A good investment is one that will give you the expected return; buying vacation property is one way of investing in real estate. If rented out to vacationers, it can pay for itself.
Real estate investments are predicated on the growth of the value of the property overtime. So when you go to sell the property, you expect to receive the difference in the value of the property when you bought it in relation to the value when you sell it. It is called the ROI or return on investment. With a rental property, you will need to focus on your current income and cash flow. While down the road you may sell the rental property at a profit, you will realize profits from the rental income. Investing in a rental property should be viewed as a long-term investment.
Real Estate Investment Risks
There are many considerations to keep in mind if you are thinking about investing in a rental property. There are several risks to be wary of including market volatility. A downturn in the nation’s economy affects travel for vacationers and they may be off a vacation until things turn around. You’ll be left with a property you can’t rent or sell but still have to pay for. Beware of changes in tax laws that could erode favorable taxation of rental properties. Compare these possible pitfalls with your financial ability to handle them.
Assessment of Your Personal Risk
Successful vacation rentals are a specialized aspect of property investment. You have to know what you are getting in to and have a basic understanding of the real estate business. There are dozens of books on the topic and local seminars are often offered in communities. Talk to friends and family who have made successful investments in vacation rental property.
Finding the best location to buy a vacation rental property takes work. You obviously want to pick a spot that vacationers will want to go to – so check with the local tourism bureau to find out what the hot spots are in real estate rentals. Talk to more than one real estate dealer – the more opinions the better informed you will be to make up your mind. Perhaps the biggest factor in determining if property rental is for you – your level and ability to maintain rental properties in peak condition so that renters will want to visit your establishment time and again. Careful attention to your property will help to increase its value over time.
Most investments have some element of risk. Ask yourself the right questions and be very realistic with your answers. Here are some guidelines that can help:
- Is the capital for a purchase readily available?
- Will your my credit rating allow a bank loan?
- Do you have savings or other access to funds for upkeep and unexpected repairs? Would your lifetime savings be depleted if you had to rely on those funds to help pay for upgrades or other bills associated with property ownership?
- If the bottom fell out on vacation rentals for a time due to economic conditions over which you have no control, do you have the money to keep you afloat until things turn around?
- Can you handle what can be stressful investment woes with all of life’s other demands?
- If the whole investment failed, do you have the ability to get back on your financial feet without it ruining your life?
A Look at the Investment Risks
There is never a guarantee that a real estate investment will turn out to be a real money maker. In lots of storm wrecked cities in the south, people are finding out that the houses they bought are no longer worth even the original selling price. So before getting into real estate make sure you know the risks you are taking with your money. Real estate is considered a highly speculative market. There are so many external factors outside of the individual’s control that can make a real estate investment fail.
Some of the risks of a vacation rental property are listed here so that you will be able to make your decision based on the facts of this type of investment:
- Changes in the tax code could adversely affect the tax advantages of real estate investing.
- Significant changes in the region where your property is located such as the loss of a large employer or military facility will impact your ability to sell your property at a time when the market is full of real estate for sale.
- Other socioeconomic factors may also come into play such as high gas prices or periods of high unemployment making it unaffordable for many people to travel.
- Mother Nature can wreak weather havoc on vacation destinations and this can affect your ability to rent vacation homes.
- The performance of the financial markets will affect real estate investments as interest rates fluctuate.
Owning vacation property requires continual attention. Caring for your property will depend on your own skills in maintenance and repairs or you can contract that kind of work to a construction or renovation company. If you have the know-how you can save a lot of money that you would otherwise have to pay a contractor.
Property values, occupancy, and rental income will vary based on a number of factors. The rent you collect will provide you with most of your return from an investment in vacation rental property. The occupancy rates have to be high if you are going to realize the gains you are looking for. That’s why your choice of location is tantamount to a successful rental income venture.
You cannot always control the factors that can affect occupancy rates. A location may seem right at the time but will it hold its value over time. . Political and economic changes can adversely affect the popularity of your vacation spot; the forces of Mother Nature such as hurricanes, forest fires, and other natural disasters are all factors that can affect your investment. Once an area falls out of favor with vacationers, it can be extremely difficult to lure them back. It’s possible that you could end up with a property you cannot sell.
A liquid investment means you can get your hands on your money fairly quickly. Vacation rentals are not a liquid investment because like all real estate, vacation rentals are relatively difficult to sell quickly and there is some uncertainty about the selling price you can get if you do put the property on the market. One of the ways you can help protect your investment is to vary the types of other investment vehicles that you have in your portfolio – stocks, bonds and other types of securities can help tide you over during down times in the vacation market.
Investing in real estate usually means you will need a large outlay of capital. This is often the reason many investors avoid real estate holdings, especially in vacation properties. The cash needed to buy and maintain the property must be available.
Since your original capital investment is tied up in the property, it makes your portfolio much less liquid, that is, you can not readily get cash from the investment. So it may be tough to secure the amount of money needed to purchase property and later on it may be hard to get a buyer for your asking price. If you don’t have the capital or the financing for the investment you can consider alternatives such as a real estate investment trust or real estate partnership.
A Look at the Investment Advantages
One of the great advantages of having rental vacation property is that you and your family can enjoy it as a vacation spot as well when the unit or units are not full with renters.
In the U.S., rental property enjoys favorable tax treatment. Property that generates income is considered business property. If your vacation property is used only for rental purposes, it qualifies for specific tax deductible breaks on r mortgage interest, property taxes, insurance, advertising, maintenance, and other expenses. However, if you do use the property for personal use as well as renting it out, the tax advantages decrease correspondingly but property depreciation is also generally deductible. It all adds up to a pretty good deal.
One of the basic decisions to make is where to buy vacation rental property. It depends largely on where you want it to be, from the wintery weather of a ski chalet in Colorado to the big city life of a downtown condo or a place that is out of the way and peaceful. Your choice of property should reflect your preference and the market for visitors to the area.
Buying a property close to your home for rental allows the owner to readily make repairs and to ensure that tenants are abiding the terms of their rental leases.
Vacation rentals are a good investment because they provide both current income and the potential for capital gains. The rent you collect for the property is considered income. Capital gains are realized when you can eventually sell the property for more than you paid for it. Compare this advantage to most real estate investments that do provide an opportunity for capital gains but generally not cash flow income.
Choose the Right Vacation Property
Your vacation rental property of choice requires deliberation of some of the pitfalls you could encounter: Today’s vacation hot spot might be tomorrow’s cold spot – that is no vacationers to rent your property – and you can’t always count on a current supply of regular renters. . Your rental opportunities are probably better with a warm coastal beach home than with a condo in Colorado but then you have to consider the vulnerability of the coastal property to hurricanes. On the other hand, the ski season doesn’t last all year in most places so perhaps a ski chalet is not a good investment for you. Is there a perfect vacation spot? No, every property has its quirks and you need to do some research to figure out what’s in your best interests.
Financing the Purchase
If you are purchasing vacation rental property, you will probably need a mortgage. Even if you have resources available to make the purchase, taking out a mortgage is typically advantageous because the mortgage interest is tax deductible as a business expense. So if even if you do have the capital outlay to close the deal, holding a mortgage could be to your advantage particularly when the vacation home is used exclusively as rental property. Check with your lender on the availability and types of mortgages that are best suited to your investment goals.
Individual and Multiple Person Ownership
Most individual real estate holdings represent sole ownership; that is, the title to the property has only your name on it as owner. But if you have others go in on the deal with you, there are several ways to set up the mortgage that is appropriate such as ‘joint tenants’, ‘tenants in common’ or as ‘tenants by the entirety’. Each of these forms of ownership has advantages and disadvantages, depending on your situation. You can also form a company to own property. It would probably be, in this case, a partnership or limited liability company.
Management and Maintenance
Taking care of the management of your vacation rental will depend on how many properties you own and their proximity to your home. But it’s a big job and there are several things to think about. Make sure you have the time and cash to commit to undertake the basics of property maintenance and management:
- Placing ads in publications that will reach your target audience
- Interviewing prospective renters
- Checking references and credit reports
- Handling tenant complaints
- Establishing and collecting rents
- Ensuring rooms are thoroughly cleaned after each renter
- Making frequent site inspections
- Doing or arranging for someone else to do repairs and maintenance
- Upgrading property features
- Purchasing the proper type and amount of insurance Paying property taxes
Professional management companies abound and this may be the way for you to go if you travel a lot, live far away from your vacation property or if you own a number of real estate holdings in different locations. Professional managers are usually quite knowledgeable about fair market rents in the area where you have purchased property. You personally will be relieved of the daily operation of the rental property but keep in mind the management companies do this for a fee. Look at these fees when you consider your expected return on investment. Before you settle on a property manager, check your local business bureau for anything on their records and talk to other property owners who may have helpful knowledge about these kinds of companies in the area.
Tax Implications
When exclusively used as vacation property for rent, your investment is eligible for tax incentives that can contribute to a successful venture for you. All business expenses (including mortgage interest, property taxes, insurance, advertising, and maintenance) are allowable deductions against rental income received on the property.
When the gross rental income is greater than your expenses, the profit you make is taxable income. But if the reverse is true, the resulting loss can be used to offset gains from other investments. Keep in mind that personal use of property will affect the tax status so find out in advance the IRS position so there are no rude surprises at tax time.
The general rules about using your own place for a vacation are listed here:
Any vacation property that is rented out for less than 15 days per year is considered a personal vacation home, regardless of how much time you may actually stay there. Mortgage interest and property taxes are deductible, but other expenses are not.
If you rent out a vacation property for 15 days or more in a given year and your personal usage is limited to 14 days or 10 percent of the time it is rented (whichever is greater), then the property is considered rental property. If you rent out a vacation property for at least 15 days in a given year, but your personal usage exceeds the 14-day/10 percent rule, the IRS considers it a second home and therefore, mortgage interest, property taxes, and other expenses are deductible on your rental income only. If expenses exceed rental income, you cannot use the loss to offset other income.
It is important to know that the IRS categorizes repairs and renovations differently and applicable taxes differ. It’s like this: repairs maintain your property in good working order but do not materially add to the value of the property or substantially prolong its life. Repairs are considered expenses and may be deducted like any other business expense. Renovations or improvements increase the value of the property and the costs are treated as capital investments.
Another tax advantage of vacation rental property is that you can deduct the depreciation. This rule takes into account an assumed decrease in value over the years due to regular daily use of the property by many vacationers. . Even if this is not true in your case, you are still allowed to deduct depreciation as a way to recover this assumed loss of value. For rental houses and apartments put on the market after January 1, 1987 depreciation is calculated on a straight-line basis over 27.5 years or approximately 3.63 percent per year. So, if you purchase vacation rental property this year for $137,500, your depreciation deduction would be $5,000 per year for the next 27.5 years. In certain instances, a property may also be entitled to a 30% additional first year depreciation deduction. Since vacation rentals are considered as capital assets, you may be required to pay capital gains tax when you eventually sell. . Usually, if you sell the property for more than you paid for it (or your stake in the property), you have realized a capital gain. But if this gain cannot be offset by other capital losses, capital gains tax on this amount will be due the IRS.
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