While there are different meanings of the term “fractional vacation home ownership”, in simple terms such ownership involves several buyers each holding an equal part of title to the vacation property. Fractional vacation home ownership differs from a timeshare in that with fractional ownership you own real estate whereas with a timeshare you have a right to use a property.

There are certainly drawbacks with owning a property with other people because there’s more than one opinion or voice in any decisions pertaining to the property. Yet for many people, the benefits outweigh the drawbacks. With this in mind, let’s take a closer look at whether it’s worth it to buy a fractional vacation home. 

What you Should Know Before Considering Fractional Vacation Home Ownership

Owning a fractional vacation property comes with some unique considerations. Knowing what you should consider before you jump in headfirst into a shared vacation home is important. Here are some things you should think about.

Understand What you Own

Before you buy into fractional homeownership, consider what you own. Is it a traditional ski resort model where you buy a quarter interest and get a quarter use of the property? In this case, you own part of the property, giving you ownership rights, like you would have if you owned a home.

Other ownership models like those of certain private residence clubs give you rights to the club amenities and services, but you don’t have any ownership rights to the property itself.

Rights and Liabilities

Before you buy a shared vacation home, understand the rights and liabilities you’ll have or incur. Do you have pre-determined usage rights where you get to use the property for a portion of the year or is it a pay-for-use situation where you pay for the time you use the property, as do your co-owners?

As far as liabilities or responsibilities, consider:

• Who manages the property?
• Who makes decisions on how the property is handled, renovated, etc.?
• Who pays the expenses? How are they divided?

To get a more detailed understanding of what a property allows/requires, read the organizational documents, including any co-ownership agreements.

Annual Costs

In shared ownership arrangements you pay the proportion of the ownership. For example, if you have 25% ownership, you pay 25% of the expenses. In a pay-for-use approach, you are responsible for usage fees, which come out of your rental income. If your usage fees exceed your portion of the rental income, you’d owe the difference. 

Annual fees typically cover all maintenance costs and reserve requirements to cover the cost of any future updates or renovations.

Financing

It’s often much harder to get financing for fractional vacation ownership. If you can find a lender, you’ll likely have to meet strict requirements and have a large down payment. For this reason, it’s often best to invest in fractional homeownership when you can pay for your portion in cash.

Selling the Property

Owning a property with others means you often can’t decide to sell the property without their consent. In most cases, all parties must be on board. Your organizational documents may prohibit the sale of one partner’s ownership without the consent of every owner. In such circumstances, the only way you may get out of it is by selling to another co-owner.

Is Fractional Vacation Home Ownership Worth it? 

In order to answer this question, let’s take a closer look at renting vs owning a fractional vacation home and whether owning one is a good investment.

Renting vs Owning

When you own a fractional vacation home, you only have rights to it for a part of the year. For this reason, you may be asking yourself whether it would be better to rent a vacation home instead of own a fraction of a vacation home? So let’s consider an example. Let’s say a ski chalet in your favorite winter destination has recently come on the market for $40,000. For the purchase price, you will receive a ¼ interest and four weeks of personal use per year. Annual fees are $1,000 per year, increasing with inflation at approximately 3.0% annually. Let’s also assume that the value of the property appreciates in line with historical norms at 4.0% annually. Instead of buying a fractional interest, you could rent a comparable unit for $200 per night. Under the rental scenario, let’s also assume that rental rates increase with inflation at 3.0% annually and instead of investing $40,000 in real estate you invest in the stock market, realizing an annual return of 8.0% per year (slightly below historical norms). Here’s what these scenarios look like after 10, 20 and 30 years:

Ownership Scenario

Rental Scenario

Using the above scenarios, there doesn’t appear to be a clear winner. In the ownership scenario, you would be further ahead in years 10 and 20 but that changes in year 30 where renting appears to make more sense. Of course, the above scenarios are an oversimplification of the actual calculations and there are various assumptions that could prove to be incorrect. By going through this exercise, however, the answer may be clearer depending upon your circumstances. 

Do Fractional Vacation Homes Make Good Investments

You have many options to invest your money, so is a shared vacation home a good way to use your money? Like any savvy investor, a diversified portfolio is a good idea – it prevents a significant loss should one asset decline in value. But does it make sense to add fractional vacation home ownership to your investment portfolio? Here are some things to keep in mind:

• You only own a fractional interest in real estate, so you will feel less of an impact with the ups and downs of the market. Historically, though, the stock market outperforms real estate. Real estate only slightly beats inflation, whereas stocks have an average annual return of 9% – 10%. But comparing real estate to stocks is in many ways an apples to oranges comparison. Therefore the best situation is to invest in both – diversifying your portfolio.
• If your property is a part of a rental pool, focus on the net proceeds. How much will you walk away with after annual maintenance costs and other required fees? While the rent you bring in may look attractive, the annual carrying costs can pile up quickly. 
• Fractional interests are hard to liquidate. When you invest in stocks or bonds, you can sell them on the open market. When you want to liquidate a real estate investment that you own with others, you often must get their approval. For this reason, there are typically less interested buyers. Given shifting consumer preferences towards fractional ownership, however, that may be changing.

To determine what your rate of return might be based on various input scenarios, try our Real Estate ROI Calculator. 

Final Thoughts

If you are clear on the ownership rights and limitations, owning a shared vacation home can be well worth it. The pride of ownership and enjoyment of the property may outweigh the drawbacks, including the lack of control over decision making and the difficulty in reselling your fractional interest.

If you’re buying the property for investment purposes, you may have other (better) options including renting a comparable property versus owning it. The annual costs, for instance, can be quite high. Yet, investing in real estate is often a wise decision and there are benefits to buying a fractional interest, including being less exposed to market price fluctuations.

The post Fractional Vacation Home Ownership: Is it Worth It? appeared first on Vacation Property Online.

As a real estate investor and owner of a vacation rental property, I’ve dealt with numerous ownership questions first-hand. I’ve also read various resources over the years in order to supplement my own experiences. Yet, there are many different resources out there on various topics, from the true costs of owning a second home to the rules and regulations governing different vacation property types such as waterfront properties. As a result, it’s sometimes hard to get a clear picture of what you should know before buying a second home and what ownership is truly like. With this in mind, I set out to create one resource that provides you with everything you need to know before buying a second home and, in particular, a vacation home.  

I should point out that I use the terms “second home” and “vacation home” interchangeably, mostly because second homes are often bought as vacation homes. Still, if you’re looking to buy a second home for another purpose, such as a part-time residence, investment property or eventual retirement home, the principles discussed in this article will still be relevant. Also, while this article focuses on subjects that are relevant for vacation homeowners in the United States and Canada, most topics will be relevant in other jurisdictions. With this in mind, if you’re wondering whether buying a second home is right for you, then you’ve come to the right place.

For an overview of how to buy a vacation home, explore my article on How to Buy a Vacation Home: A Practical Guide.

Setting the Stage

As you contemplate buying a second home, keep in mind that you will have your own unique set of circumstances, from personal finances to the locations you are interested in. Therefore, you should seek appropriate advice from qualified advisors, including accountants, lawyers and realtors, in your hunt for a second home. I can’t emphasize enough the importance of utilizing each of these experts, who have saved me countless headaches and likely thousands of dollars. Still, based on my own knowledge and experience, this is everything you need to know before buying a second home.

Types of Second Homes/Vacation Properties

As you consider buying a second home, a logical starting point is to consider the various types of properties. First up are the usual suspects in houses, condos, cabins and cottages. 

Houses, condos, cabins and cottages

Each of these property types are fairly well understood so I won’t describe them in detail, other than to highlight what you really need to know for each: 

• House vs. condo. With a vacation house, you’ll have more privacy than a condo but also higher maintenance costs. One of the things I like most about my vacation condo is that it’s fairly hands off. I can leave it vacant for extended periods of time and, other than minimal upkeep, I don’t have to worry about major repairs or landscaping the yard, for instance. It does help, however, to have a proactive and well run strata (or HOA). Still, if you want more privacy and can handle more responsibility and expense, a vacation house may be right for you.
• Cabin vs. cottage. While cabins and cottages differ primarily by the materials used to construct them, I typically consider them one and the same. Sure there may be different maintenance considerations for a log cabin versus a brick cottage, but the premise is the same. Typically a cabin or cottage is located in a more remote location close to nature. Thus, in addition to the considerations above for a vacation house, you’ll need to take into account how remoteness will impact your use and enjoyment.

Waterfront and water-access only

Waterfront properties are unique for many reasons, including the additional regulations that govern such properties and additional maintenance required. They’re in high demand and as a result typically hold their value. But the premium paid for waterfront is not the only relevant consideration as you need to keep the following in mind before buying a second home on the waterfront:

• Home inspections. In addition to the typical items to look out for in a house inspection, corrosion caused by salt in the air and mildew/mold issues from higher moisture levels can all cause damage on a waterfront property. Boundary surveys, elevation certificates and water quality tests can also be important. For instance, how far above the sea level or the lake shore is the house and is the area prone to flooding? In short, be sure to hire qualified home inspectors, surveyors and other experts before buying a waterfront property.  
• Understand what you own. With waterfront property, it is particularly important to review the legal description to determine where the lot extends. Additionally, you will need to determine whether there are any additional encumbrances on title that would otherwise limit your use of, or access to, the waterfront. Whether the property is located in the United States or Canada, it may be worthwhile to run this by a real estate lawyer before buying a second home on the waterfront. 
• Understand the limitations that come with it. Understanding what restrictions come with the property and what you can build on it are particularly important. Governmental regulations on waterfront properties govern such things as site density, minimum building setbacks from the water, the kinds of uses that are permitted, whether you can build a dock or seawall and even building design. In the United States and Canada, you may also need approval from other government departments including the U.S. Army Corps of Engineers and Department of Fisheries and Oceans (in Canada) for work in and around the water.
• Additional maintenance. Not surprisingly, waterfront properties require additional maintenance and expense in order to keep the property in tip-top shape. Potential issues include:
  • Humidity resulting in mold 
  • Corrosion from salt in the air (in the case of oceanfront)
  • High winds causing structural damage 
  • Falling trees in open areas
  • Floods 

In order to combat these issues, consider storm-proofing the house and ensure you have adequate insurance coverage. In short, waterfront properties are expensive to maintain so be prepared to pay double a typical maintenance budget.

• Water-access only. For some, owning your own private piece of paradise is appealing yet the remoteness and/or inaccessibility of water-access only properties may deter some buyers. Obtaining financing for these types of properties can also be difficult. While not for everyone, the general feedback I’ve received from other owners is that water-access only properties are an affordable alternative if you have access to reliable transportation and are willing to forego modern day conveniences. 

Fractional ownership and timeshare

Fractional ownership structures and timeshares are also an affordable option for those interested in dipping their toe into vacation home ownership. I’ve personally never been drawn to these types of properties because I’ve always (a) viewed outright ownership as a better investment and (b) liked to have complete freedom and control in terms of the use of my property. With this in mind, this is what you need to know before buying a second home that falls into one of these categories:

• Fractional ownership.  With partial ownership, several buyers each hold an equal interest in the title to the property. This is different from a timeshare where title to the property is 100% held by you as the principal owner. As an owner of a fractional interest in a vacation home, you’re also often allowed to use the property for a longer duration than a timeshare. From an investment perspective, you may see an increase in the value of your fractional interest over time.
• Timeshare – With a timeshare, your usage rights will vary slightly depending upon the type (e.g. fixed week, floating etc.). You also have no control over the property and they are notoriously hard to sell. Yet, timeshares are quite affordable, there is less responsibility as an owner and you’ll have certainty as to where and when to take your vacations. For these reasons, a timeshare is a lifestyle purchase as opposed to an investment. Importantly, I’ve heard of too many cases of timeshare owners making emotional decisions when buying-in originally so be sure to take some time before buying.

Leasehold

An owner of a leasehold property has an exclusive right to occupy the property for a specified period, in some cases up to 100 years or more. At the end of the lease, the right to occupy the property reverts to the owner. For this reason, leasehold properties are typically more affordable and there are often restrictions with what you can do with the property during the term of the lease. If you’re looking at your second home as an investment property, then I would avoid buying a second home that is a leasehold since you don’t actually own the property and therefore don’t typically enjoy the same upside in price appreciation. 

Different Second Home Uses

In addition to buying a second home for vacation purposes as a “home away from home”, there are many different reasons to buy a second home. Here are a few insights I’ve learned over the years about these other specific uses:

Vacation home vs second home vs investment property

I find there is a lot of confusion as to the difference between a vacation home, a second home and an investment property and the implications of each. Importantly, the designation of your property can have implications on your mortgage terms and tax treatment. While I encourage everyone to obtain their own independent tax advice, here are some important things to know:

• Vacation home vs second home. In short, there is no real difference between the two. More specifically, a second home is a residence you intend to occupy for part of the year in addition to your primary residence. Typically, second homes are owned as vacation properties but they could be used for other purposes (such as a condo in the city for work). 
• Second home vs investment property. An investment property differs from a second home in that it is owned primarily for investment purposes, typically through rental income, rather than as a second residence. A vacation rental property is one such example of an investment property, where the primary purpose is to generate income from the property as opposed to using it as a second home. 
• Mortgage implications. Mortgages for second homes will typically be associated with stricter lending criteria and higher interest rates than primary residences. For an investment property, such as a vacation rental, you can expect interest rates to be even higher and even higher down payment requirements, although every lender will have their own lending terms. 
• Tax implications. Depending upon the designation of your vacation home as a secondary residence or revenue-producing investment property, and the thresholds set by the Internal Revenue Service (IRS) and Canada Revenue Agency (CRA), you may be required to report and remit tax on any income derived from your property. Additionally, taxation of capital gains upon the sale of your vacation home is treated differently from a primary residence. 

For a more complete discussion of mortgage terms and tax implications for vacation homes, see below under Vacation Home Financing and Tax Considerations, respectively. 

Owning a vacation rental property

Thanks to the popularity of vacation rental platforms such as Airbnb and VRBO, it’s easier than ever to own and operate a vacation rental property. Yet there are many items to take into account before investing in one, from the tax implications of ownership to how to manage your property. While I speak to tax considerations a little later on, here are some other things you need to know before buying a vacation rental property:

• Short-term rental regulations. Many cities and towns in the US and Canada have restrictions on renting out your property short-term. This can range from a simple requirement to obtain a business license to an outright ban altogether so be sure you understand the local regulations. Rules can change overnight as well so it’s best to invest in those areas that cater to tourists, such as resort municipalities, where vacation rentals are viewed more favorably. 
• Vacation rental platforms. I’ve used multiple platforms over the years and each of them has their strengths and weaknesses. Importantly, it’s never a good idea to rely 100% on one vacation rental platform so I recommend using multiple platforms. I also recommend that you create your own website so that you can (a) take direct bookings through friends and family without having to pay any fees associated with rental platforms and (b) slowly build-up search engine optimization over time in order to show up in Google search results. If you do end up taking direct bookings, ensure you require a sufficient damage deposit and execute a short term rental agreement like the one provided here.
• Property management. When deciding whether to manage the property yourself or hire outside management, it ultimately comes down to your willingness to spend additional time and resources dealing with guests or whether you’re willing to pay someone else to do it. If you decide to hire a property manager, expect to pay between 25% to 30% of the rental fees. My wife and I manage our vacation rental and, in my experience, the biggest issue is finding good, reliable cleaners. If you’re willing to do the cleaning yourself then that’s one less issue to worry about. 
• Cell phone and internet access. This is more of an issue for remote properties, but you’ll need to be able to communicate with your guests and deal with issues as they arise. It’s therefore important to have reliable cell phone reception and internet access. 
• Insurance. This one should be obvious but you’ll need to ensure that your insurance policy adequately covers a vacation rental property. More specifically, be sure to understand the specific terms of your policy. For instance, my policy requires all guests to be 21 years or older so our house rules require it.
• House rules. Speaking of house rules, it’s important to establish house rules for your guests to follow. By doing so, you can minimize damage to your home and otherwise control the guest experience.
• Vacation rental mortgages. In order for your lender to properly assess the risk profile of your loan it will need to understand the proposed use of the property. Accordingly, be sure your lender is aware that you intend on renting out your property when you submit your loan application.

Owning a family vacation home

Dealing with family dynamics can be difficult when it comes to managing a vacation home that is shared by multiple family members. Establishing house rules and splitting up the time equitably between family members are each important. Having a proper exit strategy is also particularly important in case things don’t work out as planned or one of the family members experiences unexpected financial hardship. Before buying a vacation home with a family member, consider whether ownership as tenants in common makes more sense than joint tenants. With a tenancy in common, each family member may control an equal or different percentage of the vacation home and has the right to leave their share of the property to any beneficiary. This provides more flexibility than joint tenancy where, upon the death of an owner, title passes to the surviving owner. Note, however, that if there is a mortgage on the property, typically all borrowers sign the mortgage documentation meaning that if there is a default the lender may realize the debt on all family members.

Owning a weekend home

With a weekend home, the property will be vacant during the week when not in use, perhaps even over the winter months entirely. With this in mind, here is what you need to know:

• Costs vs benefits. With all vacation homes, and weekend homes in particular, you’ll need to ask yourself how much you can reasonably expect to use the property? In particular, ask yourself whether it makes more financial sense to rent versus own a place in your desired area. If you can regularly rent something for a reasonable price, then perhaps it makes more sense to rent instead of own.
• Travel time. Personally, I’ve always steered away from trips that are 3 hours or more unless I am planning on staying there for three or more days. Ideally, your total travel time will be under two hours if your vacation home will be used primarily for weekend use. Otherwise I just find that you spend too much time travelling to your destination as opposed to actually enjoying it. For other travel time guidelines, I find these rules of thumb useful. 
• Secure storage. If you want to avoid packing, securing and transporting all of your gear every weekend, such as a boat, ATV, paddleboard, kayak or canoe, I recommend having secure storage on site where these items can be permanently stored. 

Second Home Financing

Securing sufficient financing to buy a second home, with reasonable terms, may be the most important consideration for many would-be second homeowners. As mentioned earlier, mortgages for second homes will typically be associated with stricter lending criteria and higher interest rates than primary residences. For vacation rental properties, you can expect interest rates to be even higher in addition to even higher down payment requirements. For reference, even though I have a strong credit history, consistent income and sufficient savings for a 20% down payment, only one of the Big Five Banks in Canada was willing to lend to me when I purchased my vacation rental property and my mortgage was about 75 basis points higher than a mortgage for a primary residence. The reality is that there are fewer lenders willing to lend you money to buy a vacation rental, and those that do require a higher interest rate due to the increased risk profile.

Curious to know about how much you can afford in a second home? Be sure to explore this second home affordability calculator.

Based on my own experience, and the stated policies of major banks in the US and Canada, here is what you need to know:

• Credit score.  A credit score of 700 or more will increase your chances of approval, however a minimum of 640 is typically required.
• Interest rates. Expect interest rates to be as much as 0.25% – 0.5% higher than primary residence interest rates. For a vacation rental property, you can expect interest rates to be even higher (e.g. 50 to 75 basis points). With today’s low interest rate environment, however, it’s a great time to get affordable vacation home financing.
• Down payment. Expect to pay between 20% – 30% as a down payment. To lower the risk of default, lenders require higher down payments.
• Maximum debt-to-income ratio. Your debt-to-income ratio should be no more than 43% overall. Your debt-to-income ratio is the percentage of your gross monthly income that goes to paying your monthly debt. This includes the mortgage on your primary residence, the new mortgage on your vacation home and any other outstanding debts. 
• Distance from primary residence. In the United States, if you want to take advantage of the more beneficial lending terms (e.g. lower interest rate) associated with second homes as opposed to investment properties, your second home must typically be at least 50 miles away from your primary residence. Otherwise, your second home may be viewed as an investment property in the eyes of a lender. In Canada, the distance from your home will similarly be taken into account as to whether you truly intend to use the home as a secondary residence or an investment property.

Some of the best ways to finance a second home include:

• Second home mortgage. This is the same as a traditional mortgage except that a second home mortgage will exist over, and be secured against, your second home as opposed to your primary residence. 
• Home equity line of credit. A HELOC acts much like a credit card in that you can borrow up to a certain limit and are only required to pay interest on the amount actually borrowed. In order to be eligible, you will need to have equity available in your existing home. Depending upon the lender, you may be able to utilize up to 80% of the equity in your home (or lower in the case of federal financial institutions in Canada), assuming there is no outstanding mortgage or other loan secured against your home.
• Second mortgage. A second mortgage is just that – a second mortgage over your primary residence. These are riskier from a lender’s perspective as the lender will be in second position to the first lender should you default. 
• Cash-out refinance. With a cash-out refinance, you cancel your existing mortgage and enter into a new mortgage with a larger amount than owed on the previous mortgage. You can then use the extra cash to buy a vacation home.
• Private lenders. If traditional banks won’t lend you money, then you may be able to obtain financing from private lenders such as friends, family, a private investor or even peer-to-peer online lending. Just be aware that private lenders typically charge higher interest rates and/or other fees given the heightened risk in lending to someone that the banks won’t.  

True Cost of Owning a Second Home

Before buying a second home, it’s important to understand the true cost of ownership in order to ensure you can afford the carrying costs. In my experience, people tend to underestimate ownership costs so you can expect your monthly bill to be higher. To begin with, let’s look at my own example.

For an accurate estimate of your monthly ownership costs, be sure to explore this cost of owning a vacation home calculator. 

Vacation Home Cost Example

As an example, here is a breakdown of the one-time costs and ongoing carrying costs of my vacation rental property (all in Canadian dollars), which was purchased for $715,000 at the beginning of 2019 and was partially furnished:

• One-time costs:
  • Down payment: $143,000 (20% of purchase price)
  • Property transfer taxes: $12,300
  • Conveyancing fees and disbursements (legal): $1,630.87
  • Minor renovations and furnishings: $4,743.41
  • Special assessment in Fall of 2019: $4,029.75
• Recurring costs (monthly):
  • Mortgage: $2,898.26
  • Property taxes: $246.96 ($2,963.52 annually)
  • Insurance: $70 ($840 annually)  
  • Utilities: $40
  • Cable, internet and streaming services: $122
  • Maintenance and repairs: nil 
  • Ongoing accounting and legal fees: $41.67 ($500 annually)
  • Strata fees: $557.83

Based on the above, my monthly carrying costs are $3,976.72 but I would expect that number to be slightly higher after factoring in additional nominal costs not reflected above. If I add the one-time costs (e.g. property transfer taxes, furnishings, special assessment etc.) and spread them out over the 2.5 years I have owned my home, my monthly carrying costs have been roughly $4,733.52 over that period. Further, while I have not yet spent any material amount on repairs and maintenance, I expect this will catch up to me soon and that my spending will be in line with a more typical allocation of between 1% – 4% of my home’s value being spent annually on maintenance.

Other costs that may be relevant depending upon the circumstances and location of your property include:

• HOA or resort fees
• Vacancy, general excise and other taxes (location/use specific)
• Management, cleaning and other vacation rental ownership fees

Despite your best efforts to plan for everything, I can attest to the fact that unexpected costs arise from time to time. If it’s not a special assessment from your condo association, then it will be your hot water tank or furnace that will give out. As such, keep some cash available for these unexpected costs. 

Opportunity Cost

Perhaps one of the most overlooked costs is opportunity cost, or the forgone benefit that would have been obtained from the next best alternative. This is not easy to calculate in every instance but I recommend trying this real estate ROI calculator. It’s a simple calculator that shows the expected return on investment (ROI) from your second home over the life of the mortgage and, for comparison purposes, the ROI should you instead choose to invest in the stock market over that same period. A little later on I will explore my own expected ROI from my vacation rental property and compare it against a stock market investment. In the meantime, let’s move on.  

Second Home Maintenance

As I’ve already covered off the principal costs associated with owning a second home, I won’t explore maintenance costs any further. I will, however, provide the following insight into second home maintenance generally:

• Less may be more. The more stuff you have in your home, the more that can go wrong. While AC units and hot tubs are nice to have, consider whether it’s necessary to have them in your second home. If not, you may be better off without them. 
• Prolonged vacancy. If your home will remain vacant for long periods, consider hiring someone to check on the property. In fact, you may not have insurance coverage if your home is left empty for 30 or 60 days, depending on the policy. By having someone check on your property every 30 days, you can typically satisfy the minimum requirements under your insurance policy. 
• Install a security system with remote monitoring. Consider installing a security system with remote monitoring to reduce risk of vandalism or theft. With smart video cameras, you also have the ability to keep tabs on your property in case of unexpected events such as a flood caused by bursting pipes or an electrical fire. 
• Winterizing. Simple steps to winterize your property will keep the cold out, the heat in and your energy bill down. Steps like flushing the water heater, adding window insulation film and adding draft guards under doors will all help and with only minor expense.   
• Storm proofing. If your second home is in an area that is prone to storms, you will save yourself a lot of headache by storm-proofing the house as much as possible. Adding storm shutters, trimming trees away from the house and removing clutter from around the yard are simple things you can do. Larger projects, such as structural upgrades, may be necessary and will require hiring qualified help.

Second Home Tax Considerations

First, a word of caution. Tax rules are complex and everyone’s circumstances are different. Accordingly, you should consult a qualified tax adviser in connection with your own tax planning. 

As you consider buying a second home, it’s important to understand the tax consequences of ownership. The two most significant tax implications of ownership are typically (i) taxation of revenue derived from your property and (ii) taxation upon the sale of your property. Let’s take a closer look at each.

Taxation of Rental Income

In both the United States and Canada, the IRS and CRA, respectively, will have an interest in any commercial activities associated with the property and, in particular, rental income. Thus, you will need to give adequate consideration to the tax consequences of renting out your second home.

In the United States, if you rent out your property for 15 days or more, then the IRS may view your property as a rental property. As a result, you will be required to report any rental income and pay appropriate tax. One of the benefits of operating a rental property, however, is that you can deduct various expenses, including property taxes, insurance premiums, condo fees, utilities, mortgage interest and depreciation. These deductions can then be used to offset a portion of the rental income, thus reducing your tax burden. Note, however, that if you also use your rental property as a residence, limitations may apply to the expenses you can deduct. According to the IRS, you’re considered to use a dwelling unit as a residence if you use it for personal purposes during the tax year for more than the greater of: (i) 14 days, or (ii) 10% of the total days you rent it to others at a fair rental price. An accountant with experience in this area will be able to advise you as to which expenses you can deduct based on your individual circumstances.

In Canada, if you rent out your property then you will similarly be required to report any rental income and pay tax on it. As an owner of a short-term vacation rental property, an important threshold to keep in mind is the annual revenue limit of C$30,000. If you exceed that limit over four consecutive quarters, you will be required to charge and remit GST/HST on any rental income. Keep in mind that, similar to the US, you’re also able to deduct appropriate expenses from any rental income to reduce your tax burden. 

Whether you’re located in the US or Canada, be sure to retain accurate records of the rental income you’ve received and all of the expenses claimed on your tax return in case you’re ever audited. The retention period is three years in the US and six years in Canada.  

Taxation Upon the Sale of Your Second Home

In the United States, if you have held your second home for more than one year, any profit on the sale will be taxed as long-term capital gains. Notably, tax rates for long-term capital gains are more favorable at 15% or 20% (to the extent that your taxable income exceeds the thresholds set for the 15% rate). Prior to selling your second home, you may want to consider the taxable exclusion of $250,000 ($500,000 if married filing jointly) in gains from sales of a primary residence. To qualify, you would need to treat your second home as a primary residence for at least two of the last five years prior to selling. Note, however, that a reduction is made on a pro rata basis to reflect the period of rental, vacation home or other “non-qualifying use”. Also, keep in mind the IRS’ rules on depreciation recapture tax upon the sale of a rental property. This occurs as a result of a taxpayer deducting the depreciation of a rental property from the taxpayer’s ordinary income. The taxpayer has to report any gain from the disposal of the rental property (up to the recomputed basis) as ordinary income.

In Canada, when you sell your second home any gain will be subject to taxation. This differs from the gain realized from the sale of your primary residence, which is tax-free. If you have not claimed any depreciation expense (or “capital cost allowance”), you will realize a capital gain or loss on the sale. If the sale price is more than your cost, one-half of the capital gain is included in your taxable income. If you claimed capital cost allowance, then selling the property may result in a recapture of your capital cost allowance. When you change your principal residence to a second home or rental property (or change your second home/rental property to your principal residence), it’s called a change in use for tax purposes and the CRA may treat it as if you sold the property. For a principal residence, you don’t have to pay tax on any capital gain up to the point of conversion to a second home. For a second home, any gain accruing up to the point of conversion to a principal residence is taxable. Lastly, if you’re collecting GST/HST as an operator of a short-term rental property, you are required to collect GST/HST on the sale of your property.

Pros and Cons of Owning a Second Home

Any discussion about buying a second home would not be complete without considering the pros and cons of owning a second home. With this in mind, here is my list of the pros and cons of owning a second home:

Pros

• Relatively secure investment. Real estate prices in the United States and Canada tend to go up over time and have not experienced the same volatility as other asset classes. 
• Additional ways to increase ROI. By owning a vacation home, you have the ability to maximize your return on investment through home renovations and/or rental income when the home is not in use (but be mindful of the tax implications).
• Borrowing is cheap. Given the low interest rate environment, borrowing money to buy a second home is cheap (assuming you meet the stricter lending criteria). Because of this, you can build wealth using the bank’s ‘cheap’ money.
• Hosting friends and family. Owning a vacation home is a great way to bring family and friends together as there will be no shortage of visitors.
• Retirement. What better way to plan for retirement than owning a second home as an eventual retirement home?
• Pride of ownership. Speaking from personal experience, one of the best things about owning a vacation home is the joy it brings. Quite frankly, this is often the biggest reason to buy a vacation home.

Cons

• Real estate historically outperformed by stock market. If you’re buying a second home for investment purposes, it’s worth noting that real estate in the United States and Canada has historically been outperformed by the stock market. 
• Lack of diversification. Spending further money on real estate may be risky, especially if you’re not well diversified in other asset classes. 
• Ownership isn’t passive. Unlike owning stocks, owning a second home isn’t passive as it will require ongoing time and commitment, from paying annual property taxes to renewing your insurance.  
• Ownership costs. The expenses can pile up pretty quickly as your second home will require ongoing repairs and maintenance.
• Usage may be less than you expect. This will certainly vary from owner to owner but you may find that you don’t actually use your property as much as you expect. I have historically only used my property roughly two weeks a year but then again I’m also operating a vacation rental property. 
• Vacation home moochers. While hosting friends and family is one of the benefits of owning a vacation home, you may also have to deal with freeloaders looking for a free stay.

Is Buying a Second Home Worth it?

With the above in mind, is buying a second home worth it? As mentioned previously, this real estate ROI calculator enables you to directly compare how a real estate investment will perform (with or without rental income) against a stock market investment. Let’s consider some return on investment scenarios using my own example:

• Vacation home purchase price: $715,000
• Down payment: $143,000
• Mortgage terms: 3.61% interest rate with a 25 year amortization schedule
• Monthly rental income: $5,000
• Aggregate monthly expenses: $2,000

Based on the above assumptions, the real estate ROI calculator shows that I’m netting an extra $102.58 per month in rental income, which would not be available if I instead chose to invest in the stock market. Therefore, I need to compare the value of my vacation home plus $102.58 in monthly rental income after 25 years against investing $143,000 (i.e. the size of the down payment) in the stock market over that same period with no additional contributions. Here’s what it shows under the following scenarios:

Scenario 1: Vacation Home Appreciates 4% Annually and Stock Market Grows 8% Annually

• Value of vacation home (and net rental income) at end of term: $1,971,116.09
• Value of stock market investment at end of term: $1,049,645.16

Scenario 2: Vacation Home Appreciates 4% Annually and Stock Market Grows 6% Annually

• Value of vacation home (and net rental income) at end of term: $1,971,116.09
• Value of stock market investment at end of term: $638,490.68

Scenario 3: Vacation Home Appreciates 2% Annually and Stock Market Grows 8% Annually

• Value of vacation home (and net rental income) at end of term: $1,209,119.17
• Value of stock market investment at end of term: $1,049,645.16

As you can see, I’m better off buying a second home in each of the above scenarios. Of course, the above doesn’t take into account appropriate tax planning strategies. For instance, by utilizing a tax sheltered account such as a 401K plan in the United States or RRSP/TFSA account in Canada, you may be able to shelter some or all of the tax burden of a stock market investment. All of the sudden investing in the stock market doesn’t look so bad, especially if you can’t claim a primary residence tax exemption under the vacation home scenario. The other difficulty is that not all of the benefits or drawbacks of buying a second home can be objectively measured. After all, you can’t put a price on the time spent with the kids (or grandkids) and the lifelong memories that result. On the flip side, it’s hard to quantify or value the additional time spent maintaining your property. Personally, I’m very happy with my vacation home. From the revenue it generates as a vacation rental to the joy it brings me and my family, I expect to hold onto it for many years, and ski trips, to come. 

With that, I encourage you to consider each of the items noted above in this article before buying a second home. This is certainly everything I wish I knew before buying my vacation home.

About the Author

Peter is a father, entrepreneur and real estate investor. Together with his wife, he owns and operates a vacation rental property in Whistler, BC and is eager to pass along his knowledge and personal experience.

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For the purposes of this article, we have assumed that you are considering buying a resort property comprised of buildings and facilities located together that provide lodging, entertainment and other amenities for visitors. With this in mind, let’s weigh the pros and cons of purchasing one.

Being Your Own Boss

One of the most valued aspects of buying a resort property is being your own boss. As the owner of the property, you set the rules and hire the workers. You are in charge, which allows for more freedom than you typically have as an employee.

Being your own boss can help push you to perform to the best of your ability. It also allows you to set your own salary and gives you permission to do basically anything. However, there is also a drawback to being your own boss: the stress of running your own business. If you are the sole person in charge of your resort property, you will have a lot of details to keep organized. Hiring other workers, maintaining a proper budget, and keeping everything in order and running correctly will certainly lead to more stress than you might be used to.

Income Potential

Having greater income potential is almost always a good thing. In particular, increased income gives you the ability to hire others to take care of some of the aforementioned stressors. Overall, as your business grows you will be able to hire more people to take care of tasks that you might have otherwise performed on your own.

While buying a campground or other resort property will cost you money in the beginning, the pay-off can be quite lucrative. As you learn the ropes, you will be able to make improvements with a view to increasing revenue. As revenue increases so too will your income.

Access to the Landscape and Facilities

If you own an RV park or other resort property, you will have access to the surrounding landscape. This may include lakes, rivers, and hiking trails. Experiencing your resort’s beautiful surroundings will no doubt bring you great joy and inspiration. Even if the resort property is not particularly scenic, you will have the ability to create your own piece of paradise.

If you are an active person or otherwise enjoy resort-style amenities, buying a hotel or other resort property will give you the opportunity to utilize the facilities. Swimming pools, tennis courts, and other sporting areas that are otherwise difficult to access are now in your backyard. Rather than paying hundreds, if not thousands, of dollars a year to be granted access to these types of facilities, people will now be paying you to utilize these areas. 

Social Benefits

Buying a bed and breakfast or other resort property will not only give you a wonderful location at which to host friends and family but also provide a reason for doing so. Whether its conversations over a morning coffee or campfire sign-along, social interaction is never far away. Not to mention, owning a resort is a great conversation starter!

Hard Work

If buying a resort property seems like it will be an easy venture, you might want to think again. While there are many benefits to owning a resort property, there are certain drawbacks that you will want to consider as well.

For instance, if you dream of earning a truly passive income then buying a resort property may not be for you. Owning a resort property is active work, literally as well as figuratively. It can be grueling at times and enjoyable at others. Be sure that you are prepared to play an active role in the management of the resort before jumping into buying a resort property.

A Seasonal Job

Very few locations are perfect for vacationing year-round. Because of this, almost all resorts are seasonal. In turn, this makes your job seasonal. Once your resort has been established for a few years, it may make enough money for the seasonality of the job to not be an issue. However, for newly established resorts or those with prolonged slow seasons, you may need to have a second job or otherwise preserve cash in the slow season.

Economic Dependability

The reality is that you will be solely dependent upon the success of the resort and the travel industry in general. Largely, the travel industry depends upon the economy. When vacationing families are doing well economically, they will visit your resort often. However, when the economy is in a downturn, you will almost certainly experience a loss of visitors and therefore a loss of income. Similarly, worldwide pandemics such as COVID-19 can put an abrupt halt to travel.

While this can be expected, it is difficult to predict. Be sure to maintain adequate savings in order to keep your resort running throughout economic downturns or other adverse events.

Unpredictable Weather

A drought, prolonged rainy season or other irregular weather occurrence can impact the number of visitors. Even during the mild season in your area, there can be unpredictable weather occurrences. Storms and other undesirable weather conditions can cause guests to cancel their visit (or not schedule one in the first place).

Even worse, natural disasters can cause damage to your resort property. This can result in a need to shut down the resort for an unknown period of time, resulting in loss of income from lack of guests as well as repair costs.

Repairs and Maintenance

Last but not least, when thinking about buying a resort property you will need to consider the burden of repairs and maintenance. A 30 unit hotel with a pool will have much different maintenance requirements than a small bed a breakfast. Similarly, a small campground will have much different requirements than a waterfront fishing lodge. 

Importantly, before you buy the property understand the scope of repairs and maintenance. If specialists will be required, or the scope of the work requires more than one person, then you will be dependent upon qualified staff. If, on the other hand, you can handle the repairs yourself then you will need to be prepared to do the necessary work annually.

Ready to Buy a Resort Property?

Now that you have taken these pros and cons into consideration, you are ready to buy a resort property! Well not quite. Be sure to conduct proper due diligence on the resort property, including a careful review of the financial records. Hire properly qualified advisors to assist with the purchase, including legal and accounting. If you need financing, talk to your bank early in the process and be prepared to submit a detailed business plan.

After completing necessary due diligence, getting input from your advisors and considering the above, you can confidently purchase a resort property and feel good about your decision.

Visit our website again soon for more tips and resources on buying, selling and owning a vacation property.

The post Buying a Resort Property: Pros and Cons of Owning a Hotel, Campground or Similar Property appeared first on Vacation Property Online.

 General Requirements

While certain lenders may require a down payment of only 5% for a primary residence, many lenders in the United States and Canada will require a down payment of at least 20% for a second home. This is because second homes are inherently more risky as borrowers are more likely to default on repaying the mortgage on their second home. After all, borrowers faced with financial hardship will typically prioritize repayment of a mortgage on their primary residence as they need a place to live.

Using 20% as an example, if you’ve managed to save up $50,000, then the maximum vacation home you can afford is $250,000 ($50,000 / 20%) regardless of your overall financial picture. If you’ve managed to save up $100,000, then you can afford a vacation home with a purchase price of up to $500,000.

Yet these are just general rules of thumb and, depending upon the use of the property, there may be certain lenders willing to accept a more modest down payment. In order to provide more specific information, we have included more detailed guidelines for borrowers in the United States and Canada below.

United States Requirements

The size of your down payment will depend, in part, on the type of mortgage you choose. Each mortgage type will have its own guidelines and eligibility criteria to consider. Briefly, the following types of mortgages may be available to you:

• Veterans Affairs (VA) loans – VA direct and VA-backed Veterans home loans are only available to Veterans, service members, and their survivors, typically with no down payment.
• Federal Housing Administration (FHA) Loans – FHA loans are another government sponsored loan program that has been around since 1934, characterized by low down payments (as low as 3.5%), low closing costs and easy credit qualifying. FHA loans, however, are only available for primary residences.
• Conventional Loans – unlike VA and FHA loans, conventional loans are not guaranteed  or insured by a government agency. For conventional loans (and FHA loans), mortgage insurance may be required with a smaller down payment (i.e. less than 20%).

Conventional loans are often available for vacation homes but mortgages for such properties are typically accompanied by larger down payment requirements (at least 20%), higher interest rates and more conservative lending guidelines. If you intend on renting out your vacation home, then a lender may consider it as an “investment property” (as opposed to a “second home”), which tend to have even higher interest rates and down payment requirements (i.e. 25% or more). The reason for this is the risk profile of an investment property as owners may be more willing to walk away from their mortgage payment obligations when faced with financial hardship. To summarize, depending upon how you use your vacation home, expect to save at least 20%-25% of the purchase price as a down payment.

Fore more information on vacation home mortgages from America’s “big four” banks, click on the following:

• JPMorgan Chase
• Bank of America
• Wells Fargo
• Citigroup

Canadian Requirements

In Canada, down payment requirements for primary residences differ depending upon the purchase price of your home. Amounts range from 5% of the purchase price for homes $500,000 or less up to 20% of the purchase price for homes $1 million or more.

The rules also differ for vacation homes, in particular as between vacation homes purchased for personal use versus vacation homes used as a rental property.  As rental properties are often seen as higher risk, more stringent qualifying criteria may apply than if the vacation home is for personal use only. As outlined by National Equity Lending, you may still be able to buy a second home with as little as 5% down with the relevant insurance premium added to the mortgage. With 20% down, most lenders will finance your mortgage as a conventional loan. For rental properties, however, you will likely need at least 20% down and even then you are limited to only a few lenders who are willing to lend to you with no insurance premium added to the mortgage. In order to avoid insurance premiums and open it up to a larger pool of lenders, you will likely need at least 25% down.

Fore more information on vacation home mortgages from Canada’s “big five” banks, click on the following:

• BMO
• CIBC
• RBC
• Scotiabank
• TD

Advantages of a Higher Down Payment

A larger down payment has several advantages, including:

• More borrowing options
• Better interest rates
• Higher initial equity position
• Lower mortgage payments

Simply put, the higher the down payment the more loan options will likely be available to you at more competitive rates. By putting 30% down, for instance, lenders lower their risk profile by allocating some of the risk to you as the borrower. The thinking is that by having more “skin in the game” so to speak, you will be less likely to default on your loan. Also, your mortgage payments will be lower since you will be borrowing less money thereby paying less interest over the life of the loan. Further, if you intend on renting out your property then it will be easier to turn a profit since the cost of servicing your mortgage will be less.

Before deciding on a larger down payment, be sure to use our vacation home mortgage calculator to better understand the monthly costs of servicing your mortgage based on different down payment scenarios. It’s also a good idea to keep some savings left over as you may need funds for necessary maintenance and repairs following your purchase.

For more information on vacation home affordability, be sure you read our article on How Much Vacation Home Can I Afford?

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Buying a vacation home represents a big decision and requires thoughtful preparation and planning. After all, a substantial amount of time and resources will be required to complete the purchase and ultimately maintain the property. Further complicating things is the fact that purchasing a vacation or recreational property may be grounded in emotions as opposed to rationality. For many, purchasing a vacation home is the realization of a dream and because of this its sometimes difficult to view such a purchase with an objective frame of mind. Yet with careful planning and fiscal responsibility, purchasing a vacation home can be a rewarding experience. With this goal in mind, we’ve prepared a list of the top eight mistakes to avoid when buying a vacation home and, more importantly, what to know before buying a vacation home. 

Mistake #8: Buying a Vacation Rental Property Without  Adequate Due Diligence

Business is booming in the vacation rental industry. Thanks to platforms such as Airbnb, VRBO and Booking.com, owners of vacation properties have access to thousands of vacationers eager for more intimate experiences.

Without completing adequate due diligence, however, owning a vacation rental property could become a challenging experience. Some of the questions you will need to consider include:

• How much money can you expect to bring in weekly, monthly and yearly?
• Is demand seasonal?
• How will the use of the property impact your tax status, mortgage, insurance and other related items?
• Are there short term rental regulations in place in the area? For strata properties, due the bylaws permit short term rentals?
• Who will manage the property?
• Are support services such as cleaning and repairs available?

These are only some of the questions that need to be considered. The good news is that, with a little upfront work, it is completely feasible to purchase a vacation rental property and thrive as many others have done.

Mistake #7: Completing a Purchase Without Adequate Tax Planning

At number seven in our list of mistakes to avoid when purchasing a vacation home is the often overlooked step of completing adequate tax planning.

The tax consequences of owning a vacation home are complex. Accordingly, appropriate advice should be sought before purchasing a vacation home.

Importantly, there may be certain steps that can be taken in advance that would otherwise be impossible to implement following completion of sale. For instance, are there different ownership structures that may provide benefits from a tax perspective? Is there an opportunity to take advantage of capital gains tax treatment for primary residences? If you will be renting out the property, do you need to complete additional tax filings and registrations? Taking the time to speak with an accountant familiar with these rules can help avoid headaches later down the road.

Mistake #6: Buying a Timeshare Without Reading the Fine Print

Its no secret that many vacationers have been taken advantage of by pushy sales people looking to sell timeshares to unsuspecting tourists. What seems like a great idea while riding that “vacation high” may turn into a feeling of regret.

With a timeshare, you own a portion of a vacation property that you can use on a limited basis, usually once a year. Depending upon the type of timeshare (fixed week, floating etc.), your usage rights may vary slightly. For these reasons, its important to read the fine print to better understand your usage rights, annual fees and other obligations. While timeshares are more affordable than outright ownership, the costs can add up over time and they are notoriously hard to sell. For these reasons and more, be sure to take your time to fully-understand what you’re signing-up for before completing a purchase.

Mistake #5: Buying a Vacation Home That is Too Far Away

At number five in our list of mistakes to avoid when purchasing a vacation home is the mistake of buying a vacation home that is too far away.

Above all else, a vacation home is a place for recreation and pleasure. Any time spent travelling will take away from your leisure time.

For this reason, you will need to consider the travel time between your primary residence and vacation home. So how far away should a vacation home be? Consider purchasing a property no more than 2 to 3 hours away if your vacation home will be used for trips of 1 to 2 days and avoid travelling more than 5 hours unless your vacation home will be used for trips of 7 days or more.

Mistake #4: Buying with Friends and Family Without Ironing out the Details

Buying a vacation property with friends, family or other loved ones can often seem like a great idea. Not only will your dollar go further by pooling savings together, but you will also get to share your property with loved ones. Important questions, however, need to be asked in advance in order to minimize the risk of conflict. Such questions may include:

• What purpose will the vacation home serve? For instance, will use of the property be reserved for family only?
• How is access to the property determined? Allocating a fair and equitable schedule annually can often be a challenge.
• How long is everyone’s ownership horizon? What happens if someone wants to sell before others are ready to do so?
• Who will maintain the property?
• How will title to the property be held and what happens upon the death of an owner?
• How will you decide the timing, scope and cost allocation of any necessary renovations?

These are only some of the questions that need to be asked and, for obvious reasons, its important to deal with them before jumping in.

Mistake #3: Buying Before You Visit the Area

Before buying a vacation home, be sure to visit the desired area first. Does the city or town have the desired amenities and infrastructure? Is the location safe and are the locals welcoming to tourists? By spending some time in the area you will have a better sense of whether you can see yourself returning year after year.

Mistake #2: Buying While on Vacation

At number two in our list of mistakes to avoid when purchasing a vacation home is the mistake of buying a vacation home while on vacation. While it may seem like a good idea at the time, this may prove to be incorrect when reality sets in. Given all of the elements at play, whether it be sensory overload or other stimulus leading to a relaxed frame of mind, you are far more likely to make an emotional purchasing decision. And while it is important to spend some time in the vacation destination before purchasing a home in the area, be sure to take your time before completing a purchase. Often this means waiting until you return home with a clear frame of mind. The last thing you want to do is rush such an important decision by purchasing a property while riding that “vacation high” (see Mistake #6: Buying a Timeshare Without Reading the Fine Print).

Mistake #1: Spending More Than You Can Afford

The biggest mistake that people often make is spending more than they can afford on a vacation property.

Many factors need to be taken into account to determine how much vacation home you can afford. This may include the size of your down payment, your debt to income ratio and any rental income from the property. In terms of your total debt to income ratio (i.e. total expenses over total income), most financial experts recommend keeping it at a rate of 30% or less for home expenses. Rental income will certainly increase your borrowing power as will a sizable down payment, whether it be available through a home-equity line of credit, investments or other savings.  Importantly, crunch the numbers and be sure to avoid over-extending yourself. Owning a vacation home should be a positive experience and the financial stress of owning a vacation home can quickly erode any such positivity.

We hope you’ve enjoyed our top eight mistakes to avoid when buying a vacation home and, ultimately, what to know before buying a vacation home. Thanks for reading!

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If you’re asking yourself: can I afford a vacation home and, if so, how much vacation home can I afford?, you should consider the following:

• Size of your down payment
• Your debt to income ratio
• Rental income
• Equity from primary residence

Be sure to explore our Can I Afford a Vacation Home Calculator to better understand what you can afford. 

Affording a Vacation Home

Many people who enjoy traveling to the same spot year after year will consider purchasing a vacation home. Not only are you able to visit your favorite destination every year, but you can also often enjoy a strong return on investment through appreciation in the value of the home. Financially, however, this isn’t always an easy decision. For homeowners who will need to take out a second mortgage, they often ask themselves how much vacation home can I afford?

There are a few ways to evaluate whether you can afford a vacation home and, if so, how much home you can purchase. The following are some of the primary considerations to keep in mind.

How Down Payment Impacts Affordability

Typically your down payment must be at least 5% of the purchase price, which will limit your affordability. Depending upon the price of your home and your lender’s requirements, a down payment of 20% or more may be required. Using 5% as an example, if you’ve managed to save up $25,000, then the maximum vacation home you can afford is $500,000 ($25,000 / 5%) regardless of your debt to income ratio (see below for further discussion). Assuming 20% is required, then the maximum vacation home you can afford is $125,000 ($25,000 / 20%). Be sure to speak to your lender to determine exactly what level of down payment is required.

Using Debt to Income Ratio

Your debt to income ratio will be a primary factor when deciding how much vacation home you can afford. Your debt to income ratio is the percentage of your gross monthly income that goes to paying your monthly debt payments (total monthly debt payments divided by gross monthly income). When it comes to your total debt to income ratio, most financial experts recommend keeping it at a rate of 30% or less for home expenses and no more than 43% overall. Most lenders also have their own specific criteria on limits. Of course, the lower your debt-to-income ratio is, the better.

Some lenders will allow you to have a higher ratio but the primary determination of your personalized ratio will depend on your own financial situation. For example, if you have a higher down payment available, you’ll be in a better financial situation as you will require less debt to purchase the home. Additionally, a higher credit score may mean that you can borrow with a higher ratio. Most lenders are going to want borrowers with a credit score of at least 640 or higher. Again, speak to your lender to determine their requirements.

So, how does all of this translate into what you can afford? For illustrative purposes let’s use a ratio of 43% overall and assume a gross monthly income of $10,000 (before taxes). This means that your total debts, including mortgage, home insurance and property taxes on your vacation property, can equal up to $4,300 per month (43% of $10,000). If payments for your primary residence total $1,500 each month and other personal loans total $1,300 per month, this means that you can afford to pay $1,500 per month for a vacation home ($1,500 + $1,300 + $1,500 = $4,300). Depending on the size of your down payment, this means that you can likely afford a vacation home with a purchase price of around $350K-450K on a 25 year amortization period based on current interest rates (try our vacation home mortgage calculator here).

How Rental Income Impacts Affordability

Offsetting the costs of owning a vacation home through rental income is a great way to stretch your dollar further and increase your borrowing capacity. Depending upon the lender, they may give you credit for up to 70% to 75% of the projected fair market rents (in Canada and the US, respectively) determined with an appraisal when buying a vacation home.

Using the above example, let’s say you’re looking to purchase a vacation home with an income suite. Your monthly mortgage is $1,500 for your primary residence and you have other monthly debt payments totaling $1,300. Now let’s also assume that your monthly vacation home payments will be $2,500. That would put your debt to income ratio at 53% overall ($5,300 / $10,000), or 10% in excess of what lenders will typically permit. But let’s also assume that you can expect to generate $1,500 per month in rent from the income suite. 70% of $1,500 is $1,050 meaning that, from a lender’s perspective, your debt to income ratio is now a more modest 42.5% overall (($5,300 – $1,050) / $10,000).

Of course, each lender has their own criteria so be sure speak with your lender as to how much credit you can expect from the rental income. You can also expect to pay 25 to 50 basis points higher for these types of mortgages as compared to owner-occupied home mortgages.

Borrowing Against Value of Existing Home

If you have equity built up in your primary residence, you may also be able to borrow against the value of your home to maximize your vacation home borrowing power. This can be achieved in a few different ways (e.g. home equity line of credit, second mortgage etc.) but the principle is the same: extracting value through the difference between the value of your home and the unpaid balance of your current mortgage. Click the video below for a brief description of how a home equity line of credit works.

Let’s say your home is worth $400,000 and you owe $100,000 on your mortgage. You’d have $300,000 in home equity. Assuming you can borrow up to 80% of the value of your home less the amount you owe (which varies by lender), you would have up to $220,000 (80% of $400,000 less outstanding mortgage of $100,000) at your disposal towards an investment in a vacation home. At even 50% of the value, you will still have $100,000 available.

Of course, this option is only available to homeowners that have seen appreciation in the value of their home and/or paid off a large portion of their mortgage. In any case, this may be a viable option for many homeowners.

Owning a Vacation Home

Owning a vacation home is a lifelong dream for many and, with some creative financial planning, it may be more attainable than you think.

Be sure to check out our further resources on buying a vacation home and owning a vacation home, including everything you need to know before buying.

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If you’re dreaming of vacations on the lake with the family, owning a cabin or cottage can become a reality with a little planning and saving. A great way to help balance the cost of the investment is to rent out your cabin or cottage. Below are our top nine things to keep in mind before buying a cabin to rent out.

Top Nine Things to Consider Before Buying a Cabin or Cottage to Rent Out.

1. The Location and Accessibility

Over the last few years, the demand for cabin rentals is booming and the number of online rental platforms has exploded. But it takes more than a cabin or cottage with character to attract renters. The key to a popular cottage is location.

Proximity to water is the top criteria that cottage renters are looking for, and your property will be even more attractive if it’s also within a two-hour drive of a major center.

Cabins close to ski resorts are also in high demand. Additionally, if you plan on mortgaging the cabin, banks tend to look more favorably on rental properties that have year-round access and those that are winterized.

From an accessibility standpoint, a remote cabin in the woods may sound like a dream but it can be a logistical nightmare when buying a cabin to rent out. Before you buy, make sure you know all the ways you can access the property. Is it accessible by road or only by boat? Is it accessible during the winter? Do the roads get plowed in the event of snow? This is important to know so that you don’t end up with angry renters who can’t access the cabin or with a maintenance problem that you can’t tend to because of limited seasonal access.

2. Cellphone Reception and Internet Access

According to a recent Royal LePage survey, the most important factor when deciding to buy a vacation property is cell phone reception and internet speed. It’s with good reason too. While one of the draws of owning a cabin outside the city is to disconnect from regular life, most people want to stay connected to some degree. For a rental cabin or cottage, this is even more important for managing the guest experience. If questions arise during your guest’s stay or issues come up, you will need to have an effective means of communication. Lastly, many travelers will often wind down for the evening by watching their favorite show on Netflix or other streaming service. Without fast internet, this won’t be possible.

3. Access to Clean Drinking Water

Most of us probably take for granted the drinkable water that comes out of our taps every day, but this may not be the case with rural cabins or cottages. The risk of water problems and contamination is far greater in rural areas than in well-established cities. So, before buying a cottage to rent out, look into the water situation. If there is a well, the water will need to be regularly tested. In some cases, you may even have to bring with you your own clean drinking water.

4. Renovations

While a rustic cottage is great, a modern cottage with a newly renovated kitchen, internet, television, and hot tub is even better.

These days, renters are looking for the same comforts that they would find in a hotel.

Before buying your cottage, consider how much work you’ll have to put into it before it’s ready to be rented out. Are you confident enough to DIY the reno’s or will you hire professionals? How would renovations impact your budget? How long will they take before the cottage is ready for renters? These are all important questions to ask yourself before buying a cottage to rent out.

5. Rental Rules in Your Area

Before buying a cabin to rent out, be sure to find out what the rules are in the area. Short-term rentals are prohibited in some areas. For example, many California cities and counties have passed short-term rental ordinances to reduce problems associated with short-term rentals, including noise, parking, partying and trash. Similar ordinances have been passed in other states such as Colorado and New York. In the province of Quebec, there is an obligatory classification system for short-term rentals. This program costs owners roughly $250 annually. Out west in Whistler, BC, you will need to ensure that the cottage is properly zoned and obtain a tourism accommodation license. As the rules can vary wildly from state to state, province to province and city to city, its important to run this to ground before buying.

6. Advertising

Managing a rental property can be a lot of work, especially when you initially put the cabin or cottage up for rent. To increase the profitability of your rental cabin or cottage, you’ll need to have high-quality photos. Photos are what draw in travelers. They’re what makes potential renters decide whether or not to click on your listing to learn more about it. Having eye-catching photos can also inspire renters to save your listing to their Wish List on Airbnb. The more times your listing is saved to a wish list, the better your SEO ranking will be. Borrow a friend’s camera, if you’re unable to hire a professional photographer, and take photos when there’s lots of natural light in the space.

To increase your chances of renting, be sure to list your cottage on multiple rental sites, like Airbnb and HomeAway.

However, keep in mind that, depending upon the platform, there may be additional annual listing costs. Also, it may not be worth it to advertise on national or international platforms if your cabin or cottage is located in an area that doesn’t typically attract out of state (or province) tourists. Before signing up with any of these rental sites, do some research. Try searching on Google several keywords associated with your cabin or cottage and see what websites show up. This may help you decide where it’s worth listing.

7. Property Management and Maintenance

If you’re considering buying a cabin to rent out, you need to make sure you or someone you trust will be able to manage the property. This includes maintenance, mowing the lawn, cleaning, and even picking up or dropping off the keys. Without maintaining the property and being responsive to guests’ needs, you’ll likely accrue negative reviews, which could impact future bookings. If you’re unable to tend to the property yourself, research your options and the costs associated with a property management company. For remote properties, keep in mind that you may have relatively few options.

8. How Much You Can Rent Your Cabin or Cottage For

The price you can rent your cabin or cottage for comes down to a few factors. Firstly, location. If your cottage is in a desirable location, you’ll likely be able to charge a little more. Before buying, do some market research and compare your cottage to others nearby. That way you’ll be able to determine a somewhat-accurate price based on the desirability of the property in comparison to those around you. Second, what amenities and other extras can you offer your guests? Does your cabin include two bathrooms whereas most others in the area typically have one bathroom? Does your cabin include a canoe or kayak for guest use? Be sure to factor in any extras you may offer guests and fine tune pricing after you’ve received some bookings.

Importantly, once your cottage is open to renters, be sure to request a refundable security deposit. A hefty security deposit lowers the chances that you’ll end up with renters who abuse your equipment and furniture.

9. Insurance costs

Cabins and cottages tend to face higher risks for weather-related issues. For example, cabins in coastal areas are more likely to be hit by hurricanes or experience flooding. Cabins situated on islands are less desirable for insurers because they’re harder to get to. Your insurer must also be aware that your cabin or cottage is being used as a rental property, as you will need to update your insurance to a rental property insurance policy.

We hope you’ve found these tips on buying a cottage to rent out useful. Be sure to explore our additional resources on buying a vacation home, including everything you need to know before buying a vacation home.

The post Thinking of Buying a Cabin or Cottage to Rent Out? Consider These 9 Things First appeared first on Vacation Property Online.

When people think about buying a vacation home in the United States or Canada, they often imagine getaways to Maui, Lake Tahoe, Palm Beach, Whistler, Muskoka Lakes, Mont Tremblant and other vacation hotspots. Typically, people are drawn to vacation properties as places to go to relax. While it is undoubtedly true that second homes serve that purpose, they can also make fantastic investments. Typically buying real estate is a wise decision, as property values tend to appreciate over the years. But is a vacation home a good investment relative to other asset classes? With this question in mind, we consider the pros and cons of owning a vacation home as an investment.

Curious about your potential return on investment should you decide to purchase a vacation home? Simply complete the inputs in our vacation property investment calculator to find out more.

The Good

Historically Safe Investment

Like many other industries, real estate is prone to price fluctuations. Yet, by looking at historical home prices in the United States and Canada, it’s clear that real estate offers a fairly safe investment.

In the United States, apart from the housing crash of 2008 (which prices have since recovered) real estate prices have increased consistently since the 1950’s, going from a median home price of US$180,039.29 (inflation adjusted) in 1953 to over US$300,000 in 2021. Canada has also had historically steady growth when it comes to real estate. In fact, Canadian real estate prices have continued to appreciate despite the 2008 housing crash in the United States.

In short, it’s rare to have a complete collapse in prices as historical real estate prices illustrate. Instead, real estate prices have typically shown slow and stable growth over time.

Additional Safety Net

Perhaps one of the reasons why real estate is a relatively safe investment is that the land and structure you own will always be worth something. People will need a place to live and travel. This fact remains true both in a bull market and a bear market. While your vacation home may go down in value, it will never be worthless like other investment types.

Therefore, many people look at property as a relatively safe investment with less downside than other equities. If you are looking for a way to preserve your wealth, real estate is often a stellar way to do this. Of course, there is an added benefit that you get to enjoy your investment while simultaneously knowing that you are using your money wisely. If the worst case scenario happens and there is a complete crash in the real estate market or tourism industry, then at least you can use your vacation home for weekend getaways or family vacations.

Real estate is also unique in that there are relatively well-defined processes for extracting equity out of your home without actually selling the property at comparatively meager interest rates. If you ever find that you need money, unlike stocks and bonds, you can apply for a second mortgage or a home equity line of credit (HELOC) and access your equity for an interest rate that is typically only slightly above inflation. Meanwhile, while you are borrowing that money, your underlying asset – the vacation home – continues to appreciate and can still earn rental income to pay that HELOC back.

Ability to Generate Rental Income

When you are not using your vacation home, you have the option of renting it out. If you buy in a prime tourist destination, your home will be able to command fantastic rental rates. If you hire a property manager to coordinate these rentals for you, then most of the work will be taken care of for you. If you would like to manage things yourself, then there are any number of vacation rental platforms to choose from. 

There are also tax benefits to renting your property out when you are not using it. Expenses you incur while renting it out (e.g. property taxes) can offset rental income. If your annual property tax bill is $2,000 per year, and you rent out your vacation home 80% of the time, then you can write off $1,600 of your taxes against that income.

Of course, tax laws in the United States and Canada are nuanced and varied, so you should consult with a qualified accountant before deciding to rent out your particular vacation home.

Renovations Increase Value

Investing in your vacation home has two benefits. First, it enables you to enjoy it more while you are using it. Second, it increases the value of your vacation property.

Furthermore, if the renovations help to rent the property out or increase the amount of rent you can charge, you might be able to deduct those expenses against rental income (again, consult with a tax professional for your particular circumstance).

This point is particularly true if you buy a vacation home at a discount that needs work. As a quick example, suppose that you buy a distressed property for $300,000. Houses of similar size go for $500,000. Now, you put in $50,000 worth of renovations to make it habitable. Over the next five years, you put in another $50,000 to make it pristine. In the meantime, you’re able to enjoy the property and occasionally rent it out for other people to use.

After all those renovations, your home is now worth $600,000 because it is better than all the other homes on the market. You put in $400k between the purchase price and renovations. You were able to rent it out for some passive income during those five years. After all that time, your home is now worth $200k more than you paid for it, netting you $100k in additional equity after the cost of the renovations are taken into account. You got a place to enjoy, some passive income, and still come out ahead financially. If you’re willing to put a little bit of elbow grease into a distressed property, a vacation home can be a great way to make a little bit of money while having a fun and enjoyable place to go.

It Can Help You Achieve Your Savings Goals

If nothing else, owning a vacation home results in forced savings.

A vacation home can act as a delightful savings account. If you sometimes find it challenging to save, buying a vacation home as an investment can help you achieve your savings goals without being a bank account that you can withdraw from effortlessly. For some people, it’s easier mentally to save money by investing in a goal or a dream than it is to sock away cash for the sake of socking away cash. If you fall into that category, a second investment home might help you achieve your savings goals.

Of course, unlike a bank account that might earn 1.5% interest if you are lucky, the capital appreciation on a home has historically been much higher. If you are looking to accelerate your wealth building, having properties besides your principal residence is a fantastic way to achieve that.

Tax-Advantaged Wealth Building

You needn’t rent out your property to see the benefits of investing in a vacation home. Any property appreciation that you achieve is tax-deferred until you sell and is subject to capital gains tax instead of regular income tax. In the United States, capital gains are generally included in taxable income, but are typically taxed at a lower rate. For instance, short-term capital gains are taxed at rates up to 37% and long-term gains are taxed at rates up to 20%. In Canada, you are taxed on 50% of the capital gain, not 100%. If you held a property for ten years that appreciated in value by $100,000, you would owe tax (at the relevant rate) on 50% of that ($50,000). Whether you’re resident in the United States or Canada, you can take advantage of the lower level of taxation on capital gains. 

Of course, if you invest in stocks, bonds, etc. you also get this tax advantage, but those tend to be a little riskier than real estate. Further, if you put that money in relatively safe investments like Certificates of Deposit (in the US) or GICs (in Canada) and savings accounts, then you owe income tax on any interest generated from those accounts immediately once you earn it. With real estate, you don’t realize a gain until you actually sell your vacation home. Therefore you can defer any tax obligation until you decide to sell. Real estate blends the best of all worlds by offering a tax-advantaged way to build wealth while still providing strong returns on investment.

You Can Build Wealth Using the Bank’s Money

One somewhat unique property of owning real estate as an investment tool is that the bank will lend money at relatively inexpensive interest rates to purchase it. This money will then typically earn a higher ROI than the underlying mortgage costs. In effect, buying an investment property enables you to make “free” money.

Consider the following example. Suppose you buy a $500,000 home. You put down 50% or $250,000. The bank puts down the other $250,000 at an interest rate of 3% on a 25 year amortization schedule, and the property appreciates 8% per year. At the end of 5 years, your home will be worth $734,000. Not bad! You’ll also owe $213,000 on the mortgage after paying approximately $71,000 in monthly payments, $37,000 of which went towards the principal. You can sell your property for $734k and pay off the $213,000 balance with the proceeds. You will have $521,000 left after the sale (excluding real estate commissions, taxes and fees). That $521,000 is off of your original $250,000 investment plus the $71,000 in mortgage payments. Therefore, your net profit is $200,000, which is not bad, considering you only put in $321,000! That’s an ROI of over 60% in 5 years.

The reason you were able to have such a substantial return on investment is that you were earning 8% on the full value of the vacation home, while only paying 3% to the bank on half of that value. No other investment has access to “cheap” money quite like this. The margin rates on stocks are quite expensive. Bonds don’t have loans like this either. The only investment with interest rates that hover this low is real estate.

The Bad

Historically Outperformed by Other Investment Types

While past performance is not necessarily indicative of future performance, historical returns are an important consideration for any mindful investor. At the very least, the long term results of different investment types will paint a clearer picture as to what you can reasonably expect over the long term. Given that there are various different competing investments you can make, from stocks and bonds to gold and other precious metals and even crypto currencies, it’s important to do your research before you put your money to work.

Comparing historical real estate returns, however, is not necessarily an apples to oranges comparison with the stock market for instance. For example, real estate returns can vary substantially from city to city so national data may not be completely accurate. Further, with real estate you have the potential to not only earn a return on your investment through price appreciation but also rental income which is not always easy to measure. Finally, real estate purchases are typically highly mortgaged (or leveraged), which can magnify gains. Still, by working with the available data we’re able to see how real estate stacks up against other investments.

In the United States, the long-term nominal (not inflation-adjusted) annualized return from 1928 to 2020 was 4.0% for U.S. real estate. By comparison, US large-cap stocks returned 9.8% over the same period. In Canada, similar data suggests that equities have been a more effective way to grow wealth compared to real estate.  For instance, from 1996 to 2020, house prices in Canada increased on average 5.7% whereas the TSX composite index rose 8.0% over the same period. Of course, none of the data can accurately account for rental income nor the magnified returns when using the bank’s money.

In short, the data suggests that US and Canadian real estate are a relatively poor investment choice as compared to other asset classes. Keep in mind, however, the limitations with this data as further described above.

Not Truly Passive

The reality is that owning a vacation home will require a certain level of active involvement.

If you plan on renting out your vacation home, perhaps as a short term rental, then you’ll need to manage the bookings, collect payments and attend to other matters, although short term rental websites such as Airbnb and VRBO have certainly made this easier. Yet you will still be responsible for the guest experience and have to deal with any issues that arise. Even if you hire a property manager there will still be annual obligations such as paying property taxes, renewing insurance etc. Undoubtedly, unexpected issues will arise such as major repairs or renovations that will require your time and resources. 

By comparison, investing in the stock market is a truly passive investment and, as illustrated above, may outperform real estate in the long run.

Lack of Diversification

Diversification is an important component of any investment strategy. Simply put, rather than risking all of your resources on any single idea, venture, or asset, it’s important to invest in multiple asset classes. For instance, while investing in gold may turn out to be a prudent choice over a five year period, it may turn out to be a bad choice for the next ten years after that. Similarly, the real estate market has periods of strong growth and little to no growth. Look no further than the 2008 financial crisis for a recent example of a period of depressed real estate prices. 

Assuming you own your primary residence, then committing further money to a vacation home may be risky, depending upon how well diversified you are in other asset classes.

Stricter Lending Criteria

Mortgages for vacation homes will often be accompanied by larger down payment requirements, higher interest rates and more stringent lending guidelines.

This is because vacation home mortgages are more risky as owners may be more willing to default on their vacation home mortgage (as opposed to the mortgage on their primary residence) when faced with financial hardship. For example, many lenders will require at least a 640-credit score, and a 20% to 30% down payment on a vacation home. The higher down payment reassures lenders that you’ll make your payments on time. You can also expect to pay mortgage rates that are 0.25% to 0.5% higher than you would for a primary residence

If you can’t satisfy these more stringent lending criteria or the requirements otherwise make the investment uneconomic, then there may be other more attractive investments to make.

Increased Leverage

Assuming you qualify, a second home mortgage will increase your leverage and overall debt to income. While you may be able to handle the monthly payments (with or without rental income), it’s not without risk. For instance, as the COVID pandemic has shown, unforeseen events can seriously impact your finances. Whether it’s loss of income due to career setbacks or loss of rental income due to a downturn in the travel industry, there are many potential events that could adversely affect your finances. Even weather related events could result in your once promising vocational rental sitting idle. 

The point is that with increased leverage comes increased risk. Most financial experts recommend that you have a debt to income ratio of no more 43% overall and 30% on housing expenses. Try to ensure you stay within these limits and, when crunching the numbers on your vacation home, assume the worst. If you can handle the monthly payments in the worst case scenario, then buying a vacation home may just be a good idea.

Vacation Home Freeloaders

If you’re buying your vacation home as an investment then it can often be a challenge for friends and family to accept that they can’t use the property whenever they want, either for free or at a substantially reduced rate. Many people may even feel entitled to use your property. This is where it becomes more difficult as an investor as opposed to someone who simply wants a second home to spend time with friends and family. As an investor, you should be maximizing your investment and looking for new ways to generate revenue or increase your return on investment. Yet some people can’t understand that. With alternative investments such as stocks, you won’t have this issue as your uncle’s second cousin can’t borrow your Amazon shares for the weekend. If you do rent out your property, provide a universal friends and family discount between 10-20% and don’t deviate from it.

Vacation Home as an Investment: So Where Does That Leave Us?

Like any other asset class, investing in real estate has its pros and cons. Historically, home prices in the United States and Canada have shown consistent if not unspectacular returns. Yet you can also extract value through rental income and home renovations all the while using the bank’s money to do so. What really separates buying a vacation home as an investment from other investment types is the dual purposes for which it serves. While a vacation home can make a great investment, there are intangible benefits that can’t be measured. You can’t, for instance, put a price on pride of ownership or memories with the grandkids. The joy that a vacation home can bring is something that other investment types just can’t come close to matching.

Ultimately, if you’re looking to maximize your return with a truly passive investment then perhaps investing in the stock market is more appropriate. However, if you’re willing to assume all of the responsibilities as a vacation homeowner, then you can still enjoy the fantastic returns on investment while you have fun!

No matter what your investment and lifestyle objectives are, buying a vacation home as an investment can often get you there. For more articles and resources on buying a vacation home click here.

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