Thinking of Purchasing a Vacation Home as an Investment? Read This First.
Owning a vacation home can be a great investment opportunity for the professional real estate investor or a homeowner who wants a secondary residence, but it does have some risk associated with it. Before you ever purchase a vacation home, you need to do your homework and plan accordingly.
Vacation homes and their areas is an entirely different animal when it comes to real estate, so even if you’re confident in your planning, thoroughness, and experience in investing in other areas, you should treat a vacation home as a completely new ball game.
Know what you’re getting into – and why.
Why exactly are you purchasing a vacation home, and what do you plan to accomplish? Are you looking for a vacation home for personal use, future retirement, or as a long or short-term investment? In most investment scenarios, the property’s return is to be found in its ability to be rented out to vacationers as its value (hopefully) appreciates over time. Your goals here should inform not only your decision but also the research you do in planning towards it.
So using the given investment scenario as an example, you’d need to carefully consider your motives going in and formulate a plan. Before you commit to seriously thinking about buying, you’ll want to figure out the average nightly rate guests are willing to pay for a similar property and how many nights a year the property should be occupied. Once you have these two figures, you can easily find out how much income the property will bring in on an annual basis. When you compare the income to the monthly expenses, you should have a positive cash flow.
This arithmetic comes with certain caveats, though:
Do the math within the context of the unique economic climate of a vacation area.
As we mentioned a moment ago, you’re going to want to keep the economic quirks of vacation areas in mind, and then do the math on calculating returns. If you don’t, those returns can go negative in short order.
Vacation homes are going to have a unique set of expenses, owing in part to their distinct economic climate. Vacation areas tend to have high property taxes, ever-increasing HOA fees, and higher retail prices for goods and services (which you’ll feel when maintaining the home, or even visiting it for a few weeks).
In particular, do you intend to self-manage the property or hire a property manager? In a high-priced area this will cut into your profits considerably, which may change your calculus on how many days the property needs to be rented, which in turn may require you to spend more on maintenance as the property is more heavily used. Speaking of maintenance…
Maintenance is always important, but never more so than at a vacation home.
If you’re renting the property out to vacationers for short amounts of time, you’re going to have to come to terms with the fact that maintenance will wind up being a going concern. This is because A.) short-term guests may not always treat the property as well as they might treat their own home, and B.) only by keeping the property in good repair can you avoid more expensive renovations (or worse, devaluations) in the future.
Again, because of the high cost of services and materials in most vacation areas, that isn’t something you want to tangle with any more than is absolutely necessary. Thus, you will need to put money back into your property every year to keep it up and maintained. A good rule of thumb is that 1.5% of the cost of your home to be spent on repairs and general upkeep every year, but again, a higher volume of renters could necessitate a slightly larger allocation of funds for maintenance due to normal wear.
Location.
As with just about everything in real estate, it’s all about location, location, location. This is especially true for vacation homes because the only areas that have the highest potential for growth and value are already quite valuable. In other words, in the sort of area where you’re likely to see gains in the future, it’s unlikely that you’ll find a fixer-upper or a bargain for a quick resale. That’s just not the economic climate you’re going to be working in.
So a purchase in such an area is probably going to require a plan that functions on purchasing a property more or less at market value. There are exceptions to the rule, obviously (more on that in a minute), but your investment model needs to reflect the nature of the market.
Timing is everything, and short-term gains are almost nonexistent.
For investors, vacation homes can have high payoffs but often not in the short term. This is partly because vacation markets are notoriously volatile and sensitive. When the economy takes even the slightest hit, luxuries like vacations tend to be one of the first things consumers give up. Vacation areas are distinguished by this sensitivity and their markets should not be considered in the same way you might examine a suburban residential one.
We also just touched on the fact that areas with the highest potential for growth already tend to be quite valuable but even so, timing is still everything. When consumers start taking vacations at decreased rates (something you can easily find out from surveys, travel booking agency reports, and even things like airfare), the areas at which they spend their vacations tend to take a hit, meaning that properties values may follow suit. This happened in the wake of the 2008 housing market crash to disastrous effect, when the volume of vacation homes on the market forced their value down so much that many mortgages went underwater and a slew of foreclosures and short sales.
Timing can be your best asset here, but it throws into focus something that’s worth emphasizing: most gains from owning vacation homes are very much long-term, and that’s how most plans should be designed and approached. The longer an investor holds on to a vacation property, the better their chances are of making money from it.
Final note: The risks are great but so are the rewards.
Properties in popular vacation areas usually tend to see higher-than-average appreciation, but turning a vacation property into a profitable rental tends to be an uphill battle. Owning a vacation home is a good investment if you do your homework and research. Take your time; buying any good investment is a marathon, not a sprint. Don’t be afraid to walk away from the property if you are not totally comfortable.
For more perspectives on real estate investment, check back with us each week as we post new blogs and be sure to sign up for our Priority Access List for advance listings and market updates. You can also keep up with us on Facebook and Twitter!
- Get It Right Solutions