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Case study: ROI of €300 000 holiday homes in Gran Canaria, Fuerteventura, Lanzarote financed WITHOUT a mortgage
If you are looking for the case study using a 20-year mortgage, please follow this link
Key Considerations for Purchasing International Real Estate
Economic and Political Stability return on investment vacation home canary islands
When contemplating overseas real estate, it is essential to evaluate the economic and political stability of the country. Countries with stable economies and robust political systems typically offer favorable conditions for real estate investments. Key indicators like GDP growth, inflation rates, currency stability, government policies, and legal frameworks play a critical role in assessing the investment climate.
Market Conditions and Trends
To gain insight into the supply and demand dynamics, it is crucial to examine the prevailing conditions and trends in the local real estate market. Several factors, including population growth, urbanization rates, employment prospects, and market trends, can exert a significant influence on the profitability and potential for capital appreciation of your investment.
Legal and Regulation
Real estate transactions in different countries are subject to unique legal and regulatory systems. It is of utmost importance to familiarize oneself with the laws and regulations concerning property ownership, foreign investment, taxation, and the transfer of funds back to one's home country. Seeking the assistance of local legal professionals can be instrumental in navigating these intricacies and guaranteeing adherence to the relevant regulations.
Location and Neighborhood
The desirability and potential returns of a property are greatly influenced by its location. Key factors including its proximity to amenities, transportation links, schools, healthcare facilities, and infrastructure developments can have a substantial impact on the value of the property. Moreover, it is essential to consider the neighborhood dynamics, safety measures, and quality of life indicators to accurately evaluate the investment's long-term prospects.
Currency Exchange and Financing Options
Currency exchange rates can play a significant role in the investment returns when purchasing real estate abroad. The fluctuations in currency values have the potential to influence various aspects, including the purchase costs, rental income, and the profits earned upon repatriating funds. It is also advisable to explore different financing options, such as local mortgages or international lenders, as they can contribute to optimizing your investment strategy.
Local Culture and Lifestyle
Gaining knowledge about the customs, way of life, and inclinations of the specific market can have an impact on the desirability and rental prospects of the property. Examining elements such as tourism, expatriate societies, and cultural landmarks can offer valuable information regarding the property's suitability as a rental investment or a private getaway.
Risk Assessment and Due Diligence
Prior to engaging in any foreign real estate investment, it is imperative to conduct a thorough risk assessment and due diligence. This entails evaluating various factors including property title, construction quality, insurance coverage, environmental considerations, and potential legal disputes. Seeking the assistance of professionals such as local real estate agents, property inspectors, and surveyors can offer valuable insights throughout this undertaking.
The majority of these investment aspects concerning the Canary Islands have been thoroughly examined in our earlier publication, 9 Safe Reasons Why to Invest In Holiday Homes in the Canary Islands.
Case Study
Introduction
According to FAQ number 7 on our website, several factors contribute to the potential return of a vacation property in the Canary Islands. However, for the sake of simplicity in this post, let's focus on three properties within the same price range located on different islands: Gran Canaria, Fuerteventura, and Lanzarote. It's important to note that the investors in this case are not using a mortgage for financing. If you're interested in a similar scenario but with financing through a 20-year mortgage, please refer to our specific blog post on that topic.
All three properties are priced at €300,000 and feature a minimum of two bedrooms, accommodating at least five guests. Each property includes a terrace or garden space and offers access to a private or shared swimming pool. They are conveniently located near various amenities and can be reached within a 5 to 10-minute car ride from the beach. Additionally, all properties have undergone recent renovations with high-quality finishes and are ready for rental purposes.
Terminology
Capitalization Rate (Cap Rate)
The Cap 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 (CCR)
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%.
CCR = annual before-tax cash flow / total cash invested
Return-on-Investment (ROI)
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.
ROI = TOTAL RETURN (cash flow + appreciation + debt payment + depreciation) / TOTAL INITIAL INVESTMENT (downpayment + loan costs + acquisition + rent ready costs)
Return-on-equity (ROE)
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?”
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
Situated in Maspalomas, this 2-floor, 2-bedroom property has been recently renovated and features its own terrace, outdoor parking, and a shared pool. It offers convenient access to the beach, just a 10-minute bike ride away. The property is listed at €295,000, and the owner has invested an additional €6,000 to enhance the facilities, including a private hot tub and BBQ area. The initial cash investment, which covers 30% of the mortgage, 8.5% for closing costs, loan expenses, taxes, and rent-ready expenses, amounts to nearly €117,000.
Thanks to these upgraded amenities, the property maintains a high vacation rental occupancy rate (OCC) of 22 days per month and commands a rental price 20% higher than its closest competitors. As a result, the average daily rate (ADR) reaches €117 per night.
Given these circumstances, the property generates a gross income of €2,831 per month or €33,972 per year. Taking into account the expenses for Airbnb management services, the total operational costs amount to 48%, or €16,577.
Based on this real-life scenario, Vacation Rental Property A in Gran Canaria offers the following returns over 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.
Even if the property is rented for only 18 days per month, the average returns for the first five years remain quite attractive: (1) Capitalization rate is 4.31%, (2) Cash-on-cash return is 12.15%, (3) Return on investment is 20.32%, and (4) Return on equity is 24.21%.
Vacation Rental Property B: Fuerteventura
Situated in a newly developed area of Corralejo, a town in the northern part of the island, this two-story property boasts three bedrooms and is in excellent condition. It features its own terrace, parking space, and a pool, offering a pleasant living experience. Just a short 5 to 10-minute drive away, residents can reach the beach. The property is priced at €310,000 and has already undergone a luxurious upgrade, requiring only an additional 1% investment for furniture and other enhancements. The initial cash investment, including 30% of the mortgage, 8.5% for closing costs, loan fees, taxes, and rent-ready expenses, totals slightly over €120,000. Despite the limited availability of similar properties and the high demand for them, we have conservatively estimated a vacation rental occupancy rate of 21 days per month, with an average nightly price of €143.
In this real-life scenario, Vacation Rental Property B in Fuerteventura is projected to yield the following returns over 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.
Now, let's explore a scenario where the property is rented for only 18 days per month. Even in this situation, the average returns for the first five years remain highly attractive: (1) Cap rate = 4.99%, (2) CCR = 13.77%, (3) ROI = 21.79%, (4) ROE = 26.35%.
Vacation Rental Property C: Lanzarote
Situated near the town center of Playa Blanca in the southern part of Lanzarote, this property offers two floors and three bedrooms. It is well-maintained and features its own terrace, parking area, and pool. A quick 5-minute bike ride will take you to the nearby beach. With a price tag of €315,000, the property already includes a luxury upgrade, requiring only an additional 1% investment for furniture and other enhancements. The initial cash investment, encompassing 30% of the mortgage, 8.5% in closing costs, loan fees, taxes, and rent-ready expenses, amounts to just over €122,000. Despite the limited availability of such properties and the high demand they attract, we conservatively estimate a vacation rental occupancy rate of 20 days per month, with an average nightly price of €153.
Considering this real-life scenario, Vacation Rental Property C in Lanzarote is projected to yield the following returns over 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.
Even if the property were to be rented for only 18 days per month, the average returns for the first five years remain highly attractive: (1) Cap rate = 5.50%, (2) CCR = 15.16%, (3) ROI = 24.34%, (4) ROE = 29.43%.
Detailed Calculations
In order to promote transparency and allow readers to independently verify the calculations supporting these findings, we offer access to an online spreadsheet. You can find the spreadsheet by following this link - https://bit.ly/3WVKDcd
Results
At that particular investment level, finding a rental property in good condition with more than 2 bedrooms would be challenging on the main tourist islands of Gran Canaria and Tenerife.
Having 3 bedrooms allows for accommodating more guests, thereby increasing the potential rental income.
In terms of price, properties in Fuerteventura and Lanzarote offer more space, better quality, and additional amenities compared to Gran Canaria.
When considering returns, properties in Lanzarote and Fuerteventura tend to yield higher returns primarily due to their ability to host more guests and offer better facilities, resulting in higher average daily rental prices.
However, the difference in returns between Lanzarote, Fuerteventura, and Gran Canaria is not significantly higher.
All three properties demonstrate positive returns across various categories, making them excellent investments for cash buyers who do not require mortgage financing.
Take-Away
In spite of the extensive discussions regarding the real estate market in Spain, the Canary Islands continue to be a secure and highly profitable region for property investment within the European Union. It is crucial and highly advisable to evaluate the potential earnings of a property, regardless of the desired income level.
Conducting a simple analysis allows you to assess the associated risks and align your return expectations, helping you choose the most suitable property. The analysis reveals a growing demand for family-friendly luxury homes that offer an optimal price-occupancy ratio. However, it is also clear that more affordable properties can generate impressive additional income, making them equally rewarding investments. Several key factors contribute to these findings, such as the property's location, access to shared or private swimming pools, and the presence of spaces catering to families.
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Why would you hire us to manage your vacation rental property in the Canary Islands? Here are eight reasons why your holiday home is best managed by Hola! Hosts. Read the post.
Want to understand the Canary Islands' vacation rental industry a bit better? Here is our most current market analysis.
Ready to get in touch? We are glad to evaluate your property or help you find investment opportunities in the market. We make use of local industry data to identify the properties being sold that have the highest vacation rental potential. Contact us now!
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