Families with disposable income and a penchant for travel may be tempted to purchase a vacation home investment to use personally or to rent to other travelers.
A vacation home could save you money if you use it a lot, especially if hotel and lodging costs are high in a destination you frequent, says Connie Brazier, who has helped vacation homebuyers with loans for 20 years at Quontic Bank in Miami. The potential for value appreciation, rental income and tax benefits can be a nice bonus.
But the costs of owning a vacation home can be higher than a primary home with upkeep and insurance, and buyers could mistakenly buy in a tanking area if they don’t do their research. If the numbers and circumstances work, now may be the time to snatch up a vacation home investment.
“For the most part, vacation rentals have not been immune to the inventory crunch in the residential market,” says Emile L’Eplattenier, a real estate marketing and sales analyst for the website FitSmallBusiness.com. “Worse, real estate investing, particularly fix and flip and rentals, has seen a dramatic resurgence in the last few years. … Great deals in the vacation market might become scarcer in the next few years.”
[See: The 10 Best Ways to Buy Real Estate.]
But before you rush to buy in at your dream oasis, consider the following:
You need cash reserves and an accurate cash flow projection. Qualifying for a vacation home mortgage requires disposable cash and a solid knowledge of its rental potential, if you choose to rent it out. If mortgaging the property as an investment, you’ll qualify by using rental income. That interest rate would be higher than a primary home purchase, Brazier says.
Rental income should be calculated to include expenses such as homeowners’ association fees, mortgage payments, vacancy rates, maintenance and capital expenditures in mind, says Brian Davis, a real estate investor and educator with SparkRental.com.
Get several pro forma income estimates from vacation property managers to help you get an accurate picture of potential cash flow. But keep in mind property management fees also tend to be higher among vacation rentals than long-term rentals “because of the extra work involved in rapid turnovers,” he says.
Property taxes can also be up to twice as much without the homestead exemption offered on a primary residence, says Adrian Nazari, CEO of Credit Sesame, a free credit and loan management platform.
There are tax considerations, too: If the property is solely for personal use, all mortgage interest, real estate taxes, points and private mortgage insurance are tax deductible. If used as a rental even part of the time, there are several possible tax scenarios, says Noel Dalmacio, owner of Dalmacio Accountancy Corp. in Irvine, California.
The vacation home is tax-free income property if you rent it less than 14 days per year (you also cannot deduct rental business related expenses for those days). If you use vacation home for personal use less than 14 days or 10 percent of the time the home is rented, then all rental expenses are deductible.
And if using the property personally for more than 14 days or 10 percent of the number of days it is rented, your rental deductions are limited to the amount of your rental income but mortgage interest, taxes and insurance are still tax deductible on your tax return.
[See: 8 Strategies for Investing in Real Estate.]
Think about seasonality. If keeping the property rented at a high occupancy rate is important to you, buy in a place that doesn’t depend on seasonality to rent. Don’t count on visiting too much in the high season, either: it will eat substantially into your income, says Melanie Narducci, a Realtor with the Real Estate Firm in Phoenix.
If you live far from the property, choose a manager wisely to help you get occupancy rates high and tenants happy.
“A great manager will make it a good investment and experience; a bad property manager will break you,” Narducci says. “Because this is brisk business there are plenty of property managers to choose from in this market.”
Purchase adequate insurance. You’ll want to make sure your vacation getaway is adequately protected, which means selecting limits for the policy that allow for completely replacing the home in the event of a catastrophic loss, says Pete Ducich, head of product development for Farmers Insurance.
“The investor also needs to consider purchasing personal liability coverage that addresses the ownership and rental of the property. For liability coverage, limits should be selected that protect all the investor’s assets and not just the rental property,” he says.
You’ll also want to see how the property’s location affects your insurance premiums, such as eroding beaches, hurricane damage, or crime. If the property is kept vacant there may be insurance coverage restrictions because the property is more likely to fall into disrepair, Ducich says.
Do your homework. Local knowledge is everything when considering the purchase of a vacation home, says Lance Marrs, broker at Living Room Realty in Portland, Oregon.
“If you’re purchasing a newly built vacation home, in addition to having it inspected during the inspection period of the sale, check references for the builder and their subcontractors to see if the builder typically builds in that area, specifically if it’s a coastal climate,” he says.
It also pays to think creatively when viewing homes in popular vacation destinations.
[Read: How Rising Rates May Affect Real Estate Investors.]
“If you’re looking at homes in coastal communities, remember that oceanfront homes not only command a premium, they are also subject to more foot traffic and noise,” Nazari says. “For your vacation getaway, you might feel more comfortable off the beaten path. Similarly, properties with commanding views fetch the highest prices — you’ll have to decide whether the view is worth the higher sticker price, or that you’d rather buy something less exclusive but still in the desired community. And don’t rule out fixer-uppers.”
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4 Things to Know Before Investing in a Vacation Home originally appeared on usnews.com
