Vacation Home: Investment or Money Pit?

I'm toying (more like struggling) with the idea of buying a 30A vacation/investment home. With the current housing/mortgage meltdown, I would have thought I could purchase something up for a decent price. However, as I run my model on numerous potential properties in the area, I can't get anything to a break-even cash flow without assuming a 40% to 50% discount on the asking prices. Am I missing something? Any thoughts would be appreciated. I've had rental properties for over 15 years (albeit these are not vacation homes). Would be happy to share my model.

...nope, you're not missing anything.

Of course you can pull numbers out of your arse that will cashflow--I've seen a few posted on here.

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I have been very pleased with my investment in local rental houses. I own two. I purchased nice, but moderately priced, brand new 4 bedroom homes in the best school zone in my city. I put 20% down on each of them and they have never been empty for a day. In fact I have never had a renter stay less than three years.

After my initial 20% down, I never put another dime of my own money in them. The rent makes the payments and provides enough money for maintenance and repairs.

OTOH I own two beach house "investments." They are constant work (managing the rental) and we put money into them most months. Granted the beach properties are much bigger and finer houses but, from an investment stand point, what difference does that make???

If you want a beach property to enjoy and you can afford it, buy a beach property. Rent it out when you are not using it for a little extra income. If you are strictly looking for a real estate investment, you might want to consider other options as well.

My 2 cents!

Very few properties will cash flow, currently, especially the vacation properties. You will have better luck finding long-term rental properties which will come closer to cash flow. However, rents have decreased over the last few years, and there are many more rentals on the market now. Over the last few years, with 20% down, I can think of only a few properties here and there which mightl provide break-even or slight positive cash flow.

I'm toying (more like struggling) with the idea of buying a 30A vacation/investment home. With the current housing/mortgage meltdown, I would have thought I could purchase something up for a decent price. However, as I run my model on numerous potential properties in the area, I can't get anything to a break-even cash flow without assuming a 40% to 50% discount on the asking prices. Am I missing something? Any thoughts would be appreciated. I've had rental properties for over 15 years (albeit these are not vacation homes). Would be happy to share my model.

While there are some "relative bargains" here and there, mostly REO's, the vast majority of properties in SoWal are overpriced. Many are listed at peak 2005/2006 values. Since you are an experienced real estate investor, you know that the only benchmark that counts are resales. View some of the graphs in this forum and see the number of years of supply remaining.

Very few properties will cash flow, currently, especially the vacation properties. You will have better luck finding long-term rental properties which will come closer to cash flow. However, rents have decreased over the last few years, and there are many more rentals on the market now. Over the last few years, with 20% down, I can think of only a few properties here and there which mightl provide break-even or slight positive cash flow.

I disagree, I have seen rental rates increase and vacancy's decrease over the last few years. You are correct you will need to search and find a break even property. You may even need to add value to the property to get it to a positive cash flow.

I'm toying (more like struggling) with the idea of buying a 30A vacation/investment home. With the current housing/mortgage meltdown, I would have thought I could purchase something up for a decent price. However, as I run my model on numerous potential properties in the area, I can't get anything to a break-even cash flow without assuming a 40% to 50% discount on the asking prices. Am I missing something? Any thoughts would be appreciated. I've had rental properties for over 15 years (albeit these are not vacation homes). Would be happy to share my model.

See your CPA for the the tax benefits and see your Attorney for estate planning.
What may appear at first not be a good deal may in fact turn out to be a steal.

Very few properties will cash flow, currently, especially the vacation properties. You will have better luck finding long-term rental properties which will come closer to cash flow. However, rents have decreased over the last few years, and there are many more rentals on the market now. Over the last few years, with 20% down, I can think of only a few properties here and there which mightl provide break-even or slight positive cash flow.

That is interesting. Not only did I put 20% down, I have 15 year mortgages on the houses. They were purchased six years ago and have cash flowed from the start. Maybe my situation is unique in that they are four bedroom, which is harder to find in a rental house, and they are in a top notch school zone. Another factor might be that Tallahassee is a fairly recession-proof city, with so many people working for the state. From what I understand, home prices have not taken as big a hit here as in many other parts of the state. I have not researched that, just heard it.

I disagree, I have seen rental rates increase and vacancy's decrease over the last few years. You are correct you will need to search and find a break even property. You may even need to add value to the property to get it to a positive cash flow.

I'm speaking in particular about the long term rents. They have indeed decreased, and more are springing up every day. This is very different from the market peak.

However, with all of the inventory of vacation homes in our area, I would venture to guess that anything off the Gulf will have much more competition as the number of homes built from 2004-2007 likely came close to increasing inventory of vacation homes by 25%+ (just a guess). Basic economics -- as inventory increases, prices (rent) will decrease.

That is interesting. Not only did I put 20% down, I have 15 year mortgages on the houses. They were purchased six years ago and have cash flowed from the start. Maybe my situation is unique in that they are four bedroom, which is harder to find in a rental house, and they are in a top notch school zone. Another factor might be that Tallahassee is a fairly recession-proof city, with so many people working for the state. From what I understand, home prices have not taken as big a hit here as in many other parts of the state. I have not researched that, just heard it.

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.

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.

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.

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!

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.

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.

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).

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.

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.

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.

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.

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 second that emotion.

Even people who bought vacation property a couple years "pre-bubble" can't manage to cashflow.

IMO, if you're not thinking of living here permanently, it makes a heck of a lot more sense to just rent what you want. $400K will buy you lots of vacations, both in SoWal and around the world, which will supply a lifetime of "experiences" with none of the headaches.

On the other hand, if you've got lots of money taking up valuable living space at your primary home and you're getting tired of dusting it off every week--by all means, you might want to 'consider' diversifying into some real estate--even then, I'd pick up a few acres of vacant land you can hang on to and pass to your next of kin.

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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.

Renting vacation places is certainly a great way to build experiences. No need to have a vacation place of your own - or even travel at all - to do that. The great thing about experiences is that they are just as available for free if you notice them, create them, and enjoy them with others. Some people have beautiful places/vacation homes and don't enjoy them (or the places may have become a burden to them for one reason or another).

If you're financially in good shape and your accountant agrees that it's a decent decision, then it would be useful to consider "experiences that you can savor" into the equation. But owning a second home is definitely not for everyone (and can become a burden for many people).

For some people, setting down roots in a place and making it their home is part of the experience (I'm a "nester"). I know that my kids love coming to their second "home" in SoWal and just settling in, knowing that some of their stuff is there, enjoying dining off my mom's dining room table that I inherited that they ate at during holidays when they were little, using the table stand from my grandmother to store their popcorn while watching TV, and knowing that they'll be able to use the place with their families someday when they may not have the money to travel (and I get to enjoy the thought of watching future generations hang out in the place someday, but I hope that's not for a long time). And it does indeed make a difference that I hope to spend several months a year in SoWal, maybe even become a resident and make my current home the "second" home in the years to come (where we also have roots). I don't know if I would have bought a place if I didn't intend to partially live in it at some point. So, for me (and other "nesters"), the responsibilites and ups and downs of having second home are offset by these kinds of things.

fisher, you make some valid points about not forgetting about the amount borrowed. I calculated that $160,000 into the math in the way of paying it off over the 30 year period at the fixed rate of 6% (and paid in principle and interest). It isn't forgotten in my calculations. By the way, this interest is the biggest portion of those payments for the first 15 years, and this calculation isn't a return on equity, because interest isn't accumulated and converted into equity. It is an expense as a cost of money.

The returns are calculated on amount invested, because when making investments, we have to calculate the opportunity cost of what you could have done with the money.

fisher, you make some valid points about not forgetting about the amount borrowed. I calculated that $160,000 into the math in the way of paying it off over the 30 year period at the fixed rate of 6% (and paid in principle and interest). It isn't forgotten in my calculations. By the way, this interest is the biggest portion of those payments for the first 15 years, and this calculation isn't a return on equity, because interest isn't accumulated and converted into equity. It is an expense as a cost of money.

The returns are calculated on amount invested.

SJ - Fisher is using the GAAP (generally accepting accounting procedures) definition of ROE vs. ROI. While your definition makes "sense" in layman's terms and is helpful for decision making his version is the textbook method.

We plan to downsize for many reasons. One of them is that when we die, daughter and future son-in-law worry that they can't afford to pay the taxes, insurance, and maintenance on a big house in Florida. Plus, if he decides to go to grad school at MIT or Stanford instead of Georgia Tech, they won't be able to use the house.

We absolutely adore the 30A area. If we didn't own here, we wouldn't drive down every other weekend, even though renting a place every other weekend would be cheaper. We have our "stuff" here -- groceries in the owners' closet, a small refrigerator in the owners' closet, etc., etc. We each keep a bag packed and just hop in the car whenever we get the notion. Last weekend we hopped in the car and ... OOPS! ... there was a renter here. Thankfully, sister has two homes here, one of which she doesn't rent, so we stayed there.

We plan to downsize for many reasons. One of them is that when we die, daughter and future son-in-law worry that they can't afford to pay the taxes, insurance, and maintenance on a big house in Florida. Plus, if he decides to go to grad school at MIT or Stanford instead of Georgia Tech, they won't be able to use the house.

We absolutely adore the 30A area. If we didn't own here, we wouldn't drive down every other weekend, even though renting a place every other weekend would be cheaper. We have our "stuff" here -- groceries in the owners' closet, a small refrigerator in the owners' closet, etc., etc. We each keep a bag packed and just hop in the car whenever we get the notion. Last weekend we hopped in the car and ... OOPS! ... there was a renter here. Thankfully, sister has two homes here, one of which she doesn't rent, so we stayed there.

Hi BR I love your place. One reason we got the two smaller side-by-side cottages is that we could sell one if needed and still keep one - we'll see how the college bills go...