Can a Hermosa short-term rental pay its mortgage? The Review ran the numbers on a six-unit building now for sale. At market rates, the answer is a fairly clear no. We'll try to break it down for you.
Amidst all the current controversy, a Sand Section six-unit building now on the market advertises short-term rental potential. A Hermosa Review analysis finds that, bought with a typical mortgage, it would need to beat the local vacation rental market by about 22% just to break even.
The listing for 1500 Manhattan Ave. makes the pitch in its final selling point. The six-unit building, it says, is "located within the California Coastal Zone, offering the potential for future short-term rental use, subject to buyer verification of all applicable regulations and permitting requirements."
That potential is new. Since a Los Angeles Superior Court judge ruled in March that the city could not enforce its coastal-zone ban, Hermosa Beach has been registering short-term rentals west of the Greenbelt and collecting its 14% Transient Occupancy Tax from them.
The Review tested whether the numbers work. Assuming a buyer pays the $4,125,000 asking price with 25% down and a 7% mortgage, the building would lose about $71,000 a year as a short-term rental at typical Hermosa occupancy and nightly rates. It would break even only if every unit were booked about three nights in four, all year. City-wide, Hermosa listings are booked about two nights in five.
Hermosa Beach banned short-term vacation rentals in residential zones in 2016. On March 26, Judge James Chalfant ruled in Koerner v. City of Hermosa Beach that the ban could not be enforced in the coastal zone because the city never obtained Coastal Commission approval for it.
On June 4, the city told operators that short-term rentals are now allowed throughout the coastal zone. It directed them to register through a new online portal, obtain a business license and pay the 14% tax, including tax owed since May 2022.
In September the city filed notice of Ordinance 26-1502. According to its CEQA filing, the ordinance prohibits short-term rentals outside the coastal zone, "formalizes post-judgment STR status within the Coastal Zone" and adds registration, safety, nuisance and hosting-platform rules.
The city expects the tax to pay off. Manhattan Beach already collects between $1-2 million a year from its own short-term rental tax.
Built in 1962, 1500 Manhattan Ave. has six units on a 4,506-square-foot lot: one three-bedroom, two two-bedrooms, one one-bedroom and two studios. The asking price was cut by $125,000 on Oct. 29, to $4,125,000, or $896 a square foot.
A buyer putting 25% down would borrow about $3.09 million. At 7% over 30 years, that loan costs $20,583 a month, or $246,994 a year. Running the building as six vacation rentals adds an estimated $134,875 a year in fixed costs before a single guest checks in.
Annual fixed cost | Amount |
|---|---|
Mortgage principal and interest | $246,994 |
Property tax (1.18% of price) | $48,675 |
Utilities and Wi-Fi, six units | $25,200 |
Short-term rental insurance | $20,000 |
Capital reserve | $18,000 |
Repairs and maintenance | $15,000 |
Licenses, software and other | $8,000 |
Total | $381,869 |
On top of that, a professional manager would typically take about 20% of rent, and the booking platform about 3% more.
Published market data puts Hermosa's average nightly rate at about $400. Rabbu reported a $399 average at 41% occupancy across 90 active listings in April. AirROI reports a $408 average, a $313 median and 42.7% occupancy, with rates peaking in July and bottoming out in November.
The Review priced each unit by size: $520 a night for the three-bedroom, $360 for each two-bedroom, $275 for the one-bedroom and $210 for each studio. Fully booked, the building would earn $1,935 a night. After fees, it would need to average about $1,360 a night, every night of the year, to cover its costs.
The Review modeled three levels of demand. Each assumes busy summers and quiet winters, following the seasonal pattern in the market data. Cash flow after mortgage takes into consideration the management and platform fees, along with supplies, fixed operating costs and the mortgage payment.
Scenario | Avg. occupancy | Rental revenue | Cash flow after mortgage | Rate needed vs. market |
|---|---|---|---|---|
Conservative (near city average) | 44% | $333,212 | -$139,866 | 55% above |
Base (80% summer, 42% winter) | 58% | $428,078 | -$71,147 | 22% above |
Strong | 70% | $511,875 | -$10,590 | 3% above |
Even the strong case, with the building booked seven nights in ten across the year, leaves the owner about $10,600 short. To break even at market rates, occupancy would need to hold near 75% every month, including November through February.
An interest-only loan would not close the gap. It would cut payments by about $30,400 a year, but the base case would still lose about $40,700 a year, and such terms on commercial loans usually last only a few years.
In the base case, the owner would have to charge about 22% more than comparable listings all year. A two-bedroom that might rent for $468 in summer would need $569 a night, or $649 once the 14% tax is added. A studio worth about $158 in winter would need $191, or $218 with tax. Platform guest fees and cleaning charges would come on top of those prices.
The tax works against the owner here. It is paid by guests and passed to the city, so it never counts as the operator's income. But it raises the price guests see at checkout, which makes it harder to charge above the market. In the base case, the building would generate about $60,000 a year in tax for the city.
The listing's own figures show the building does not cover a 7% mortgage as a conventional rental either. It advertises a 4.11% capitalization rate "after available rent increases," which implies about $169,500 a year in net operating income. That is roughly $77,500 short of the mortgage modeled here. The listing's projected 4.82% rate "upon stabilization" would still leave a gap of about $48,000.
The Review's base-case vacation rental would net about $175,800 before the mortgage. That is about $6,300 a year more than leasing the units, in exchange for furnishing six apartments, near-constant guest turnover and less certainty about income.
Three other factors cut against a quick conversion.
The numbers point to a split market. For an owner who already holds a property, with a small mortgage or none, a vacation rental can add income on top of costs that are mostly paid. For a buyer paying today's prices with borrowed money, the same rental struggles to cover its debt.
That matters for how much the coastal-zone ruling changes Hermosa. If new purchases rarely pencil out as vacation rentals, growth in short-term rentals is likely to come mainly from existing owners converting homes they already hold, rather than investors buying buildings to convert.
It also bears on the city's revenue hopes. Each rental that registers adds tax, but the economics shown here suggest that buying and converting apartment buildings is not a straightforward bet.
The Review built a cash flow model using the asking price, 25% down, a 7% fixed rate and 30-year amortization. Operating costs are estimates, not quotes. Management is assumed at 20% of rent, platform fees at 3% and supplies at $15 per occupied unit-night. Cleaning fees are assumed to be charged to guests and are excluded from both revenue and costs. Nightly rates vary by season: 1.30 times the average in June through August, 1.00 in March through May, 1.05 in September and October, and 0.75 in November through February. Income taxes, depreciation, appreciation and financing fees are not included.
Sources
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