The secret to never feeling homesick while on vacation is to simply buy a property in each of your favorite vacation destinations. So clever right? Well, that was what I thought until I blew my finances up buying a Lake Tahoe condo a couple years before the financial meltdown in 2008 – 2010.
Ever since I was a kid, I’ve been a dreamer. Most dreams never came true, but it didn’t stop me from fantasizing what could be. After I discovered San Francisco in 1995 when I went with a childhood friend to visit UC Berkeley, I knew I had to go West at some point. Life felt so much better than in Virginia.
Soon after relocating from New York to San Francisco in 2001, I discovered Lake Tahoe and told myself, if I could spend six months in San Francisco, two months back home in Honolulu, two months in Lake Tahoe, and two months traveling internationally, how sweet that would be!
A VACATION PROPERTY IS BAD FOR YOUR FINANCES
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. Roughly 11% of primary home occupiers also have vacation homes.
It sounds nice to have a vacation home, but I can assure you lots of issues randomly pop up once you own one. For example, I recently went up to my place in Squaw Valley for four days. When I entered, I found blue and green marker doodles all over my sofa and two sofa chairs! I couldn’t believe the tenant wouldn’t fess up to the damages, nor could I believe the housekeeping didn’t report the damage to the front desk and make the tenant pay.
My condo is being professionally managed. If I’m paying 25% of revenue to the property manager, I shouldn’t have to spend time inquiring about this incident.
Rental income is also highly contingent on the weather for ski season. These last four years have been pretty dry, causing very little income growth even as the economy boomed back in the Bay Area. At least there’s strong Spring, Summer, and Fall rental income, otherwise, I’d be losing at least $30,000 a year for the luxury of owning a property I only use at most five weeks a year.
QUESTIONS TO ASK BEFORE BUYING A VACATION PROPERTY
Here are a few questions you should consider before purchasing a vacation home:
1) Do you sleep around? I’m asking you figuratively whether you enjoy sleeping in different resorts. When you buy a vacation property, you are wed to that property until you sell. You’re going to be experiencing the same amenities over and over again for years to come. Alternatively, you can add up the annual cost of ownership, divide by the estimated days you’ll use the property over the years, and figure out where else you can go vacation with that type of money. Once you do, you’ll start get excited by the buffet of vacation options ready to take your money.
2) Are you a work slave? Most American workers average 2-4 weeks of vacation a year, excluding those who are able to work from home. Only after 10 years at one firm did I finally have the ability and the guts to take six weeks of vacation off a year. Before making Executive Director, I knew taking too much time off would be career suicide. Once I realized I wouldn’t be making Managing Director within my desired time frame, I decided to fully enjoy my company benefits. If you can’t escape work for more than four weeks a year, you’re much better off renting.
3) Can you make rental income from your vacation property? Banks are funny. They are much more stringent on mortgages for vacation and investment properties because they assume you require rental income to afford the mortgage. Meanwhile, you’re thinking to yourself, I can afford the place on my own, but if I can get rental income, that reduces my credit risk as a borrower!
Rental income is a great way to offset the ongoing cost of owning a vacation property during the 45+ weeks a year that you will likely not be there. 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. But at the end of the day, you must think like the bank and consider any rental income from your vacation place as a bonus. Only buy the vacation property if you don’t need the rental income.
4) Do you already have the ideal mortgage amount of $1 million? The IRS says you can write off a maximum of $1 million in mortgage indebtedness between your primary and qualified secondary home. For example, someone with a $700,000 primary mortgage plus a $300,000 secondary home mortgage should be able to deduct all of the mortgage interest from their income. If you’re shooting to go to the $1M limit, make sure you’re making at least $250,000 AGI to make the deductions worthwhile.
5) Do you plan to own your vacation home forever? According to the NAR survey, the average vacation property owner only plans to own his/her home for seven or eight years. That’s not a long enough time to withstand a potentially wrongly timed purchase and the ridiculously high 5% selling commission. Forever is a very long time. But I say if you don’t plan to own your vacation property for at least 20 years, I seriously wouldn’t bother.
6) Are you minting money like Oprah? Nobody needs a vacation property, just like nobody needs 10 pairs of jeans, 50 pairs of shoes, or $20,000+ automobiles. The vacation property market gets hit the hardest during a downturn as people let go of non-essentials first. Can you imagine losing your job, and losing a ton of equity at the same time? Not good. You better have multiple income streams, strong cash flow, and a financial backup plan if you plan to buy a vacation property.
7) Is your net worth properly allocated? If you’re thinking vacation property, you’re probably doing OK with your finances. Just make sure you don’t have greater than a 40% exposure to real estate if you want to sleep better. When the financial crisis hit, the average American saw their net worth get wiped out because property accounted for 80%+ of their overall net worth.
8) Will buying this vacation property make my life better? If you don’t think a vacation property will improve the quality of your lifestyle, then forget about it. I went the expensive route by buying a condo in a great location with a high HOA so I wouldn’t have to do anything to maintain my property. Buying a house would have probably been a better investment, but a house doesn’t have three pools, three outdoor hot tubs, a spa, a golf course, ski-in/ski-out access, and restaurants. I paid up for convenience and amenities because I was focused on lifestyle first.
DON’T BUY A VACATION PROPERTY
Buying a vacation property can be a wise long-term investment if you buy at the right time. But in order to capitalize on your investment, you must either make rental income or sell. If that’s the case, are you really buying a vacation property for a better lifestyle, or are you simply buying an investment property to make money? Hopefully you can do both.
For the large majority of people, buying a vacation property is a waste of money. You simply won’t use the property enough to justify the costs. The memories over the past eight years of ownership have been wonderful. But I sure wouldn’t mind having several hundred thousand more dollars in the bank right now!
Explore real estate crowdsourcing opportunities: If you don’t have the downpayment to buy a property, don’t want to deal with the hassle of managing real estate, or don’t want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today.
Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. For example, cap rates are around 3% in San Francisco and New York City, but over 10% in the Midwest if you’re looking for strictly investing income returns. Sign up and take a look at all the residential and commercial investment opportunities around the country Fundrise has to offer. It’s free to look.
Shop around for a mortgage: Check the latest mortgage rates online through LendingTree. They’ve got one of the largest networks of lenders that compete for your business. Your goal should be to get as many written offers as possible and then use the offers as leverage to get the lowest interest rate possible.
Updated for 2019 and beyond.