Buying vacation property is one way of investing in real estate. Properties in many areas can be purchased and rented out on a short-term basis to vacationers. Real estate investments are usually growth oriented. This means that the return on investment is based on the rate at which your property increases in value from the time you purchase it until the time you sell it. However, when you purchase rental property (either residential or vacation), your focus will be on current income and cash flow. Vacation rentals are typically long-term investments because even though you might sell the property at a profit someday, the greater part of your return will most likely come from the rental income you generate over the years.
The risks involved in buying a second home
Although vacation rental property is not as speculative as some real estate investments, substantial risk is still associated with investing in vacation rentals. In particular, vacation property investments are subject to market risk and liquidity risk. The chosen location could unexpectedly fall out of favor with the vacationing public, causing the rental income and property values to fall. A poor economy could cause more people to cut back on vacation plans, leaving you with fewer rentals. Changes in tax laws could reduce the favorable tax treatment of rental property. Should you find yourself with an unexpected cash need, you will probably not be able to sell your vacation property. Before purchasing property as a vacation rental, you should evaluate your ability to deal with these risks.
Strengths
1. Variety of property types and locations provides flexibility:
When you purchase vacation rentals, you can choose from a wide variety of property types and locations. Your choices range from a beachfront house in Key West to a ski chalet in Colorado, to a three-season A-frame in the Adirondacks, to a townhouse in New Orleans, and more. Perhaps you'll want to purchase property near your home, so you can conveniently make inspections and repairs. Or maybe you've found an idyllic vacation spot that you and your family enjoy, and you want to purchase property near this paradise. In any case, the options are virtually endless when it comes to choosing vacation rental investment property.
2. Favorable tax treatment for rental property:
Income-producing real property is considered business property. If your vacation property is used exclusively for rental purposes, it qualifies for certain favorable tax treatment: Your mortgage interest, property taxes, insurance, advertising, maintenance, and other expenses are typically tax deductible. However, if you use the property for personal use as well as renting it out, these tax advantages decrease accordingly. Property depreciation is also generally deductible.
3. Current income and the potential for capital gains:
As mentioned, most of the return on your vacation rental investment will be current income in the form of rent payments. However, rental property also has the potential for capital gains because there is a chance that you can eventually sell the property for more than your original purchase price. By contrast, most real estate investments provide an opportunity for capital gains, but little current income.
Tradeoffs
1. Not a liquid investment:
Like all real estate, vacation rentals are cannot be sold in a hurry, and there is little certainty about the selling price you will receive if you do manage to find a quick buyer. Other types of investments, such as stocks, bonds, and other short-term securities, should be included in a balanced portfolio to provide adequate liquidity.
2. Real estate can be a highly speculative investment:
There is absolutely no guarantee you will realize a profit on a real estate investment. In fact, there is no guarantee your property will even retain its current value. Many of the factors that determine the success or failure of a given real estate investment are outside of the investor's control.
3. Vacation property requires near-constant attention:
Vacation property is not a "make and forget" investment. Before you purchase vacation rental property, you need to decide how you will provide for its management and maintenance. Whatever you're paying for maintenance, remember that it is cutting into your profits.
4. Property values, rental income and occupancy depend on the popularity of the area:
Since the majority of your return from an investment in vacation rental property comes from rental income, it is important to keep your occupancy rates as high as possible. The future popularity of an area is largely outside of your control. A decline in popularity can also affect your property value and could be devastating when you eventually decide to sell the property.