The Capitalist Investor - Episode 29

“Is a vacation home an investment?”

This is one of our commonly asked questions. So in this episode of The Capitalist Investor, Derek and I dissect the pros and cons of purchasing a vacation home. We run the numbers and share the data. In the end, you’ll find out if a vacation home is an investment worth your time and money—or a second home purely for enjoyment.

Outline of This Episode

  • [1:10] Is a vacation home an investment or pure consumption?
  • [3:01] Should you pay off your mortgage when you retire?
  • [6:56] We break down the vacation home investment math
  • [14:09] What if you plan on renting out your vacation home
  • [17:03] Considering in the removed cost of vacations
  • [18:31] Mortgage applications rebound 21%
  • [21:47] Real estate is one of the most misconstrued investments out there

Vacation home: pure consumption or investment?

Our knee-jerk response is that purchasing a vacation home isn’t an investment but on the consumption end of the spectrum. If the goal is for it to be an investment, it depends on how much time you want to spend on it and what your net return is. People look at appreciation as their net return—but that’s just NOT the case.

Most people have dreams, goals, and aspirations of owning a vacation home. But when it comes down to it, buying a vacation home—without a doubt—is consumption. You need to enter into the arrangement thinking that with an investment component simply being the icing on the cake.

What the vacation home math tells us

On the very high end, you may be lucky enough to see a 6% annual appreciation on your investment. People think that’s the return they’re getting—but it doesn’t work that way. Firstly, you have your mortgage and mortgage interest. If you’re lucky, the interest will be around 3–3.5%. If the bank knows it will be a second home it may be closer to 4.25%. That’s the first cost you have to consider. So far, your net return has now been reduced to 1.75%. That is NOT a good ROI.

But wait—those aren’t the only costs. You also have to consider taxes, insurance, and HOA fees which might equal 2–3% a year. Then you have to factor in upkeep and maintenance. If you’re the only one using the home, you may spend 2% of the home’s value a year for upkeep and maintenance. Which could be $10,000 a year up to $50,000 a year depending on the cost of the home.

So with the math, 8.25–9.25% is the cost associated with owning a second home based on today’s low mortgage rates. Does that sound like a good investment? You’d have to see astronomical annual appreciation to break even on your investment.

What if you rent out your vacation home?

So what if you took your vacation home and rented it out when you aren’t living there? Well, there are a few things you have to consider:

  1. How much time will you have to spend to turn a profit?
  2. How much is your time worth?
  3. What if someone doesn’t pay their rent?
  4. What if you have huge maintenance costs?

If a snowbird gets a place in Florida or Arizona and stays there four months a year and attempts to rent it out for eight months, the best-case scenario is they’ll offset the cost of the upkeep. There will always be additional expenses that you don’t think of.

If your mortgage has a 4.5% interest rate, and HOA/taxes/insurance is 2–3%, and upkeep is 2%, it’s still costing you more than your projected net return of 6% annually. What if you offset your expenses with the money you’d be saving on vacation costs? Keep listening to hear our thoughts.

Should I pay off my mortgage?

A complementary question we are often asked is if someone should pay off their mortgage when they retire. Others want to downsize and get a vacation home.

Scenario #1: If you’re in a position to do so, and don’t have to take enormous amounts of money out, of course you can consider paying off the mortgage. You won’t make money, but you won’t lose thousands.

Scenario #2: If you have $75,000 left to pay and have $300,000 in non-qualified investment accounts, the math would tell us that it is NOT better to take the lump sum out to pay off the mortgage.

The bottom line is, if you’re close to the tail end of a mortgage and want peace of mind, go for it. You need to be able to sleep at night. But the jury is out on vacation homes and it’s safe to say they’re not a great investment. However, they’re wonderful if you’re just looking to have a second home to enjoy.

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