Consider these Factors Before Investing in a Vacation Home
Why a Second Home is Not an Investment
Do you dream of owning a vacation home? Under ideal circumstances, owning a second home in a desirable location is a dream come true. However, all too frequently, owning a vacation home turns into a nightmare. Unexpected circumstances and high expenses such as mortgage payments, utilities, repairs, taxes, homeowners’ association (HOA) dues, and more have the very real potential to put a vacation homeowner in a difficult financial position.
Before buying a vacation home, consider the following:
#1 – Why do you want a vacation home?
The most common reason to purchase a second home is for vacations. Given the busy game/performance/travel schedule you likely face as a professional athlete or entertainer, a place of your own to get away can be especially appealing. While a dream home in your ideal setting that is used solely for family fun can be a very worthwhile purchase, be aware that a second home is a long-term financial commitment and make sure you know what you are getting into. From the moment you purchase your vacation property, you are giving it priority over other financial goals, such as planning for retirement and achieving financial independence. You automatically commit yourself to the expense and upkeep of a property that, most likely, is located far away from your primary residence.
Determine whether you are considering this purchase because you need a home or because you need an escape. If your true objective is to escape and relax, consider less stressful ways of visiting your ideal location, such as a short-term rental (Airbnb) or a nice hotel. This allows you to visit an oasis without the long-term commitment of owning a home.
#2 – Your investment priorities
If you are not already financial independent, determine how this purchase will impact your ability to get there as quickly as possible. Financial independence is the point in life when you have enough income (from investments, passive businesses, real estate, etc.) to pay for your living expenses for the rest of your life without having to rely on formal employment. Achieving financial independence for athletes and entertainers is especially important, as you typically have a much shorter career span in which to earn enough income to last a lifetime. Just like you wouldn’t take medicine without properly evaluating its side effects, you shouldn’t make a big financial decision before fully understanding the impact of that decision on reaching your other financial goals. What if buying a second home means that you can’t provide for your family should an unexpected event, such as an injury, derail your career earlier than expected? For many, the cost is not worth the sacrifice.
#3 – A vacation home is not an investment
A second home is rarely a good financial investment because it requires additional expenditures and does not pay income. In essence, you are committing your vacation budget to pay for property tax, insurance, maintenance, HOA fees and mortgage payments. In addition, during recessions, vacation homes tend to be the most sensitive segment of the real estate market. In the aftermath of the 2010 real estate crisis, one in three homes was a foreclosed vacation property, as there is tremendous price pressure on this segment of the real estate market.1
If you choose to make your vacation home available for short-term rentals to cover some of the expenses, keep in mind that rental income may only be enough to pay for taxes and insurance. In many cases, a property’s maintenance costs actually increase when it is rented out, and if you hire a property manager to secure your rentals, you will likely pay 20 to 30 percent of your earnings. If you choose to avoid the middleman property manager, be ready to field calls from renters at all hours of the day.
Depending on how much you charge to rent your home and if you are renting it more than you are using it, you may be able to write off a portion of the costs as well as taxes and insurance, but you must meet certain IRS qualification requirements.
Like most decisions related to real estate, location has a big impact. The COVID-19 pandemic is causing a large-scale migration from big cities to more remote, less densely populated areas. For example, the Lake Tahoe real estate market has seen an unprecedented increase in demand. According to a recent CNBC article, Lake Tahoe brokers are reporting an inventory that’s 10 times lower than average. Many homes sell within a day, receiving several above-asking-price offers.2 Don’t be caught up in a classic case of irrational exuberance!
#4 – Consider how often you will visit the home
Will your visits to your vacation home be frequent enough to justify the financial responsibilities? If you will likely only visit a week or two each year, it might not be worth the investment. If you must travel by plane to your home, also consider your travel time and airline expenses. A vacant home sitting in the middle of paradise is not serving its purpose of allowing you to relax and get away.
While purchasing a vacation is rarely the best decision from a purely financial standpoint, the time spent with family and friends in your own private paradise may be priceless. Ultimately, you can make more money, but you can’t make more time. If owning a vacation home will not greatly impact your ability to achieve financial independence and it will allow you to squeeze the most happiness out of your finances, then making that purchase may be just the right decision for you.
Creative Planning Sports and Entertainment is a specialty practice of Creative Planning. Each of our dedicated teams specializes in working with athletes and entertainment professionals and includes an attorney, a CPA and a CERTIFIED FINANCIAL PLANNER™ practitioner. These experienced professionals work with clients to develop personalized financial plans that take into consideration a wide range of factors, including their current financial situation, goals for the future and any challenges they may face. If you’d like advice about whether purchasing a vacation home is the right move for your, or for any other financial matters, please schedule a call.
Tamara serves as a Partner and Managing Director of Creative Planning, working directly with clients to develop and implement comprehensive financial plans to address their goals and most complex financial needs. Tamara practices in the areas of retirement planning, investment management, tax, estate planning, business succession planning, as well as corporate stock option planning, liability and risk management and charitable planning. Tamara’s approach focuses first on a thorough understanding of the client’s circumstances in order to provide a truly customized plan and investment approach to achieve their goals.
This commentary is provided for general information purposes only and should not be construed as investment, tax or legal advice, and does not constitute an attorney/client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.