property gets rented only 18 days per month? Even in that scenario, the average for the first five years is still very attractive. (1) Cap rate = 4.31%, (2) CCR = 12.15%, (3) ROI = 20.32% , (4) ROE = 24.21%.
Vacation Rental Property B: Fuerteventura
Located in a new area of the town of Corralejo, in the north of the island. It is 2 floors, and has 3 bedrooms. It is in great condition. It has its own terrace, parking, and pool, and it is a 5 to 10-minute car ride to the beach. It is priced at €310 000, and since the property already has a luxury upgrade, the new owner only had to invest an extra 1% to upgrade things like furniture. The initial cash investment (30% of the mortgage, 8.5% in closing costs, loan costs, taxes, and rent-ready expenses) adds up to a bit more than €120 000. Despite the short supply of this type of property and the high demand for them, we have assigned a conservative vacation rental occupancy rate of 21 days per month, at an average nightly price of €143 per night.
Based on this real-life scenario, Vacation Rental Property B in Fuerteventura will generate the following types of returns in a 20-year period:
The capitalization rate for the total time is 6.59% for the total time, or 6.11% for the first 5 years. Note that a rate that falls between 4% - 12% is considered to be good.
Cash-on-cash return for the total time is 18.17%, or 16.84% for the first 5 years. Note that in general investors agree that a good CCR is between 8% to 12%.
Return on investment for the total time is 26.67%, or 24.86% for the first 5 years. Note that most real estate experts agree anything above 8% is a good return on investment, but it's best to aim for over 10% or 12%.
Return on equity for the total time is 24.17%, or 28.47% for the first 5 years. What is a good ROE? Think that the stock market has returned 8-10% on average over the long term. Also, private equity real estate deals should be able to make you 12 to 15% over the long term. Investing in real estate that can provide adds ROE above that, making it totally worth it.
Ok! But what if the property gets rented only 18 days per month? Even in that scenario, the average for the first five years is still very attractive. (1) Cap rate = 4.99%, (2) CCR = 13.77%, (3) ROI = 21.79% , (4) ROE = 26.35%.
Vacation Rental Property C: Lanzarote
Located close to Playa Blanca town centre, in the south of Lanzarote. It is 2 floors and 3 bedrooms. It is in good condition, and it has its own terrace, parking, and pool. It is a 5-minute bike ride away from the beach. It is priced at €315 000, and since the property already has a luxury upgrade, the new owner only had to invest an extra 1% to upgrade things like furniture. The initial cash investment (30% of the mortgage, 8.5% in closing costs, loan costs, taxes, and rent-ready expenses) adds up to a bit more than €122 000. Despite the short supply of this type of property and the high demand for them, we have assigned a conservative vacation rental occupancy rate of 20 days per month, at an average nightly price of €153 per night.
Based on this real-life scenario, Vacation Rental Property C in Lanzarote will generate the following types of returns in a 20-year period:
The capitalization rate for the total time is 6.78% for the total time, or 6.28% for the first 5 years. Note that a rate that falls between 4% - 12% is considered to be good.
Cash-on-cash return for the total time is 18.69%, or 17.32% for the first 5 years. Note that in general investors agree that a good CCR is between 8% to 12%.
Return on investment for the total time is 28.35%, or 26.50%% for the first 5 years. Note that most real estate experts agree anything above 8% is a good return on investment, but it's best to aim for over 10% or 12%.
Return on equity for the total time is 25.69%, or 32.03% for the first 5 years. What is a good ROE? Think that the stock market has returned 8-10% on average over the long term. Also, private equity real estate deals should be able to make you 12 to 15% over the long term. Investing in real estate that can provide adds ROE above that, making it totally worth it.
Ok! But what if the property gets rented only 18 days per month? Even in that scenario, the average for the first five years is still very attractive. (1) Cap rate = 5.50%, (2) CCR = 15.16%, (3) ROI = 24.34% , (4) ROE = 29.43%.
Detailed Calculations
To enhance transparency and provide the reader with a chance to double-check the calculations behind these results, we provide access to an online spreadsheet. It is available here - https://bit.ly/3WVKDcd
Summary of Results
on that investment level, in the main tourist island of Gran Canaria (and also Tenerife), it would be difficult to find a property in good rent-ready condition with more than 2 bedrooms
3 bedrooms allow for more guests, than 2 bedrooms, increasing the rental income potential
on that price level, you get more space, better quality, and more own facilities in Fuerteventura and Lanzarote than in Gran Canaria
when it comes to return, the properties in Lanzarote and Fuerteventura are higher, mostly because you can host more guests, and you have better facilities that increase the average daily price of the rental
return is not much higher in Lanzarote and Fuerteventura than in Gran Canaria
in all three properties, the different types of return reach very positive levels making it great investments for cash buyers not needing to finance through a mortgage
Take-Away
Despite the extensive discussion surrounding the Spanish real estate market, the Canary Islands remain a secure and highly lucrative region within the European Union for property investment. Regardless of the desired income level of a property, it is crucial, beneficial, and strongly advisable to assess its potential earnings.
Engaging in this straightforward analysis allows you to gauge the associated risks and align your expectations for returns, thereby assisting you in selecting the most suitable property. The results of this assessment indicate that there is a growing demand for family-friendly luxury homes, which offer an optimal price-occupancy ratio. However, it is also evident that more affordable properties have the potential to generate remarkable additional income, making them equally rewarding investments. Several key factors contribute to these outcomes, including the properties' location, access to shared or private swimming pools, and the presence of family-oriented spaces.
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Are you considering investing in a holiday home in the Canary Islands? Contact Canary Home Invest and we will help you make a proper evaluation based on your property preferences, and return on investment expectations.
Wondering how's the purchase process, and the costs and taxes related to buying a property in Spain? Check out our 2022 guide to buying real estate in the Canary Islands.
Why Canary Islands, Spain, and not invest in foreign property elsewhere? Here are nine sound business reasons why it is not only a safe choice but also a rewarding one.