Lakefront has never been so cheap. Resort condos sit empty. Is now the moment to invest in a vacation home?
Only if you have a very narrow definition of ‘invest.’
Financial advisers agree that a slim set of circumstances defines the window for buying a second home this year as an investment.
Do so if:
• You will not overweight your portfolio to real estate
• You can shoulder the carrying cost of the house on your current income – without relying on rental income
• You have sufficient savings to cover the carrying cost of the house if your income is reduced
• You are buying your eventual retirement home and you are confident you will be moving into it within seven years
“There are good deals out there. I’ll bet there will be even better deals in the next twelve months,” says Diane Pearson, a financial planner with Legend Financial Advisors, Inc. The Pittsburgh-based firm has many clients, she says, who own Florida condos – or want to.
Until the real estate bubble burst, vacation home owners often figured that a trophy house was a great parking spot for a wad of extra cash. What other asset lets you live in it while it gains in value?
That sweet spot has turned sour. Second homes should be considered part of your estate, but not really part of your investment portfolio, caution financial advisers. In fact, taken together, property taxes, maintenance, services and other fees can more than cancel out appreciation.
Many families are covering the cost of their houses by renting them by the week or month. A wide range of online listing services like TripAdvisor, HomeAway, VRBO.com and regional rental agencies let owners capture income by renting the houses short-term to vacationers or even corporate groups.
As quickly as homeowners have waded into renting to cover the carrying cost of the houses, local authorities have followed, sniffing out lucrative fees and licenses. (See the accompanying story for more on the licensing debate.) New layers of regulations have slathered on hundreds of dollars of additional fees, sapping the income that homeowners expected would cover the mortgage and costs.
But longstanding IRS regulations also lie in wait for vacation home owners eager to sluice some cash from their often-empty houses.
The rule of thumb is that you can rent your home for 13 days while still counting as the primary owner. Past that, your ambition lands you in a small business-like category in which you must track the income, expenses and taxes for your rental operation – even if you’re only renting out your own house.
Despite these hurdles, it might be worth buying your retirement home now. Sale prices of vacation homes have dropped in concert with those of the country overall…in some cases, as much as 30%. That, plus the wide array of houses to choose from, and low mortgage rates, might open a window for an affordable, gradual transition from work to retirement. You might be able to renovate and move at your leisure and take your time getting to know your new hometown.
Be sure to review your plans for second home ownership with your financial planner and tax adviser to avoid complicating your tax and estate arrangements. Often-overlooked points include:
• Assuming that the property and homeownership tax structure are the same as the rules you are accustomed to in your state of primary residence. Michigan, for example, extends a homestead property tax category to the primary home, but not to vacation homes. Some states are more generous, and some more stingy, when it comes to counting the value of the second home in your estate tax calculations.
• If you rent out the house for more than a couple of weeks, you must get landlords’ insurance, which is much more expensive than homeowners’ insurance. Not making the switch invalidates the policy, and you are vulnerable to covering the entire cost of repair or replacement if damage occurs.
That’s what happened to one of Martin Shenkman’s clients. Shenkman, a Paramus, NJ based estate planner and lawyer, relates that a client had a “beautiful beach house, which they rented out one summer. The tenant was a biker, and brought his motorcycle into the living room and changed the oil right there. The old oil dripped through the carpet, the floor and into the basement.” It cost thousands to rip up and replace the floors – an expense not covered by homeowners’ insurance because the damage was inflicted by a renter.
• Similarly, a heavy rental schedule might conflict with terms of your mortgage and you might have to convert to a commercial loan – on much different terms, says Shenkman.
• Finally, it might be prudent to put the house in a limited liability company to provide at least a nominal shield in case of a lawsuit. “That means that you aren’t sued personally,” says Shenkman.
Find the right vacation community for you!
Hate to admit it: selling by owner is more common for vacation home purchases, according to National Association of Realtors.