Keep your eyes wide open. That’s what financial planners say you should do if you have designs on buying a second home be it as a family retreat or for the possibility of earning rental income.
“I see a second home as a common goal,” said Chris Chen, a certified financial planner with Insight Financial Strategist. “The challenge to make it happen is lining up the stars. Make sure that it’s what you want; that your other goals are funded; that there are enough assets to cover the purchase; that there's enough income to cover the expenses; and last but not least, there’s enough time to enjoy it.”
Indeed, knowing upfront just how expensive owning a second home can be is critical.
First, with demand up and supply down, the price of such homes has risen, according to a recent Merrill Lynch blog.
And second, no matter whether you’re buying a second home as an investment or for pleasure, owning a second home will likely cost more to keep up than you may imagine, said David Mullins, a certified financial planner with David Mullins Wealth Management Group. “Make sure you can afford 5% to 10% of the purchase price a year for upkeep and incidentals,” he said.
You should also evaluate whether you want to be a landlord or just have a place to get away with family and/or friends for vacations and holidays.
Second-home buyers need to start with the end in mind when considering buying and ask themselves what the goal is, said Mullins. “If purchasing for pleasure, understand the time when you are not there will likely be periods when ownership is very unpleasurable,” he said. “Taxes, upkeep, and a potential mortgage all are costs that must be paid regardless of where you lay your head.”
If you’re buying a vacation home, make sure it’s in a place that your family enjoys as well, said Chen. “There is nothing worse than buying a home in the mountains, while your family prefers the sea,” he said. “In that kind of situation, I envision some lonely vacations.”
As a corollary, ask yourself: Will you be using the home enough to justify the trouble and the expense? “If all you are going to do is go there for a limited number of days or weeks, you may be better off renting,” said Chen.
And, if you are thinking of it as a home where you might transition from taking vacations to retiring, make sure you like it in the off season, said Chen.
But if you’re purchasing a second home as an investment, Mullins recommends weighing the opportunity cost. “Why does this investment make sense and how much effort will go into managing the property?” he asked. “Sure, money talks. But your time is valuable, too. Calculate the time spent managing the property and make sure the investment compensates you for that time. After all, even a part-time job can pay well.”
Another financial planner agreed that being a landlord isn’t all that it’s cracked up to be.
“I have had personal, negative, experiences with this in the past,” said Brandon Opre, a certified financial planner with TrustTree Financial. “I have since gotten rid of all such property and only have my current house.”
Opre’s biggest lesson was that as great as you might think the numbers appear to make rental income from it, the reality is it's much harder to pull off. “You'll either have to find renters, clean and fix things on your own, or pay a management company as much as 50% of your income,” he said. “I would call this much more of a lifestyle purchase than an investment. Sure, if you have enough disposable income and money wasn't an issue, this could work out just fine. But I think for the majority of people out there, the headaches and time spent really may not be worth it in the end.”
For his part, Opre said he wanted to spend time with his family and exercising, and not necessarily taking care of the additional bills and time commitment required to make his second home an investment.
“Plus, if you want to travel the world and see/do other things, having a second home might persuade you to spend more time there than you normally would,” said Opre. “I wanted to see other parts of the country, regardless of how much I liked being in Park City.”
If you do plan to offset the carrying cost with rental revenue, if you rent it out for more than 14 days a year, it could effectively become a rental instead of a vacation home with the tax consequences, said Chen. “Check with your planner to get a rundown,” he advised.
Other factors to consider: How you’ll finance the purchase, can you care for the property, and what tax breaks might you get.
“Make sure that you can afford the purchase,” said Chen. “Do you have enough for a down payment and does your income support an additional mortgage? In general I see a simple litmus test: Do you have spare assets and spare cash flow after taking care of your priorities?”
Chen also recommends having in place a plan to take care of your second home. “Many homeowners struggle with finding the time to take care of their primary home,” he said. “If that's the case, it's going to be difficult to take care of a vacation home. There is the option to pay someone to take care of it, but that adds to the carrying cost.”
Bottom line: “If the math works and the exit plan is clear, a second home can be a rewarding venture,” said Mullins. “But don't expect it to be as easy to manage as the home you're in each day of the year.”
Others meanwhile say the exit plan sales price shouldn’t be the ultimate goal. “It is best if the value of the vacation home increases,” said Chen. “Although this may be an important goal, it should be the least important one.”