Real estate is back.
Prices have stopped their slow, agonizing slide south, and interest rates remain blessedly low. Both institutional and individual investors are on a tear, snatching up homes to turn into rentals, leaving homebuyers – especially first-timers – empty-handed in their wake.
Those low interest rates are sure attractive, aren’t they? They kind of make you think about jumping into the market yourself, maybe picking up a cute little vacation cottage on the lake. Before you get too carried away, there’s a lot more to investing in a vacation home than doing so because of a healthy, sexy real estate market.
How to Invest in Real Estate While Working a Full-Time Job
Many investors think that they need to quit their job to get started in real estate. Not true! Many investors successfully build large portfolios over the years while enjoying the stability of their full-time job. If that’s something you are interested in, then this investor’s story of how he built a real estate business while keeping his 9-5 might be helpful.
Crunch the Numbers
When thinking about buying a vacation home, crunch the numbers before pulling the trigger on the purchase. First, add up all the expenses for one year that you’ll encounter when trying to support a second home: taxes, insurance, utilities, maintenance, repairs, property management fees, HOA fees and your mortgage payment.
Add that sum to what you currently pay, annually, for those same expenses for your primary residence. Divide the result by 12 to determine the monthly outlay required to own the vacation home.
If you didn’t have to pick yourself up off the floor after reading that figure, congratulations! You might just be the ideal candidate for owning a vacation home.
Mark Purtell, owner of LeaseYourPlace.com, a website for landlords, suggests that you divide the annual expense of owning a vacation home by how many days you’ll use it each year. Compare that figure to what it costs to rent a similar home in the area. If it’s cheaper to own than to rent, it just might make sense to purchase.
Advantages of Owning a Vacation Home
Most of the advantages that come with owning a vacation home contain caveats – covered more thoroughly in the Disadvantages section, below.
If you don’t plan on renting the home out regularly, it isn’t considered an investment property, and you may get the same mortgage interest rate that you would were you purchasing a primary residence. There is also the possibility, depending on your particular circumstances, of being able to deduct the interest you pay from your income taxes.
If you rent out the home fewer than 15 days per year, you may be able to pocket the rental income tax-free, but you can’t write off any of the expenses.
The opportunity to realize income from renting out the property more often, however, is a big attraction for many buyers. After all, who doesn’t like passive income? If the home is located in a popular vacation destination where steady occupancy is more reliable, ongoing income can cover some of your expenses.
Then there is the chance that the home will increase in value, making it a sound financial investment.
Before you entertain visions of all the passive income you’ll make renting out your vacation home, understand that the business of vacation rentals is seasonal. Depending on where the home is located there could be a vast expanse of time where you aren’t bringing in any income.
If you are buying a vacation home to have a place for relaxation and recreation, you may have a rude awakening when reality hits. Many vacation-home owners complain that they end up spending their vacations performing repairs, upgrading, chopping firewood, landscaping and all the other chores that don’t get done while they aren’t there.
Remember, you are the homeowner – no matter how much or how little time you spend there – and homeownership brings with it certain responsibilities.
Get ready to plunk down a hefty amount of cash if you need financing for your vacation home – typically 30 to 40 percent of the purchase price. Second-home loans are considered riskier than mortgages on primary residences, so lenders have more stringent rules.
If the lender considers the home an investment property, expect to pay 1.5 to 2 percentage points more than you would for a primary residence. Of course, lender standards vary, and you’ll find some lenders that refuse to make second-home loans, others that actively solicit buyers for second homes, and a range of variations between the two extremes.
Finally, what look like tax benefits while you own the home – deducting depreciation, for instance – may be what John Girouard, author of “The Ten Truths of Wealth Creation,” calls a “tax time bomb.”
“If you’ve owned a rented-out vacation home and claimed the deductions you were entitled to for two or three decades, you could be in for an ugly shock,” he warns.
All that equity you thought you were building? It may be wiped out by IRS depreciation recapture rules when you sell. Girouard explains that the IRS imposes a tax on those depreciation deductions you took all those years you owned the home.
Get ‘em While They’re Hot
Almost half of vacation purchases are made with cash, according to the National Association of Realtors®. For these buyers, many of the downsides of owning a second home don’t apply. If you’ve stared those disadvantages in the face and decide you can swing it, the time to make your move is right now.
While real estate prices nationwide are still considered low, prices in some of the more popular states for second-home owners, such as California and Arizona, are on the rise. Expect prices in regions with low inventories, such as South Florida and the Hamptons, to rise more than the average this year, according to Jonathan Miller, president of Miller Samuel, an appraisal firm.
While 2013 is shaping up to be the year of the vacation home, and there’s an urgency to get into the market before prices rise even more, it’s important to take your time and talk to your CPA before making a final decision.
Shannon O’Brien is a staff writer for RealEstate.com. Her first love was real estate and she has over a decade of residential listing and sales experience.
Photo: Jeda Villa Bali