A Vacation Home: Better to Rent or Buy?

Tuesday, April 28th, 2015

Should you just buy a vacation property rather than renting every year?

Let’s weigh some of the pros and cons:

The Good

Getting Started on a Retirement Home – If you’re a soon-to-be retiree, you can start building equity in a vacation property that you plan to ultimately live in during retirement. This also gives you a chance to test drive the area before permanently relocating.

A Space for Family Gatherings – By establishing your own corner in a desirable vacation spot, you can create a meeting place for family and friends. For many, maintaining a place to make these memories is a life goal in and of itself.

Opportunity to Subsidize Your Cost – No conversation about a second home is complete without a discussion of the potential for rental income. Reducing your expenses with rental income can go a long way toward making the dream a reality.

Tax Benefits – If you decide to rent out your vacation home, and depending on the amount of time you plan to occupy the property, the tax benefits associated with the rental activity can improve the cost-effectiveness of your purchase. Be sure to talk with an accountant or CPA when factoring taxes into your decision.

The Bad

Becoming a Landlord – If you buy a vacation property with the intent to rent it some of the time, you will be a landlord as well. Maintaining the booking calendar, marketing the property, handling cash flows, and resolving guest complaints are just a few of the responsibilities. Management companies will provide these services, but frequently at a cost of 30% to 40% of rental income.

A Cyclical Market – Rental traffic will ebb and flow with the state of the economy, desirability of the location, and, of course, the season. Many of your costs, however, will be fixed. Mortgages, HOAs, taxes, maintenance, and even cable bills are constant in good times and in bad. You must be able to bridge the financial gap when rental income lapses. This consideration can quickly erode the cost-effectiveness of owning over renting.

The Fine Print – Make sure you understand before you buy what you can and cannot do with the property. For example, some communities and HOAs have minimum stay requirements (e.g., one month) or may not allow rental occupancy of any fashion, putting a quick stop to the potential for rental income.

Opportunity Cost – Funds dedicated to a vacation home can’t be invested elsewhere. Real estate values, over a long time horizon, have historically appreciated near or slightly above inflation. In comparison, stocks have historically returned far more. You should consider the return trade-offs when putting your hard-earned cash to work.

Maintenance – Even if you decide not to rent out your vacation property, don’t underestimate the time, effort and money it takes to maintain a second home. When you are the renter of a vacation property, when your stay is over you can simply pack your bags and return the key.

The Conclusion

Each individual’s financial situation is unique, as is the investment potential of each property. The decision to purchase a vacation home may very well deliver value beyond what money can buy. However, we recommend you create your own list of pros and cons in the context of your personal financial plan before taking the leap.

Check back in two weeks for discussion on providing care for aging parents.