Should I Buy A Vacation Property?
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Should I Buy A Vacation Property?

Imagine sitting on the lanai of your Hawaiian vacation home, overlooking the ocean while the sea breeze kisses your face as you pour yourself and your loved one another margarita. You’ve escaped the daily grind and aren’t checking any work e-mails until you return to the mainland a couple weeks later. If you’ve got a couple million dollars to spare, what a life!

Owning a primary home is a part of the American dream. But having enough money to own a vacation home might very well be an American fantasy. Who actually has a vacation home? And what questions did they address before taking the leap? We discuss these issues and more in this post.

According to a 2014 National Association of Realtor’s Investment and Vacation Home Buyers Survey, vacation-home sales accounted for 13% of all transactions in 2013. NAR’s analysis of U.S. Census Bureau data also shows there are 8.0 million vacation homes and 43.7 million investment units in the U.S., compared with 74.7 million owner-occupied homes. In other words, roughly 11% of primary home occupiers also have vacation homes.

The typical vacation-home buyer is 43 years old, has a median household income of $85,600 and purchased a property that is a median distance of 180 miles from his or her primary residence, according to the NAR. For those of you who live in New York City, perhaps a vacation home in The Hamptons or The Jersey Shore are desirable locations to choose from. For others who live in the San Francisco Bay Area, Napa Valley, Santa Cruz, and Lake Tahoe are popular destinations. Only 34% of vacation homes in the survey were over 500 miles away.

Let’s focus on some things to think about before you consider buying another piece of property.

Related Post: What You Need To Know Before Buying Rental Property

Vacation Property Considerations

Here are a few questions you should consider before purchasing a vacation home:

1) What are the alternatives? Before buying a vacation property, compare what other properties you could rent for the same cost of owning your property. Owning property will include property taxes, maintenance costs, time, effort, insurance, and a mortgage if you do not pay cash. You’ll also have to pay homeowner’s dues if you purchase a time share or condo. Make a realistic assessment of the number of days of planned usage and divide by the annual cost of ownership to come up with a rental cost per night. Now look on online at various sites like VRBO, AirBnb, and Expedia to see what else is out there in the same price range.

2) How often do you truly plan to use the property? Most American workers average 3-6 weeks of vacation a year, excluding those who are able to work from home. Do you really want to spend all your vacation days at one place? Or would you like to visit different parts of the world instead? It could be difficult to spend as much time as you’d like at one specific vacation property depending on your schedule and interests.

3) Does your vacation property have rental income potential? Rental income is a great way to support the ongoing cost of owning a vacation property during the 40+ weeks a year that you will likely not be there. There are services such as VRBO and vacation management companies that can help you earn income. The IRS tax laws even allows you to rent out your vacation home for up to 14 days a year without paying taxes on the rental income generated from those days. You might be able to deduct any uninsured casualty losses too, within limits, though you can’t write off rental-related expenses. If the home is rented for more than 14 days, however, you must claim the income.

4) Are you maxed out on your mortgage indebtedness? The IRS says you can write off a maximum of $1 million in mortgage indebtedness between your primary and qualified secondary home. If you are already capped out with a $1 million or greater mortgage on your primary home, then you can no longer write off your vacation property mortgage to your income. But if you rent out your vacation property, you are able to deduct the interest as an expense off of your rental income. Use Schedule A to make the deductions. See the IRS for more details.

5) Do you need to finance it? Getting a mortgage for a vacation property can be a tough ordeal. Banks are still quite strict on limiting borrowers to a 42% debt/income ratio. Meanwhile, the average credit score for rejected mortgage applications was around 729 according to FICO back in 2012.

6) Do you plan to own your vacation home for at least five years? Despite the proliferation of online real estate sites that help you find homes, real estate selling commissions have stayed stubbornly at 5%. Almost every other industry has seen a decline in transaction costs due to the Internet except for real estate. Given the high transaction costs associated with buying property, it’s best to own your vacation rental for as long as possible.

7) How strong is your income? A vacation property is largely considered a luxury purchase. The vacation property market is typically the first market to get hit during a downturn. And the vacation property market often suffers the biggest declines as well. During the financial crisis, many people not only suffered pay cuts, but they also lost their jobs and saw huge hits to their real estate portfolios as well.

8) Can you see yourself retiring in your vacation property? One ideal scenario is buying a retirement property long before you actually retire. If you absolutely know where you want to retire and have the financial means to afford a vacation property, then buying a retirement property decades in advance might not only bring tremendous capital appreciation, but a place where you’ll have already paid down your mortgage. The difficulty is predicting your tastes in the future.

9) What is your current net worth allocation? When the financial crisis hit, the average American saw their net worth get wiped out because property accounted for the large majority of their overall net worth. Each person’s risk tolerance is different. However, having more than 50% of your net worth in any single asset class, especially one where leverage is required may not be a great idea. Property is one of the least liquid investment classes.

10) Can other people benefit from your property? Perhaps you might only be able to visit your vacation property three weeks a year. But maybe your children, relatives, parents, clients, or friends can also take advantage of your second home. This goes back to utilization rates. If utilization rates are low, then perhaps it’s best to simply rent a home or a hotel room instead for a few weeks a year.

A Vacation Property Is A Luxury

Nobody needs a vacation property. It’s just nice to have one. Chances are high that you’ll be better off financially just renting instead. You’ll have a lot more freedom and flexibility to relax as well.

That said, there’s no reason why buying a vacation property can’t be a wise long-term investment. But in order to capitalize on your investment, you must either make a rental return, sell or retire there. It’s important to know ahead of time whether you are you really buying a vacation property for a better lifestyle, or are you simply buying an investment property to make money?

Finally, make sure your vacation property isn’t a hassle to manage. The more you have, the more problems that may ensue. You can only live in one place at a time. Here’s hoping you’re living exactly the way you want!

Readers, do any of you own a vacation property? Are you thinking about buying a vacation property? Do you think a second home is a good idea?

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The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.

Sam Dogen is the author of the new personal finance book "Buy This, Not That: How To Spend Your Way To Wealth And Freedom." Sam has been using Personal Capital to keep track of his finances for 10 years. He is the founder of Financial Samurai, one of the largest independently-owned personal finance sites with over one million visitors a month.
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