Why Buying A Vacation Rental Is A Big Risk Right Now And What To Do About It

About eight years ago, Americans saw big falls in their net wealth thanks to the mortgage and stock market crash. It was a trying time, and many people thought they’d never see their lost wealth again. If markets had been allowed to work, they wouldn’t have. But the Federal Reserve rode to the rescue as our collective knight in shining armor. It pumped trillions of dollars into the banking system to keep it liquid. And it then proceeded to suppress interest rates to near zero until the present.

House prices, therefore, never really collapsed. They briefly dipped down to levels the market could have sustained in 2009. But because of the Fed’s easy money policy and cheap mortgages, they soon jumped right back up. The amount that people have to fork out on down payments is still low. And the interest they’re paying right now on their mortgages is lower. It’s a bizarre economy, and something is eventually going to give.

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So why is any of this important for buying a vacation home? Just think for a moment what happened in Spain after the last housing crash. Thousands of properties were left vacant after demand for housing assets evaporated. Right now in Spain you can still visit enormous vacation housing estates that were abandoned in the wake of the crash of 2008/2009. But central banks didn’t learn the lessons of past bubbles. In fact, the real estate boom continues to this day. Central banks had recreated the economic conditions that prevailed before the housing bubble popped. And that means that vacation houses are probably overvalued. Because interest rates are so low, just putting money in the bank doesn’t offer a return. So trillions of dollars of savings are finding a home in real estate derivatives. It not because real estate is a great productive asset. It’s just an attempt by investors to find some sort of return on their money.

Life, however, must go on, despite concerns about the future. There’s still a demand out there for vacation homes. And we can’t sit around waiting for a collapse in the price of housing that might be a decade away. So what should prudent home buyers do?

Go With Your Head, Not Your Heart

The market for vacation homes is large. After all, the amount of money involved in each transaction is enormous. But that doesn’t mean that the market is going to remain stable. Many people buy vacation homes because they expect that the value of their assets will continue to rise. Their family or investors convince them that there is nothing safer than investing in property. After all, it’s bricks and mortar and will always be there. Even if the stock market goes to zero, your home will still be standing there, you’re told.

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But when you think about it more carefully, this logic is flawed. Sure your home will still be standing, but what about your equity? After all, it’s your net worth you’re concerned about. If your equity in your home goes negative, thanks to a fall in house prices, you’ll be paying over the odds for your mortgage. And that means you’re in big trouble.

That means that those investing in a second home need to be firmly rooted in reality. When thinking about buying a holiday home, it’s easy to get carried away in the romance. But at the end of the day, you should approach it as you would any other investment. If you expect the price to fall, perhaps you should consider some other way of getting the services you want from a vacation home without buying one.

Estimate Your Rental Income

If you purchase a vacation home, you’ll no doubt have to take out a second mortgage. (Unless you’re one of the few Americans who still has substantial savings). How will you finance that mortgage? Perhaps you can afford to let your vacation home lie idle while you’re not there. Good for you.

But most people will want to rent out their vacation properties to other holidaymakers to cover the payments on their mortgages. In theory, the cost of renting a home should equal the cost of the mortgage in the long run. But that’s only if the vacation home remains fully occupied. The problem comes when vacation homes aren’t occupied for big chunks of the year, like in the middle of November. This is when you stand to lose if you’ve planned on renting out.

Speak to an expert, like a local rental agency, and ask them what to expect. They should be able to give you a good idea of how full vacation properties get in the depths of winter, as well as demand in the summer. They may also be able to advise you on how to price in peak times to make back some of the money you’ll lose in other parts of the year.

Remember, the rental income you can expect from your home will fluctuate alongside home prices. If prices go down, so too will rental income. Remember also to factor in the cost of carrying out repairs on any property that you lease out. Conservatively, you can expect repairs to cost about 1.5% of the value of your property every year. On a $200,000 holiday home, that’s $3,000 worth of repairs. It’s not an insignificant amount.

Go Alternative

When you think about it, what’s the main reason you’re looking for a holiday home? In all likelihood, it’s not for the investment return. It’s about having an adventure. That’s why, in this uncertain climate, you might want to consider an alternative type of retreat. Yes, I’m talking about buying a mountain home.

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Mountain homes, or as they’re more commonly called, log cabins, are obviously a great base for adventure. More often than not, they’re closer to the action. But they also come with some substantial benefits.

For one, they cost less that your regular bricks and mortar home. That means that if things do go bad in the housing market at large, you’re in the hole for less. But also, these days they can be just as comfortable as regular houses. Sites like http://MountainHomeBuildingProducts.com/chinking-and-sealants/ sell chinking products that keep the elements out.

Understand The Tax Position

The government doesn’t like it very much when people buy second houses. Why? Because it increases the demand for houses and elevates prices out of the reach of first-time buyers. It’s not those wanting to buy a second home who are at fault here. It’s those who pumped up the prices of homes in the first place. The wealthy almost have to invest speculatively in property if they have any hope of maintaining their wealth.

Tax on second homes is, therefore, an issue. If you receive any rental income from renting out a vacation home, that’s subject to income tax. Then you may also face higher property taxes. That could be because property taxes are running higher in the area of your vacation property. Or it could be because you are penalized by the tax man, just for owning a second property.

There may be ways around these tax hike, like buying outside of city limits. But the best advice is probably just to plan for higher costs when you make your decision.

Buy Well Under Budget

As argued earlier, now probably isn’t the best time to go all in on a new house buy. Take some time to think about how much you really want to spend on a vacation property. Don’t go for the maximum that you can afford. Keep some of your assets elsewhere. Remember, your vacation home is not so much about the home, but the destination in which it resides.

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If you buy up to the maximum, you risk losing a far bigger chunk of your money should house prices come back down to levels that regular incomes can support. So buying a mountain home, or even a bungalow should be considered.

Rent First, Buy Later

Right now you probably imagine that you’ll use your vacation home a lot. After all, why would you spend so much money on it?

The problem is that real life usually gets in the way. There will always be things that interrupt a week- or month-long trip and force you back to your regular home.

The best thing you can do is rent first. Try it out for a couple of weeks and see whether you enjoy living at the new property. Get to know the area and find out whether it fits in with your way of life. Understand the seasonal variations of the area. Do you like it in the height of summer when thousands of tourists descend? Do you like it in the depths of winter when your only companion in a single grazing sheep? You’ll only find out if you spend some time there.

The bottom line is that the housing market is risky. Sites like www.zerohedge.com post articles every day suggesting that the party might be coming to an end. Yes, life must go on, but keeping realistic when it comes to buying a vacation home is important.

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