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Consider these Factors Before Investing in a Vacation Home

Tamara Lowenberg, CFP®

Partner & Managing Director

Last Updated
December 21, 2020

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. A dream home in your ideal setting that is used solely for family fun can be a very worthwhile purchase. However, be aware that a second home is a long-term financial commitment and be 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 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. 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 need to continue working for five or 10 more years to pay for it? 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. According to NY Times Article In July of 2010, a study by researchers from the European University Institute, Northwestern University and the University of Chicago concluded that the strategic default ( a practice of walking away from price depressed vacation properties) trend was “large and rising” among homeowners with an equity shortfall of $100,000. In 2010 strategic defaults accounted for 35.6 percent of all foreclosures, compared with 23.6 percent a year earlier.

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 the latest 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. 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 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.

At Creative Planning, our teams work with clients to identify their priorities and help them achieve their long-term financial goals. Our advisors consider your current financial situation, any challenges you face and your specific objectives as they build your personalized financial plan. If you have questions about your personal financial situation, please contact us.

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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.

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