Purchasing Rental Property on Maui – Summary & Definitions

This blog series has focused on our personal journey purchasing four properties on Maui.

Purchasing real estate here on the Island of Maui has proven to be one of the most exciting projects we have ever undertaken. If you have been following this blog series, you will see that there is a consistent thread in our approach to choosing a property for rental purposes. Our personal criteria have been:

1. The property would be newer, and would have the potential to appreciate in value.
2. The property would be rentable, allowing someone else to pay for it.
3. Rental income from the property would provide positive cash flow. The key to this was to come up with an appropriate down payment.

 
Keep in mind there are many correct ways to direct your approach to purchasing real estate in Hawaii. It is important to define your personal wants and needs, and then look to achieve those wants and needs within your budget.

Defining Your Wants & Needs

What is the purpose of the purchase?

1) Will the property be for full-time owner occupancy? There are several potential tax advantages for full-time owner occupants. Lower property tax rates and lower capital gains taxes upon re-sale are just a couple possibilities. Check with your accountant…again, check with your accountant.

2) Will the property be rented out as well as be used by you (the owner) for a period of time each year? Many buyers enjoy the use of their own property for vacation time each year in Hawaii, and rent the property out for the remainder of the year. There are potential tax ramifications with this approach, and you need to review this type of usage with your accountant.

3) Will the property be rented out full-time on a long-term basis? There could be the possibility for tax advantages such as depreciation when the property is rented out full-time. Also, there could be tax issues regarding capital gains taxes when the property is sold. It is very important that you explore all of these issues with your accountant.

Definitions

Long-Term Rentals:

“Long-term residential” or “long-term residential basis” means occupancy of a dwelling unit or lodging unit by an owner, family, lessee, or tenant for one hundred eighty days or more per year.[i]

Short-Term Rentals:

“Short-term rental home” means a residential use in which overnight accommodations are provided to guests for compensation, for periods of less than one hundred eighty days…”[ii]

Determining Your Budget

One of the most critical steps is to define your budget right upfront before you begin shopping. The budget might be comprised of several different sources. A couple of examples might be:

1. Cash
2. Mortgage

 
We looked at the amount of cash we could invest, and then we made up the difference with the proceeds of a mortgage. We needed to keep in mind that the larger the mortgage, the larger the payment. This would affect criterion #3; Rental income from the property would provide positive cash flow. The key to this was to come up with an appropriate down payment. In the event you are looking to obtain a mortgage, it is crucial to be pre-approved by a lender.

Definitions

Pre-Qualified:

“Getting pre-qualified is the initial step in the mortgage process, and it’s generally fairly simple. You supply a bank or lender with your overall financial picture, including your debt, income, and assets. After evaluating this information, a lender can give you an idea of the mortgage amount for which you qualify. Pre-qualification can be done over the phone or on the internet, and there is usually no cost involved. Loan pre-qualification does not include an analysis of your credit report or an in-depth look at your ability to purchase a home.

The initial pre-qualification step allows you to discuss any goals or needs you may have regarding your mortgage with your lender. At this point, a lender can explain your various mortgage options and recommend the type that might be best suited to your situation.

Because it’s a quick procedure, and based only on the information you provide to the lender, your pre-qualified amount is not a sure thing; it’s just the amount for which you might expect to be approved. For this reason, a pre-qualified buyer doesn’t carry the same weight as a pre-approved buyer who has been more thoroughly investigated.”[iii]

Pre-Approval:

“Getting pre-approved is the next step, and it tends to be much more involved. You’ll complete an official mortgage application (and usually pay an application fee), and then supply the lender with the necessary documentation to perform an extensive check on your financial background and current credit rating. (Typically at this stage, you will not have found a house yet, so any reference to “property” on the application will be left blank). From this, the lender can tell you the specific mortgage amount for which you are approved. You’ll also have a better idea of the interest rate you will be charged on the loan and, in some cases, you might be able to lock-in a specific rate.

With pre-approval, you will receive a conditional commitment in writing for an exact loan amount, allowing you to look for a home at or below that price level. Obviously, this puts you at an advantage when dealing with a potential seller, as he or she will know you’re one step closer to obtaining an actual mortgage.

The other advantage of completing both of these steps – pre-qualification and pre-approval – before you start to look for a home is that you’ll know in advance how much you can afford. This way, you don’t waste time with guessing or looking at properties that are beyond your means. Getting pre-approved for a mortgage also enables you to move quickly when you find the perfect place. When you make an offer, it won’t be contingent on obtaining financing, which can save you valuable time. In a competitive market, this lets the seller know that your offer is serious – and could prevent you from losing out to another potential buyer who already has financing arranged.

Once you have found the right house for you, you’ll fill in the appropriate details and your pre-approval will become a complete application.”[iv]

We discussed a few methods of obtaining cash in the previous blogs; refinancing our existing home and funds from our retirement account. We were comfortable redirecting funds from the retirement account (paper assets) into Hawaiian real estate (hard assets). This is something you would need to discuss with your accountant. In our case, we made back the taxes and penalties that were incurred within two years due to the appreciation in value of our properties.

Definition

Appreciation:

“Appreciation is the measure of how much a home’s value has increased over time. A home value can appreciate when the market conditions of a neighborhood improve and can also increase based on improvements made by the homeowner.

Homes generally appreciate following the same trends as comparable homes in the neighborhood.”[v]

Find the Perfect Property

The perfect property is different for everyone. For us, the perfect property met our wants and needs:

1. The property would be newer, and would have the potential to appreciate in value.
2. The property would be rentable, allowing someone else to pay for it.
3. Rental income from the property would provide positive cash flow.

 
In addition to the above list, we looked at these purchases as investments, and we financed the first three properties with investor mortgage products. As investments, we are looking to increase our equity in these properties. For us, this is currently happening in two ways:

1. Decrease in Mortgage Amount
2. Increase in Value (Appreciation)

Click on image to enlarge

You can see from the chart that after 5 years, $13,399 in equity gain was a result of the mortgage balance reduction, $162,400 was from equity from the original down payment, and $177,600 in equity gain was a result in appreciation, for a total of $353,399 in gross, pre-tax equity. After 5 years, equity grew $190,999. This example closely follows what we are currently experiencing with one of our properties.

Definition

Equity:

“Equity in Real Estate is a property right valued at the difference between the market value of the property and the amount of any mortgage or other encumbrance.”[vi]

More Information

For more information regarding real estate on Maui, contact:

Rick Wyffels, Realtor-Broker, RSPS
808-495-6092
rickwyffels@hawaiilife.com

Rick is a licensed real estate broker in New York State (30+ years) and is a licensed real estate broker in the State of Hawaii. He has been involved in residential development (Wyffels Road, Canandaigua, NY), has served on the Town of Canandaigua Planning Board, owned Wyffels Log and Timberframe Homes, and was involved in over 600 log and timber frame projects over a 30 year period.