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  • Writer's pictureFito Benitez

Case Study: Return of vacation rentals for holiday homes in the Canary Islands [2022 updated]

Updated: Jun 8, 2023



UPDATE


Market conditions change and so do results. Find our latest 2023 edition on this link.


Factors to consider when investing in real estate


No matter if you are an individual or an investor, you want to make the most out of your money. And buying real estate property at home or abroad is no different. When confronting such a situation, there are two issues to consider, risk, and return on investment.


Risk


There are different types of risks when buying real estate property. In the case of foreign real estate, we are going to focus on two.


The first type is related to the political, economic, and societal aspects of the country and region you are considering investing in. 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). While buying property and renting it does not build massive wealth, it is a safe option chosen by the wealthy since the term private property exists, and there are reasons why. On the one hand, the property tends to pay itself off with the rent made from it, and on the other hand, the value of the property itself will at least maintain throughout time, if not increased (depending on the location), while the debt runs off. And in recent times, with the introduction of platforms as Airbnb and the support of property management companies to run the properties as vacation homes, real estate investors have enjoyed a pump on the property's yield. Obviously, not all houses are created equal, and therefore they produce different yields, and this post and the available calculations will evaluate two different holiday home investments. To summarize its findings, after analyzing a series of aspects, the article provides some on-point argumentation to prove that the Canary Islands are a very safe and rewarding option when investing in foreign real estate property.


The second risk aspect is related to the exact location of the properties being considered. For example, while the main islands of Gran Canaria and Tenerife are normally the safest options, they are also where the prices of real estate are highest, especially for the properties that can attain the highest yields with vacation rentals. While investing in property in secondary islands like Fuerteventura and Lanzarote could increase the risk, doing it in well-established urban areas within those islands make it safer, and keeps the risk under control. For those interested in higher risk, and therefore higher rewards, it is also an interesting time to invest in the islands. In times of economic crisis, properties in new areas of urban development are normally the ones that lose the most value. If the investor can hold on to the property for a couple of years during recovery, the value of the property will get back to pre-crisis levels, as it happened after 2000 and after 2007.


Return-on-Investment


While buying property and renting it does not build massive wealth, it is a safe option chosen by the wealthy since the term private property exists, and there are reasons why. On the one hand, the property tends to pay itself off with the rent made from it, and on the other hand, the value of the property itself will at least maintain throughout time, if not increased (depending on the location), while the debt runs off. And in recent times, with the introduction of platforms such as Airbnb and the support of property management companies to run the properties as vacation homes, real estate investors have enjoyed a pump on the property's yield. Obviously, not all houses are created equal, and therefore they produce different yields.


Case Study


Introduction

As we have 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 FAQ's answer, we will work out the calculations for two different properties.


Both properties are located in Gran Canaria's main tourism location, Maspalomas. They both have a terrace/garden space and can host a family of four. They are both located within the range of all expected amenities nearby, as well as healthcare in tourists' local languages. The difference is that property A has a shared swimming pool and a less luxurious feel, while property B has a private swimming pool and all premium details.


Property A


It is valued at €250,000.00, and the new owner invested to upgrade facilities and include a private hot tub and BBQ area on the terrace. The initial cash investment (30% of the mortgage, 8.5% in closing costs, loan costs, and taxes, and 6% on rent-ready renovation) adds up to a bit more than €111K. Thanks to the upgrade on the property's amenities, the property keeps a high vacation rental occupancy rate of 25 days per month and gets rented at a 20% higher price than its closest competitors at €125 per night.

​At this level, the property generates a gross income of €3,125 per month or €37,500 per year. Including the Airbnb management services, the total costs of the property add up to 46% or €17,145.

Based on this real-life scenario, Property A will generate the following types of returns:

  1. The capitalization rate of 8.03% for the total time of the mortgage loan, standing at 7.25% during the first 5 years. Note that a cap rate that falls between 4% and 12% is considered to be good.

  2. Cash-on-cash returns at 12.36% during the total time of the mortgage loan, standing at 10.36% during the first 5 years. Note that although there is no rule of thumb, investors seem to agree that a good cash-on-cash return is between 8% to 12%.

  3. Return on investment at 27.64% for the total time of the mortgage loan, standing at 23.61% during 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%.

  4. Return on equity at 17.71% for the total time of the mortgage loan, standing at 28.70% during 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 22 days per month only, which is the industry average in the Canary Islands? Even in that scenario, the average for the first five years is still very attractive. (1) Cap rate = 6.31%, (2) CCR = 7.96%, (3) ROI = 21.21% , (4) ROE = 25.73%.


Property B


It is valued at €450,000.00, 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, and taxes, and a bit more than 1% on rent-ready renovation) adds up to a bit more than €178K. Due to the short supply of this type of property and the high demand for them, the property keeps a high vacation rental occupancy rate of 25 days per month and gets rented at a yearly average price of €275 per night.

​At this level, the property generates a gross income of €6875 per month or €82,500 per year. Including the Airbnb management services, the total costs of the property add up to 38% or €31,605. Based on this real-life scenario, Property B will generate the following types of returns:

  1. The capitalization rate of 11.65% for the total time of the mortgage loan, standing at 10.52% during the first 5 years. Note that a cap rate that falls between 4% and 12% is considered to be good.

  2. Cash-on-cash returns at 22.92% during the total time of the mortgage loan, standing at 19.80% during the first 5 years. Note that although there is no rule of thumb, investors seem to agree that a good CCR rate is between 8% to 12%.

  3. Return on investment at 38.75% for the total time of the mortgage loan, standing at 33.45% during 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%.

  4. Return on equity at 22.21% for the total time of the mortgage loan, standing at 36.16% during 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 a ROE above that, makes it totally worth it.


Ok! But what if the property gets rented 22 days per month only, which is the industry average in the Canary Islands? Even in that scenario, the average for the first five years is still very attractive. (1) Cap rate = 9.20%, (2) CCR = 16.16%, (3) ROI = 29.82% , (4) ROE = 32.19%.


Take-Away


While there is a lot said about the Spanish real estate market, the Canary Islands keeps on being a safe and highly rewarding EU region where to invest in property. No matter the degree of income you expect from the property, it is insightful, useful, and highly recommendable to analyze its income potential.


This simple exercise will keep you in check with the risk involved and your return expectations to help you choose the best property. From this exercise, it is clear that family-friendly luxury homes are gaining momentum and can offer the best price-occupancy ratio, but also that less expensive properties are also able to generate fantastic levels of extra income and make it a rewarding investment. Some common factors are the location of the properties, access to a shared or private swimming pool, and family-friendly 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.


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