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Why (and How) You Should Invest in a Vacation Home

·8-min read

The vacation home landscape has changed significantly since the arrival of websites such as AirBnB in 2008, and the rebranding of Vrbo in 2019. Not only has a spare bedroom become a cash cow, people are learning that second and third homes can yield the best of both worlds. Rather than paying for pricey hotels on vacation, a second home can allow a homeowner the opportunity to enjoy a new city and become a seasoned real estate investor at the same time.

Although the flexibility of having multiple homes allows owners to pull off geographic arbitrage and unlock a variety of tax benefits, most people are intimidated by having another mortgage (that, and landlording). But the reality is that homeownership is a highly lucrative venture and, in most states, really straightforward.

Here are three reasons why you should invest in a vacation home, and three simple ways to get started today.

Three reasons why you should invest in a vacation home

Homeownership is a good investment.

There are many reasons to own real estate property, explains Christopher Liew, a CFA Charterholder and the founder of Wealthawesome.com, where he shares tips on money, travel, career, and real estate. He says that a vacation home, in particular, offers tax incentives, potential property appreciation, higher rental income (in comparison to long-term leases), ideal venues for gatherings, and the freedom to renovate or furnish anytime. While the latter two reasons reap benefits that might be hard to quantify, the former three are all about crunching the numbers.

The tax component can vary significantly based on where the home is located. For United States taxpayers buying U.S. properties, the IRS website can explain everything from property depreciation to tax breaks for military and clergy. There are a lot of breaks on the books, which can make mortgage payments and even visiting rental properties tax-deductible. For those buying abroad, it is important to keep in mind the tax regulations in both your home country and where the property is located. Expat tax advisors can help with the financial projections, especially keeping in mind property appreciation.

Simply put, appreciation considers how much the property will be worth in the future, whenever the owners might decide to sell or refinance it. Using historical data, it is relatively easy to guestimate a modest appreciation rate and build a vacation rental business around those figures. The reality is that short-term rentals, which typically range from a few days to a few months, outpace the income from long-term rentals, which typically extend beyond a year. Homes in major tourist cities like Miami, Lake Tahoe, New York, and San Diego see well-located residences rent better as vacation getaways, rather than a family's home base. After crunching numbers specific to your market, it is easy to see that owning a furnished home in a good neighborhood could be very lucrative.

Mortgage rates and down payments are lower for vacation homes than for investment properties.

Getting a loan is not as cumbersome as some might think, but it does take patience—and paperwork. Mortgage loan rates are lowest for those who have a good credit score and who plan to live in their homes all year round. Often, these owners can put down as low as 5 percent of the asking price in a downpayment. According to Bankrate, these loans are now hovering around 3 percent APR. Second homes tend to require at least 10 percent down and mortgage rates can be .05 to 1 percent higher than primary residence rates.

An investment property, on the other hand, can be purchased even while someone else is living in it, but the downpayment is usually between 20 and 30 percent down and those rates often reach 2 to 3 percent above primary residences. With this in mind, many people who have lived in their primary residence for over a year see great financial benefit in buying a new home for themselves at these low rates, and putting their existing home on the short-term rental market. Otherwise, if you crunch the numbers correctly, buying a second home outright could still yield great returns.

Melinda Satterlee of Marathon Wealth Management says that each person should review their own finances to see which mortgage product is best over the long-term.

"With current interest rates so low, you can leverage your investment by putting less of your own cash into the property and instead use the bank's cash to pay for your second home," Satterlee says. "When you use someone else's money to buy, you may be able to increase your returns. For example, if you discovered that the rate of return on real estate has been 7 percent a year and you're able to get a 4 percent rate for your loan, you will earn the 3 percent difference from the bank's money," she explains.

Owning offers more consistency than hotels and more flexibility than timeshares.

Hotels are consistently inconsistent. They shut down, get new owners, and book up. Furthermore, their prices are in constant flux, making them cheap buys for a weekend away in one season and extremely cost-prohibitive in another. Also, the rules around additional guests and pets can make it hard to feel completely at home. And we've all heard timeshare horror stories.

Lisa Ann Schreier, who calls herself the Time Share Crusader, reminds future buyers that there is a big difference between buying a vacation home and a timeshare. "First, a timeshare is never an investment, and purchasers can expect little or no resale value once it's paid off," says Schreier. "If there's still an outstanding loan on the timeshare, there's almost zero chance of being able to sell it."

Timeshares are typically purchased for a week or two per year, and sometimes there's the vague promise of exchanging it for access to another destination. In short, for people who want to constantly return to the same place, buying a vacation home is a smart bet.

Three simple steps to get started

Buy the traditional way: Use a realtor, find a home, and seal the deal.

Just as with buying a personal residence, vacation home purchasers can check websites such as Zillow, RedFin, Realtor, and MLS to research different markets and consider price points. Once you narrow it down to a few choices, it's time to talk to an agent.

Set up a phone or video call to explain what you're looking for, hope to achieve, and want to pay. It's important to share that you plan to rent out your home, so that the agent can confirm that the communities and buildings where you might be looking allow this type of arrangement. Many cities and homeowner's associations limit whether and for how long an owner can host a short-term renter, so it is imperative to verify this before buying.

If you're buying a home out of town or abroad, there are a few caveats. Consider that the title company may need you to e-sign documents or to give power of attorney to someone who can take care of this on your behalf. Also, if documents are in a language you're not entirely familiar with, hiring a lawyer, if not also a translator, is a must to provide a verified translation that you fully understand.

Co-own—and get a property manager.

The notion of buying a vacation home with a bunch of friends has enticed many of us at one point or another, but the idea of joint bank accounts, shared responsibilities, and conflicting schedules deter the majority. Now, there's Pacaso, which allows normal people to own a share in a property-specific LLC. The home is fully managed and designed specifically for co-ownership, bringing together a small group of co-owners to purchase a share of a single-family home.

In this way, owners get the benefit of a timeshare but none of the hassle of management details. With homes in the U.S. and Spain, Pacaso also offers property management, so you get the service of a hotel and easy bookkeeping for tax season.

Other sites, such as CoHome, offer a similar fractional ownership model for people looking to co-own a vacation property with like-minded people.

Invest, but don't become a landlord.

Corey Walters, the CEO of Here, says that now it is possible to invest in vacation rentals online and earn passive income anywhere in the world. Much like REITs and Real Estate Crowdsourcing, sites like his offer the option to own dividend returns from a vacation rental without the hassle of even setting foot in it.

"Vacation rentals consistently outperform every other class of real estate," says Walters. "These types of rentals have recently climbed the ranks of popularity due to their impressive rate of return," he explains. Investing in vacation homes is valuable because they offer more than one way to earn a profit. But landlording isn't everyone's thing; luckily, there are lots of ways to earn money from real estate without the traditional hassles or overhead of full ownership. The same is true for vacation homes.

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