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Every summer, Americans fall in love, but not with a person — they fall in love with a piece of property and the idea of planting roots in a vacation spot.
The problem with falling in love with vacation property is that even when a vacation home feels like freedom, it can easily turn into a financial anchor.
Before you buy that second home, run the real math instead of the Instagram version that tells everyone they should have a picture-perfect home away from home.
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Is that vacation home worth the cost? The answer is different for each individual, but there are some things that everyone should understand before considering a vacation home purchase.
Ownership can cost more than buyers expect
Mortgages for second homes can be considered riskier by lenders, so they typically carry higher interest rates and fees. If you’re expecting similar interest rates on a vacation home with what you see advertised for primary home loans, you’re likely in for an unpleasant surprise.
Beyond the mortgage, second homes can have property taxes that are higher than the those on your primary home, not just because of location, but because the vacation home doesn’t qualify for a potential exemption as a primary residence.
Add increased insurance premiums (especially in coastal states) and the price of upkeep, and the costs can quickly add up.
Buying a vacation home can be right for some people, but it’s important to go into the process with a realistic view of the expenses associated with owning a second home.
Rental dreams vs regulation nightmares
If you think the solution to the extra costs of vacation home ownership is to become an Airbnb host, you might want to reconsider. Cities are cracking down on short-term rentals.
Some cities, such as Washington, D.C., have put strict licensing requirements in place for all short-term rentals. Others, such as New York City, generally prohibit short-term rentals unless the host is present.
Why? Short-term rentals can drive up rental prices in neighborhoods as the number of available long-term rentals decrease. It can become more difficult to buy a home as the inventory dwindles.
Some communities have sounded the alarm on short-term rentals when they feel their cozy neighborhood has become infiltrated by short-term renters who aren’t invested in the community. It’s a shift that makes them uncomfortable and has led communities to urge regulation or outright bans.
Before assuming that you can use your vacation home as a short-term rental to solve the problem of extra fees, research regulations in the area associated with short-term rentals.
The results might surprise you and could sway you from the idea altogether, or they might reveal that renting the home out short-term will be favorable.
Renting gives flexibility (and less risk)
On the other side of the short-term rental issue is the idea of long-term rentals, in which renters sign a lease and reside within the home.
- The upside is the income potential from rent and real estate appreciation
- The downside is that the home is occupied by tenants, so you can no longer treat it as a vacation home that you can visit and stay in on a whim
Timing the leases right can be a solution for long-term rentals. Suppose your plan is to eventually retire to your vacation home; you’ll time the lease to expire adjacent to your retirement so you can make the joyful transition to your vacation home as your primary residence.
Long-term rentals typically need less monitoring and maintenance since the residents will likely have more pride in where they live as opposed to a weekend stay.
That’s not to say that rental homes need no management whatsoever, but rather that long-term rentals don’t need the same rapid-fire maintenance and upkeep as a short-term rental, as when different people are frequently coming and going.
If you buy, buy smart and treat it like a business
If the numbers work, and you decide that being a landlord of either a long-term or short-term rental makes sense for you, structure it wisely.
- Explore liability protection strategies, such as an LLC or umbrella insurance. Much as you would do with a business, don’t personally assume the liability risk of renting a home.
- Track every deductible expense. There are tax deductions available to landlords, but only if you properly track your expenses.
- Consult your adviser if you plan to sell later. Your adviser can help you determine if the property will be eligible for depreciation benefits and a 1031 exchange.
A vacation home that becomes an investment property can be lucrative, but it’s not something you should do on a whim.
The same due diligence you’d do with any investment to ensure it works with your budget and goals is vital. A vacation home shouldn’t be an impulse buy.
Emotional ROI still matters
Return on investment (ROI) isn’t only about numbers and tax deductions. It’s also about reaching goals and living a life you’ve dreamed about.
Remember, however, that renting can give you the same sunsets as buying. Be realistic about what you’re getting yourself into, and don’t romanticize a vacation home as a dream purchase when you might actually be buying a bunch of maintenance obligations.
If owning a vacation home has always appealed, but the idea of managing a rental property doesn’t, there’s nothing wrong with buying a vacation home simply because it makes you and your family happy.
If the numbers work with your budget and you’re realistic about the expenses, a vacation home can certainly bring joy. A conversation with your adviser can help you decide if you’re ready for a vacation home and what that might look like for you.
