Picture this: you take a trip somewhere great and have an absolutely wonderful experience. You love everything about this place: the area, the climate, the people and just the overall ‘feel’ of being there. Then the inevitable question presents itself- wouldn’t it be great to have a little place here that we could retreat to any time we want? Next thing you know, you have a local real estate agent and are ‘running the numbers.’ It’s a done deal, we are going to do this and it’s going to be amazing.
SPOILER ALERT –buzz kill ahead.
In my nearly twenty years of helping clients “run the numbers” I have discovered that most of the time, the excitement of a second home is quickly squelched once they are faced with the reality of the financials. There are precious few scenarios in which purchasing a second home pencils out from a financial perspective, yet there is a myriad of ways that people try to justify this purchase regardless. Here are few of the most common:
Justification: “We will rent out our vacation home whenever we are not there.”
Reality: The best season to rent your second property will be the same season you will want to use it.
Justification: “What we receive in rent will cover the expenses of purchasing a second home.”
Reality: Start by adding up actual expenses, especially if you want to rent the property. You will find that the expenses of renting out a vacation property are significant: Property management, cleaning, maintenance, insurance, taxes, mortgage interest, etc.
Justification: “We will save money by not spending on other vacations.”
Reality: You will only be able to go to one place every time. What about visiting family and friends in other places (they can’t be expected to always come to you)?
Justification: “We’ll use our second home as an investment property.”
Reality: Depending on the area and timing, the capital appreciation (fair-market value) of the property will have a just-over-inflation kind of return.* Once you subtract all the expenses along the way, that ‘return’ will be significantly reduced. Furthermore, the house is an illiquid asset. It won’t do you any good in providing funds for your ongoing living expenses until you sell it.
Justification (very common where we live): “We need a place to go for the long, wet, cold winters.”
Reality: The price of maintaining two congruent residences is extremely high. Instead, I would encourage those looking for a winter getaway to consider one of the options below. None are perfect, but both are worth considering as a money-saving alternative.
|Type of Property||Pros||Cons|
|Can often trade for other properties if you want to try someplace new
Provides the feeling of familiarity without the total cost of ownership
Can usually be reserved each year for the same block of time
Smaller up-front cost
|Maintenance fees are ongoing (and ever-increasing)
Constantly subject to the “upgrade now!” sales pitch
Depending on the contract, may be difficult to trade properties without a significant outlay
Nearly impossible to get rid of (make sure you die before selling so the kids deal with it)
Annual payments and fees regardless of whether or not you actually use the place
|Type of Property||Pros||Cons|
|Vacation Rental||Gives you the freedom to go somewhere different every time if you choose- OR rent the same place each year
After your stay, turn in the keys and walk away (no maintenance or repairs)
No taxes, insurance, or mortgage interest
Rent any place that suits your needs- big or small depending on the size of travel group
Often far less expensive than hotels
No carrying costs
|Not guaranteed the same property on an ongoing basis (owner could sell, somebody else rents it, etc.)
Subject to a landlord and regulations/rules for use
In almost every case, the cost of either of the above options will be significantly less than the taxes, insurance, mortgage interest, maintenance and repairs that come with buying a second home to rent out. Upon considering all these factors, most people eventually come to the realization that a second home will be an outright expense or side business that never breaks even.
Take, for example, the following illustration that examines two similar properties in comparable locations. It is meant to be a simple illustration to give a ‘ballpark’ idea of the cost comparison between owning and renting a second home:
That said, there is a case to be made for owning a second home for a different purpose if you have the financial assets to make it happen without detriment to your overall retirement or longevity plan.
When to Purchase a Second Home
Buying a second home may be a good idea if the goal is to have a family legacy property that will be passed down as inheritance to your beneficiaries and used for generations to come. If this is your end goal, working with your financial advisor to build the expenses into your retirement plan is a great place to start.
Still, this is not a decision or goal to be taken lightly as the expense will be great. When this goal is a priority, there are a variety of ways to consider saving for this purpose, including:
- Work longer than you otherwise would. Consider working beyond your projected retirement date, with the sole purpose of saving all funds in excess of your needed amount for expenses.
- If you just can’t handle working any longer at your current job/business, then upon retirement, take a part-time job doing something you enjoy, saving 100% of that income into a “second-house fund.”
- It may be advantageous to ‘buy up’ in your primary residence for a few years. The thought would then be to sell the residence, which is more than you currently need and realize all (or most) of the capital gains without having to pay taxes on the proceeds up to the exclusion amount. There are several qualifying rules for this but the capital gains exclusion amount for primary residences is currently at $250K for single filers and $500k for married. Keep in mind that this exclusion is just for the gains portion of the sale, not the entire proceeds of the sale. You can then use these total proceeds to buy a new, smaller primary residence and your second home.
- Consider taking simpler vacations now, for the big reward of getting your second home later. Choose to cut your current vacation expenses by a third or even a half and invest the rest in a non-qualified account for your second-house fund.
In short, a second home can rarely be viewed as a wise financial investment, but in some cases, may be a way to leave a beautiful legacy for the future generations of your family. As always, every financial situation is vastly different, so if you are considering purchasing a second home, speak with your financial expert first to make sure you’re setting yourself up for success in the long run.
*According to a study done by the National Association of Realtors: The price of existing homes increased by 5.4% annually from 1968 to 2009, on average. This is also the same figure as new homes by the Census Bureau for a similar period. Once we adjust for the fact that homes get bigger over time, the annual rate is 3.7%. The general rate of inflation during this time was 4.5%.
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