Considerations of Purchasing a Vacation Home
Are you dreaming of a home on the beach? Or maybe in the mountains close to skiing and hiking? A place of your own where you can get away from the hustle and bustle of your daily life? It may sound like a dream, but before you leap into purchasing a vacation home, make sure you know what you’re getting into.
It’s important to be honest with yourself about why you want to purchase a second home. The way in which you view the property can have a significant impact on the type of home you purchase, its location and the expenses associated with maintaining it. Do you view the home as an investment property or a lifestyle asset?
Real estate investors typically take one of two approaches to making money from a property.
Renting the home
If you plan on making your vacation home available for rent, it’s important to be aware of the following.
Renters can be expensive. Many owners who accept short-term renters are shocked at how much damage can occur in a short period of time. Renters will not show the same care and respect for your home as you do. If you choose to rent, be prepared for additional costs related to property maintenance and the replacement of missing or damaged items.
Rental income isn’t guaranteed. There are many factors that go into how often and for how much you will be able to rent your property. If you’re dependent on a steady stream of rental income to cover expenses, you may find yourself in a tough situation. It’s best if you can cover the mortgage, maintenance, taxes and other expenses on your own and using any rental income as a supplement.
Renting takes time. There is a significant time commitment involved with listing, renting, and collecting fees on a rental property. Plus, maintenance issues have a way of cropping up at the most inopportune times. If you plan on renting your property, consider paying a property management company to do the heavy lifting. These companies typically charge 20% to 40% of the gross rental amount.
You may be held liable. If someone is injured at your property and you are found negligent, you could be sued for a significant amount. This could be millions of dollars, depending on the degree of negligence. Consider placing each rental property in a separate limited liability company (LLC) to protect your personal assets. LLCs are not difficult to create, but they can add complications in the form of costs, lender ramifications, recordkeeping, cash management, etc. If creating an LLC proves too onerous, consider adding significant personal liability (umbrella) insurance to cover the excess liability. It may be wise to add a $5 million to $10 million policy, depending on your risk exposure. The good news is that umbrella insurance is relatively inexpensive, typically $250 to $300 per year per million dollars of coverage.
Selling the home
If your plan is to enjoy the home for a certain number of years then sell it for a profit, it’s wise to consider the following expenses to help determine whether this approach makes sense given your specific situation.
- Purchase price
- Mortgage interest
- Closing costs (typically around 2% to 3% of the home’s value)
- Realtor commissions
- Ongoing maintenance (lawn care and landscaping, snow removal, trash collection, repairs, and other expenses)
- Property taxes (including potential future increases)
- Insurance (especially expensive for properties along the water where big storms can pass through)
- Maintenance fees, homeowners’ association dues, and/or special assessments for condominiums and homes in planned communities
- Utilities (gas, electricity, water, cable and internet)
- Furnishing and decorating (can add up to 10% to 20% of the home’s value)
- Travel expenses to get back and forth to your property
- Entertainment expenses when you are hosting friends and extended family
- Closing costs and realtors’ fees for selling the home (typically 6% to 8% of the home’s value)
Given these expenses, what price will you need to receive when you sell the home to recoup your costs? Is that amount realistic given the location and anticipated market environment? What type of profit can you expect? Is the expected profit significantly greater than what you would expect if you had chosen to invest those funds in a diversified investment portfolio instead?
Many people dream of owning a second home simply as a way to enhance their lifestyle. If your main goal is to purchase a second home as a lifestyle asset and you have the means to do so, go for it!
I believe my job as a wealth manager is to make sure you can afford this investment without negatively impacting your other goals, such as saving for retirement, educating your children, donating to charities or leaving a financial legacy for your loved ones.
If you’re evaluating whether it makes sense to purchase a vacation home, it’s important to first make sure you have enough liquid assets to cover your cash flow needs. The amount you may have to put toward your home purchase depends on your existing debt, current home and lifestyle expenses, and any other obligations, such as retirement savings, college expenses for a child or grandchild, child support, etc. You’ll need to balance these expenses against your income to determine if you have enough left over to comfortably purchase and maintain a vacation home. Once you have an idea of your net cash flow after expenses, consider the costs of purchasing, owning and maintaining the home. (See list of expenses previously.)
It’s important to truly consider all the pros and cons of purchasing a second home before taking the next step. The last thing you want is to end up regretting an emotional and impulsive purchase you made while on vacation. As with any major financial decision, it’s wise to consult with your wealth manager prior to purchasing a second home. He or she can help you crunch the numbers to determine whether a vacation home makes sense given your current financial situation and goals for the future. If you’d like help determining whether purchasing a second home is right for you, or for any other financial matter, please schedule a call.