PERHAPS YOU WERE VACATIONING IN A QUAINT MEXICO HIDEAWAY, AND YOU THOUGHT, “HEY, WHAT IF WE BUY A HOME HERE, AND RENT IT TO TOURISTS LIKE US? WE CAN RETIRE HERE WITH OUR HOME PAID OFF!” WHAT IF? IT MIGHT NOT BE A BAD IDEA. READ ON…
Sometimes it works out perfectly. Often it doesn’t. But with careful planning, it is possible to get some, or even a large portion of your vacation home expenses and costs paid for. This article will help you evaluate the real possibilities.
GOALS OF OWNING A VACATION HOME
What are your vacation home goals? This is a major investment, so you don’t want to rush into buying a vacation home on a romantic whim. Here’s an example of goals: “I want to use my vacation home two weeks every year over Christmas and two weeks in the summer. I want the rental income to at least cover my mortgage, and if possible, some of my other costs. In ten years I want to retire to my vacation home.”
Once you have a clear goal in mind, evaluate, evaluate, evaluate. Add up the costs of owning, the income you can produce from rents, the likelihood of getting the rents you need to cover costs, the cost of your down payment vs. simply holding that money in other investments until you’re ready to retire, and finally, the reason you think owning in this wonderful place outweighs simply renting when you visit.
Below is some guidance on each of these questions.
ADD THE COSTS OF OWNING (NOT INCLUDING DOWN PAYMENT)
Start with your fixed costs, which include your mortgage, property taxes, home owner association (HOA) dues, homeowner insurance, and liability insurance for a rental. Plus the cost of a property manager if you’re using one.
Then include your variable costs, which include utilities, maintenance, and rental operation costs (cleaning, finding renters, potential down-time, other expenses…some of which will be included in the cost of a property manager). The utility costs can include telephone, heating and air conditioning, electric, water, cable TV, telephone, etc. All of these costs will vary according to the location, the unique vacation home itself, and the number of services you’ll provide. Also include estimates for annual repair and maintenance.
EXAMPLE: Beach cottage in Mexico – $380,000
- Let’s say that your costs for this little slice of heaven include $1,400/mo for mortgage payments, insurance, HOA, and taxes. That comes to $16,800/yr.
- Your property manager runs $240/mo, or $2,880/yr.
- Variable costs run $165/mo for utilities (all), or $1,980/yr.
- Now add in a maintenance factor (which will depend somewhat on the type, age, and condition of property you buy), let’s say it’s $200/mo, or $2,400/yr. That’s money you want to put aside until needed.
- Also add one month of downtime, just to be on the safe side. If rents are $1,600/mo, that’s an extra $1,600/yr you need to put aside to cover costs when there’s a month with no renter. It happens.
- Your total to purchase and maintain this example vacation home would be $25,660/yr, or $2,138/mo.
You have to ask yourself if that’s a worthwhile expenditure. Will values rise in the location, so you can resell? Perhaps you’re afraid values will rise before you retire, pricing you out of that location? Are rents rising, so you’ll always be making money? These are the questions to ask before making an offer.
DO A REALITY CHECK – WHAT’S THE RENTAL REALITY?
The big question is this: If you need the home to pay for part or all of your expenses, how many nights will you need to rent it? Are you better off with a long-term renter who might pay a little less, or short-term vacation renters who might pay more, but leave gaps in your income?
The answer to these questions depend on a number of factors including the tourism draw of the area, the amenities of the vacation rental, and whether the location is a two season or one season tourist destination.
To learn about the best options for the properties that interest you, consider the following:
The first thing you will want to check on is the rental history of the vacation home itself, if it has been rented in the past. If that information is not available, then you have no choice but to estimate. Rental rates vary dramatically from one area to another, even street by street.
Some rental management companies will rent your property as part of a pool of available properties, and all the rental income from all the properties is pooled and divided equally among all property owners. If that’s what you’ll be doing, then your income results may be lower than if you were to rent it directly, so you’ll want to consider that in your estimates.
EXAMPLE: Mountain Cabin Nightly Rental (like Airbnb)
Suppose you find a nice mountain cabin in a ski resort area. You want to analyze the potential return based on making it into an Airbnb rental.
There are 365 nights in a year. Let’s say you want to personally use the cabin 30 nights per year. That leaves 335 nights available to rent it out.
A key factor that comes into play for nightly rentals is timing. Your property will not rent for the same amount each night of the year. It’ll vary based on the time of year, the day of week, and holiday seasons.
Consider that if you plan to use the best 30 nights of the year yourself, then you’ll potentially lose some of your highest income nights. You’ll want to adjust your averages if that’s the case.
Next, you’ll want to estimate how often you’ll be able to rent the property, and in what seasons and days of the week. Once you complete that analysis, you’ll have a better idea if this is a worthwhile investment or not.
Suppose your peak season is January and February. You can get a 75% occupancy during those 60 days. That means you’ll have it rented at peak rates for 46 nights.
Your two shoulder season months (60 days) may rent at about 50% occupancy, yielding you 30 more nights rented.
Now you’ve rented the property for a total of 76 nights.
Suppose the remaining months of the year (8 months), you can rent it every other weekend, but can’t count on anything during the week. That’s 32 weekends possible x 50% occupancy = 16 nights.
Now your rental nights total 92 nights out of 365. Suppose all your expenses come to $37,000/year. You’d need to get $402/night average (some more, some less) to make that work. That would have to be a truly amazing property!
Clearly, this would not be a great investment. Mountain cabins are harder to rent, and often have smaller high seasons than tropical properties (for example).
But this analysis gives you some idea of how to play with the variables.
Remember, this is just a first pass to help you dream and plan. You’d still want to review your figures with your accountant or financial planner. There are other factors to consider, such as rising rents or property values, your down payment, proximity to where you live now (so you can manage it yourself), and so on.
OTHER VARIABLE COSTS TO CONSIDER
This is not a complete list, but it includes some of the most common additional costs most people do not think about.
- Furniture and equipment used in the vacation home
- Linens and towels
- Goodies and other touches that make staying in your home nicer
- Special assessments by the homeowner’s association (such as roof repairs)
- Local taxes and assessments
Everyone’s tax situation is unique. You should definitely seek the advice of a tax professional before purchasing a vacation home. Depending upon your specific circumstances, you may find that a rental vacation home is tax advantage. There may be ways to use your property to create a tax advantage. Your tax professional can advise you about such things as trusts, depreciation and capital appreciation/gains.
Often vacation home owners find that rental operations cover some if not all of the annual costs while the appreciation of the property’s value over time can be substantial.
You may want to consider factoring in an annual appreciation percentage to determine the total financial picture for your vacation home investment. Depending on your goals, you may be able to refinance and lower your payments significantly in the future.
WHEN ALL IS SAID AND DONE…
Owning your own vacation home and renting it out can be a rewarding experience or a disappointment depending upon your expectations. When buying for a combination of investment and personal use, it is always good to have realistic expectations, clear goals, and the advice of your financial professionals.
Your tax or financial professionals might be able to help you prepare a budget forecast of the property over your holding period. He or she can project the revenue and costs, plus potential property appreciation. That forecast will give you a complete picture of the potential upside or downside for your investment.
If you or someone you know is considering buying a vacation or second home in our area, I can help locate ideal properties and provide the data needed to evaluate it.
Article From: Fast newsletters month reports July 2021