Vacation Home: Investment or Money Pit?

[Beach Runner]

Rentals don't cover our expenses. Our home is normally full from the second full week of May through the first of August. We reserve two of those weeks for ourselves. We have 2-3 weeks of rentals during spring break (we really don't like to rent to spring breakers, so we keep the price high), and another 3-4 weeks in August and September.

Having school start back the first week of August really hurts the potential rentals.

We spend too much time taking care of having someone repair rental damage and replace items stolen or lost by renters. We wish we had built a smaller house so we wouldn't have to rent.

Then the Florida weather causes the house to need a lot of maintenance. Things just deteriorate faster here than in GA. The closer to the beach you are, the worse it gets. When our beachfront neighbor has his house painted due to the sand literally blasting his home, it needs repainting after a year. Anyhow we spend a lot of time on maintenance.

So we never truly vacation here. There is always work for us to do or either make arrangements for and supervise others doing the repairs/maintenance.

We are thinking about buying condo that we wouldn't rent so that we could actually come to the beach and relax.

 

[TooFarTampa]

I think one of the issues is we don't know what a healthy SoWal market really looks like. At some point we are going to get to a place where the market is back in balance, construction is steady, homes appreciate at a modest amount each year, and vacation rental rates follow suit. The price swings could be fairly unpredictable for a couple of more years though.

Beachrunner's post lays out pretty well the challenges of owning a vacation rental. While you do have renters helping pay your expenses and some of your mortgage, on the flip side you are offering a service to the people who want to vacation there. (I think sometimes this service is taken for granted by the renters.) Maintaining a rental home and building a good relationship with a management company is something of an art form. After several years you get the hang of it, and by that time you know if it's worth continuing indefinitely or not.

Prices may continue to fall, but I don't think the fall will be significant or permanent. If they get low enough, you will find people wanting to buy just for their own use, and deciding not to rent their homes at all. If enough home sell at a low enough price, the number of vacation rentals will fall, and rates will naturally rise. As a result homes prices will go back up again to some degree.

Once that happens I think we will be in balance and the "investment" aspect will be twofold -- slow but steady increase in value and gradual increase in rates. But we are not at that place now.

I don't think at any point it is realistic to expect a property to cash flow right away, because SoWal real estate does and should always come at something of a premium relative to the average market.

But I think buyers with a long-term horizon may be pleased with their investment if they can get in at a comfortable price.

Bottom line is I think you have to consider yourself an end user, and have some emotional attachment to the area to feel good about such an investment. It is worth noting that in my experience, the rental market for single family homes is as strong in SoWal as it is anywhere in Florida. There are many lovely coastal communities that do not permit transient rentals. Taxes also tend to be lower than other Florida coastal areas, which is another benefit to owners.

 

[Kurt]

Great info y'all.

Smiling Joe, I'm surprised you have any free time at all with all the great info you post here. I'd think your inbox would be full of buyers and sellers. Thanks!

 

[Smiling JOe]

Great info y'all.

Smiling Joe, I'm surprised you have any free time at all with all the great info you post here. I'd think your inbox would be full of buyers and sellers. Thanks!

I'm still at the office (Sunday afternoon), just in case, but mostly Spring Breakers coming in for directions, bathrooms, locked out of rental units, etc, but it is Sunday. I need to get outside and enjoy some cloudy, overcast skies.

 

[scooterbug44]

You buy a vacation rental in Sowal because you want to spend time here and rent it out when you are not here to offset the costs. The profit comes in the memories and time spent together at the beach, not into your bank account.

 

[Paula]

I bought two small side-by-side cottages in 2003/04 and am happy I did, but I bought in part for emotional reasons, in part to spend many months each year in SoWal (which I'll be able to start doing in about 4 years), and as part of a diversified portfolio. But, frankly, from a purely financial perspective, I can't tell you if it was a very wise financial decision (but it was a good-enough financial decision and an excellent make-me-and-my-family-and-friends-happy financial decision). And I checked with my accountant and he said it was an OK-enough financial decision. Here's what I learned:

• Buy something smaller all on one story so that you can maintain it yourself (or so that maintenance is less expensive to hire out than a 2-3 story house - think about washing those windows...). You can get 3 bedrooms/2 baths in 1100-1200 square feet if the place is designed efficiently.
  
• A smaller place costs less and has lower insurance and expenses (e.g. cooling/heating/electricity/etc.).
  
• If you get a smaller place, try to get a large porch because it adds a lot of space but not much more expense.
  
• Factor in the monthly association fees - the simpler the environment, the lower the fees. And remember that if you buy something new in a new community, the fees are likely to be quite low at first and then go up significantly once the place is settled and everything is up and running.
  
• You don't need to buy flood insurance if you're up high on a dune (check before you buy to see if you'll need flood insurance - it is $450 or so/year - I get it anyway even though we technically don't need it because we're across the street from the beach and up on a high dune, but I sleep better having it).
  
• Rentals help take about half of the expenses in my view. They haven't covered all my bills, but - on the other hand - I don't have to put much into the cottages now because they are fully furnished, equipped, painted, etc., so maybe the expenses will start going down. IThe cottages are rented throughout the summer, on and off in fall/spring, and I've had very nice snowbirds a few months each winter who rent it for a song, but it's nice to have someone in the cottages rather than have them empty. If rents are slow in any year, then you're paying more of the expenses. Also, I use a management company and they get 25% of the rental income and they also charge other expenses (linens, cleaning, and more) that comes out of my income. But it has been worth it for me for now because I'm so far away and I'm too busy with work/family to do what the management company does at this point in my life.
  
  
• Definitely check with your accountant. I would guess that your accountant would tell you to consider a beach house only if you are sure you can fully fund your retirement account every year, and keep 6 months or more living expenses saved. If you're not doing those things already, I would think your accountant would say it's too risky to buy a second property. My accountant also told me to not count on rentals to pay the bills, which was wise advice (even though rentals have paid about 1/2 of the bills and may eventually pay more of them). You'd have to decide whether it's worth working extra to cover the expenses of having a beach home). And the money you put into a beach home doesn't go into your main home, so that's something to consider, too.

Frankly, I bought primarily because I wanted a sunny and warm place to escape to in the winters someday when I retire, and the prices were right when I bought in 2003/04. In the meantime, the kids have fallen in love with SoWal, as have I, and we have made many great family memories and will continue to do so at the cottages.

Scooterbug is right! The research on happiness says that spending money on experiences - which is what the cottages in SoWal give us -- is a wise investment (more so than spending money on things so you'd want to consider whether the beach house would be primarily a "thing" or whether it is primarily an experience that you share with others). Of course, if you get into financial difficulty because you bought a place, it's not going to make you very happy at all. According to the research, investing in experiences that you share with others is a wise investment because we get to "savor" our experiences for a long time. We get to "savor" looking forward to the experience, "savor" the experience while we're having it, and then look back and "savor" the memories that last a life time. I savor our experiences so much with our SoWal vacations and cottage/beach experiences that I start drooling sometimes...

I hope this is helpful (the advice, that is, not the drooling).

 

[fisher]

You are correct that Tallahassee homes are not in the same ball game as vacation properties in South Walton. We are talking about apples and bananas.

The old rule of thumb is that an investor would like to beat the average return of other investments. This is changing greatly over the last decade, with the stock market being at the peak, and now off tremendously. I'm not sure what the average rate of return is on the stock market over the history of the market. It used to vary between 7-8%. Anyway, some simple math to keep in mind for true investment property is that (without considering property value increases/decreases and tax shelters) an investor would want to see monthly rents of 1% of the purchase price, in order to receive a 10% return per year. eg- a house costing you $200,000 should pull rent of $2000 per month. That is far from the case here today. At best, a $200,000 house in South Walton might on a good day pull around $1000 per month. That math doesn't work inside these guidelines. Here is why:

$200,000 purchase price
20% down = $40,000
balance of loan = $160,000
(assuming a 6% fixed interest rate for 30 years)
Monthly principle and interest = $960
expect a monthly cost of taxes to be around $150
expect insurance to cost around $200 per month
_______________________________________
So, you have monthly rental income of $1000
less monthly expenses of $1310 per month*
leaving you an estimate NEGATIVE cash flow of $310 per month, and you have a part time job of a landlord, costing you time and labor.


*(we'll stop there, but there are additional cost of maintenance and repairs and if you aren't calculating at least 2 months per year of no occupancy, you are leaving out meaningful numbers.)

I will gladly look at examples of possible POSitive cash flowing properties, but on average, you won't find any to purchase in South Walton at this time, and probably won't see many in the future. This doesn't mean that property won't increase in value and return money on your investment. Just means that properties purchased today in our area, don't tend to Cash Flow in a positive manner.

Let's use the example above with a monthly rental income of 1% (of purchase price) per month to see how the cash flow would vary:

$200,000 purchase price
20% down = $40,000
balance of loan = $160,000
(assuming a 6% fixed interest rate for 30 years)
Monthly principle and interest = $960
expect a monthly cost of taxes to be around $150
expect insurance to cost around $200 per month
_______________________________________
So, you have monthly rental income of $2000
less monthly expenses of $1310 per month*
= $690 per month, or $8280 per year

Remember, you have $40,000 of your money tied up, plus $1310 per month ($15,720 per year). Divide $8,280 (return) on $55,720 (money invested) = 14.9% ROI (return on investment). Again, we aren't calculating the time when there is no occupancy, and not setting aside money for repairs and maintenance. Both are real costs, and when included, you will come closer to a 10% ROI, which still beats the life time average return of the stock market. (You still have a part time job as a landlord, which may mean calling the plumber on a Sunday to fix the flapper on a toilet, at a cost of $120, or doing it yourself. -- Being a landlord is no glorious job.)


*(but there are additional cost of maintenance and repairs and if you aren't calculating at least 2 months per year of no occupancy, you are leaving out meaningful numbers.

You actually calculated the ROE or return on equity. Not a great way to look at it in my opinion.

Actually, the ROI should be calculated on the entire $200k that is invested. In your example, you borrowed $160k from the bank for which you are on the hook (just ask all those folks in foreclosure and short sale positions if they were on the hook for the loans they took out). Your investment includes the amount borrowed plus the equity you put into the deal (unless the debt is non recourse to you which is never the case with a mortgage on a personal home).

So, in your example, the ROI is acutually about 4% excluding the extra costs you mention, not 15%. Including the extra costs you mention, the return starts moving toward 0%.

Unfortunately for many, many people, they looked at the ROI like you posted above when making their purchases in 2003, 2004, 2005... They assumed that the mortgage didn't exist, that the only money they had in the deal was the down payment. Didn't quite work out that way. They found out that the real amount invested in the property included that pesky mortgage.

Never forget the money borrowed when determining your risk and your return, it really does count.

Buying in SoWal hoping to cash flow is not a good idea.

 

[xaa]

You buy a vacation rental in Sowal because you want to spend time here and rent it out when you are not here to offset the costs. The profit comes in the memories and time spent together at the beach, not into your bank account.

Thanks for the comment. Having been a frequent guest of some wonderful homes throughout 30A over the years, I would say that I've accumulated a nice profit of memories. And based on the comments of the others, it would behove me to remain as a guest. Thanks to all for the comments.

 

[fisher]

Thanks for the comment. Having been a frequent guest of some wonderful homes throughout 30A over the years, I would say that I've accumulated a nice profit of memories. And based on the comments of the others, it would behove me to remain as a guest. Thanks to all for the comments.

Well said and smart decision. Good luck.

 

[Beach Runner]

Thanks for the comment. Having been a frequent guest of some wonderful homes throughout 30A over the years, I would say that I've accumulated a nice profit of memories. And based on the comments of the others, it would behove me to remain as a guest. Thanks to all for the comments.

I disagree. I would say buy a low-maintenance property that you don't have to rent so that you can enjoy this paradise whenever you want. In our case, we like to be here every other weekend and for weeks at a time when the college is on break.