Second Home -- a Good Idea?

      So my wife and I are finally traveling. We're vacationing in South Carolina and visiting children and grandchildren while we're here, as we've done almost every year since the kids moved down from New York in 2012.

     We always get our own place when we come. Their house really isn't big enough to accommodate us. Plus, we'd rather be out at the beach rather than in the suburban development where they live.

Our rental. Would you buy it?

     It only takes a few days for us to become accustomed to the Carolina beach lifestyle, which at this time of year involves throwing open the windows to the sea breezes, wearing t-shirts, and going out to the beach or up to the marina to watch the sunset.

     And it only takes a few more days before we start looking around and begin thinking about buying a second home at the beach -- or near the beach. Lots of other people do it. Why can't we?

     Just last night we ate outside at the Salty Dog Cafe. We were outdoors so we didn't have to wear masks. There was a nice breeze wafting off the water so we didn't even have to worry about Covid. After dinner we walked up along the boardwalk, got ice cream, then stuck around to watch the sun set over the sailboats. We strolled down the boardwalk, eyeing the condominiums that face the water and the sinking sun beyond. 

     This morning I recalled reading an article about owning a vacation home by Jeremy Kisner, director of financial planning at Surevest Private Wealth in Phoenix, AZ, who writes a blog Clear and Concise Financial Advice. I thought I'd better consult the piece to get a dose of reality. Is it really a good idea?

     Here's what Kisner says about second homes:

     I thought vacation homes sales would be breaking records since Baby Boomers are better positioned to buy them than any previous generation. A number of other factors should also be propping up the vacation home market: a strong economy, a decade-long bull market in stocks, low mortgage rates.

    However, vacation-home sales, despite having picked up within the last year due to the crosscurrents of Covid, have actually been relatively weak for the past decade. For example, price appreciation in popular vacation home areas lagged non-vacation home areas by some 10 percentage points from 2015 through 2018.

     One reason vacation home sales have lagged may be airbnb and other similar sites. These services have made it easy to find vacation rentals in desirable places -- without any down payment, mortgage or upkeep costs.

Jeremy Kisner

     Are you still tempted to buy a beach house, mountain cabin, or Gulf-side condo? If so . . .

Here are a few things to consider before buying a vacation home:

     Costs. The median vacation home price nationwide is over $200,000 -- higher in popular beach locations. In Delray Beach, FL, for example, the median house price is over $300,000. Even if that seems reasonable to you, do not underestimate the ongoing expenses. A modest home will likely have up to $1000 in monthly expenses (taxes, utilities, HOA, maintenance).

     Financing. Approximately 30% of second-home buyers pay all cash. The remaining buyers need to come up with a hefty down payment. Most banks require 25 to 30% down on a vacation or rental property. They also require a higher credit score and charge higher interest rates. This is because these properties have more severe default rates than primary residences.

     Insurance. Homeowner insurance tends to be more expensive for vacation homes than for primary residences, because vacation homes are at greater risk for damage or theft since they are not lived in year-round. You may be required to carry a "landlord policy" which can cost 20 or 30% more than typical homeowners insurance. In addition, many homes are in hurricane or flood zones. Due to more severe storms, flood insurance costs have gone up significantly in recent years.

     Renting it out. People who rent out their vacation homes do so for an average of 18 weeks per year, according to HomeAway, a vacation rental marketplace. Property management firms typically get 20 to 35% of the rental income. Or you can do the work yourself. Some people make a decent side income by renting out their guest house on airbnb or VRBO. However, it usually takes a few hours a week to respond to inquiries and coordinate check-ins, check-outs, reviews and cleaning services. For more information about potential rental income vs. expenses consult this rental income resource.

     Classification as a Rental Property. If you limit your personal use of your second home to 14 days, or 10% of the time it's rented, it can be classified as a rental (investment) property. That means you can write off most of the expenses (insurance, maintenance, utilities, interest, depreciation) against the rental income. If the result is a loss, it is typically considered a Passive Activity Loss which in most cases can be used to offset other income on your tax return. 

     Classification as a Vacation Home. On the flip side, your property will be categorized as a vacation home if it is used primarily for personal use. You do not get to write off all the expenses like you do with a rental, but you can still write off the interest expense as an itemized deduction assuming you meet the requirements. In addition, you can rent your place for 14 days or less and keep that rental income tax-free, with no extra reporting requirements.

     Second homes can be a great place to make memories with your kids and grandchildren. They can also be a major expense and/or commitment of time. So a piece of advice: the wealth-maximizing strategy for a second home is to have a friend or relative with a vacation home ... and then an offer to house sit.