It’s that time of year, when legions of vacationers decide they want to take the plunge and buy a second home. And this year, perhaps, it may be especially true: The economy is firming up, interest rates are still relatively low and investment accounts are brimming.
So consider this a reality check. Whether people are looking for a spot to enjoy themselves, rent to others or resell for a big profit, there are many mistakes that could bring them big headaches or cost them a lot of money.
Experts and homeowners warn newbies, for instance, that they may end up putting in a lot more work than they expect—and taking on a lot of frustration—to keep renters happy. They can easily run afoul of rules laid down by local governments or homeowners’ association, or find themselves facing unexpected costs. And there’s no guarantee the rental or resale market will stay strong enough to justify the expense.
“Costs of owning and renting a vacation home can be very high,” cautions longtime real-estate investor Todd Huettner, owner of Huettner Capital, a Denver real-estate lender. “The hassles and costs of short-term vacation rentals are higher than most people expect….People are way too optimistic about rent rates, vacancies, management fees, maintenance costs and home-value increases.” Owners who live far away can also be surprised by climate-related issues like damaging snow loads in the mountains or corrosion from salt air at the beach, he says.
Caveats aside, many people have already sealed a deal. After slumping in the years after the financial crisis, prices of vacation properties are back where they were in 2006, a National Association of Realtors survey found. The median sales price of a vacation home rose by 4.2% in 2016 to $200,000, following a 28% gain as the housing recovery gathered steam in 2015.
And, of course, bad experiences aren’t universal. Many who work hard enough at managing their vacation properties can’t say
“I bought a vacation home because Lake Tahoe was either too expensive to book for a last-minute weekend or I couldn’t find any vacancies,” says Sabrina Robinson of Santa Cruz, Calif., four hours from Tahoe. She says she rents her vacation condo to tourists year round, devotes about two hours a week to managing the property, mostly to deal with cleaners and renter inquiries, and covers her mortgage and utilities with about $20,000 in annual rental income. The homeowners’ association does outside chores.
But even those who are successful have to put in a lot of effort to make it work—starting with careful thinking and planning before they take the plunge. Here are things potential buyers should consider, whether they are buying for pleasure, renting or as an investment.
Buy it for the right reason. The Realtors association surveys find that the primary motivation for a vacation-home purchase is vacationing. And many experts think that’s the best way to approach the deal. Rental income is so unpredictable it should be viewed as gravy, they say, and buyers certainly shouldn’t rely on it to cover their mortgage and other expenses. And the market is too unpredictable to expect to profit on a sale.
The approach with the fewest risks, many experts say, is for buyers to pick a place they will enjoy and focus on that as their top priority.
“Our buyers today are buying for a number of reasons, with the No. 1 reason being lifestyle and use,” says Nick Cassini, senior vice president of sales and marketing for Four Seasons Private Residences in Anguilla.
John Banczak, executive chairman of Turnkey Vacation Rentals, a property-management company, says that people who buy as a lifestyle choice “are the people that realize they love spending time in one place, may even retire there, have done the research and made the decision a second home is for them. Getting additional revenue through rentals is the icing on the cake.”
Pick a location that’s good for business. Although rental income shouldn’t be the top priority, it’s still going to be crucial for many buyers. So as with all real estate, location is key.
Sale prices and renter demand vary dramatically even within a given community, and not just because a beach-front property is going to be much more desirable than a property just a few blocks inland. For instance, a lot of construction may mean the location is hot—or that a glut will depress rent rates and sales prices.
“The owners that are most displeased are ones that rush the purchase decision because they are blinded by their dream,” says David Angotti, co-founder of SmokyMountains.com, a vacation-rental listing site in Tennessee. “For example, they fail to understand location, view, features and other amenities are critical to the overall revenue, and just want a vacation home.”
Another aspect of location to consider: how far the spot is from the owners. The National Association of Realtors says 57% of vacation properties are at the beach or lake, with the median distance 200 miles from home—far enough to require spending money for a manager and caretaker. Little chores an owner would do himself or herself at home can thus get costly.
“In our experience, living close is really helpful if something goes wrong, but there are a huge number of services out there to hold keys, offer concierge services or otherwise help if you live further away,” says Laura Hall, communications director for Kid & Coe, a vacation-rental website. “So anything is possible if you’re willing to pay for it.”
Don’t delude yourself about costs and profits. Even if rental income is only a secondary goal of buying, pros urge a clear-eyed analysis of the expenses involved.
Among the common rookie mistakes are focusing on purchase price, rental rates and recent market trends, and counting on more renters than are likely. Doing that means missing out on other crucial considerations that can eat away at earnings, such as costs for cleaning, management, routine maintenance and repairs. In some hot markets, homeowners-association charges can exceed $1,000 a month. Then there are real-estate taxes, insurance costs, utilities and perhaps state sales tax on rental income.
The same holds true for buying a property with the intent to sell it. Experts warn that only a reckless buyer expects a vibrant market every year. From the end of 2007 through 2012, primary-home prices dropped by 14.8%, vacation properties by 23%, the Realtors’ group says. Sales of vacation homes dropped in 2016 to 721,000, off 21.6% from the 920,000 in 2015. Mr. Cassini says there are fewer speculators in today’s market compared with the prerecession boom.
And, to underscore the risks, in 2016 foreclosures and short sales—when the lender settles for less than owed—accounted for 38% of vacation-property sales, compared with 9% for primary residences.
Don’t get tripped up by local rules. Local ordinances and homeowners-association rules can reduce the pool of potential renters. The association, for example, might ban pickups, motorcycles and pets, or mandate how much or how little time a property can be used for rental.
Then there are government regulations that may limit an owner’s flexibility. Will owners be able to ban college students planning to party on spring break? Possibly. But antidiscrimination laws limit whom they can say no to, forcing them to rent to guests they don’t want, like people with rambunctious toddlers that can boost cleaning costs or annoy neighbors.
Have a plan for getting renters. Finding, vetting and negotiating with renters is more work than many owners are willing to take on. So, many use a service to bring in business. But it’s important that owners understand what these services involve before they sign up. Real-estate agents often charge 18% to 25% of the rent, and sometimes much more, usually deducted from rent passed to the owner. And their contracts may even require commissions on renters who owners find themselves. They provide damage insurance and bar renters who have posed problems for other owners.
These days, many owners use online services like Airbnb, HomeAway and TripAdvisor ,but this industry is no longer a simple subscription-based advertising service. These outlets, which usually charge on a sliding scale depending on the rent rate, are evolving into full-service operations: They not only handle renters’ payments, but provide insurance to protect owners and automatically remind renters of payments due and return renters’ damage deposits.
Some listing services also dictate cancellation policies and other terms that many owners like to control themselves. And some listing sites withhold contact information from the owner and prospective renter until renter payments are received, to hinder off-site deals to avoid “service fees” that can cost renters hundreds of dollars for a week-long stay.
Watch out for tax traps. Federal tax rules offer deductions for mortgage interest, property tax, insurance premiums and many other expenses on second homes. But the rules are complex, and the biggest breaks generally go to owners who use the property no more than 14 days a year themselves, reducing benefits for owners who want to use their property heavily. And when it comes time to sell a rental, profits are likely to be taxed as long-term capital gains—and not sheltered like profits from a primary home—although many owners avoid that by converting a rental to a primary residence in retirement.
Your renters may do more vacationing than you. Business and pleasure don’t always mix, experienced landlords say. For maximum rental income, owners have to offer their properties during the peak summer or winter season, which may be when they want to use it themselves.
“If you’re going to essentially be competing with people interested in renting your home, then you aren’t…going to have much success,” says Adham Sbeih, CEO of Socotra Capital, a real-estate investment and lending firm based in Sacramento. “Even if you’re only trying to use your home for a week or so out of every summer month, that can create enough conflicts that it significantly reduces your ability to consistently rent the property out.”
Brace yourself for tenant demands. Renters expect perfection and won’t tolerate little annoyances that homeowners come to live with, like a balky ice maker or sticky door, and renters have no long-term stake in the property.
“Expect all the unexpected that arises when multiple people are rotating through the property and treat the property from the ‘I’m on vacation’ mind-set,” says Victoria Shtainer, an agent at the Compass real-estate firm in New York City who specializes in the Hamptons.
There’s also the question of guests who do things owners aren’t anticipating. Gail Lynne Goodwin, owner of two luxury rentals in and near Montana’s Glacier National Park, warns about things like “having a noisy guest that disturbs your neighbors, having a larger cleaning bill than anticipated, having a guest from Florida that wants to set the heat at 80 degrees, etc.”
And when owners use the property themselves, they may end up spending a lot of time with tenants on the brain. They may have to end their own visits emptying drawers, changing sheets, storing family photos and making trips to a storage unit with items they don’t want renters to use, like bikes, kayaks or the family silver.
So is buying a vacation rental a good idea? It can mean putting a lot of money at risk, more work than many buyers anticipate and headaches with renters. But those who have picked good properties in hot locations and have an ability to roll with the punches say they’re happy.
“Having a second home has been a dream come true and has also paid for itself,” says Ms. Robinson, owner of the California vacation home.