More people are buying second homes, but do they make economic sense?

For most people, the American dream of home ownership used to be fulfilled with just one house. Now a growing number of individuals find that the dream isn't complete until they own two.

The second-home market grew 36% between 1991 and 2001, according to a survey released last year by the National Association of Realtors and, an online company specializing in resort properties and second homes. That amounted to 359,000 units in 2001, or roughly 6% of all home sales. Both groups say this number is probably understated, given the difficulty in differentiating between primary and secondary purchases at the time of sale.

Secondary homes have been a good place to park one's money-the median price of second properties jumped 27% between 1999 and 2001 compared with about 8% for primary homes. And we don't need to mention how equities performed during that span.

Of course, the stock market's lousy performance during the past several years helped boost real estate in general and the second-home market in particular as people turned to property as a safe haven. No longer just the domain of the hoity-toity, the second-home market has been fueled by the hoi polloi as middle-class baby boomers seek outlets both for their investable money and their recreation time. The recent survey says that the typical second homeowner's household income was $76,900, and that the vast majority use their home for vacation purposes.

But the recent boom in vacation home valuations raises questions about whether this is a market bubble waiting to burst, or at least go flat. "People buying at some of these high prices may not see any appreciation for five to 10 years," warns Sidney Blum, president of Successful Financial Solutions in Northbrook, Ill. "Buying at the top could decrease potential gains in a cyclical market like real estate."

Others are more optimistic. "My sense in doing a client's planning is that if they can afford to buy a vacation property, I encourage them to buy it," says Thomas Posey, president of Posey Capital Management in Houston. "Looking out 10 years, I wouldn't be surprised if the stock market is in the same trading range as it is now. If you have a nice vacation property in a desirable area, it's not a reach to see a 5% to 6 % annual return. You're getting enjoyment from it along with a capital gain on the back end."

Still, with vacation homes now more prevalent among smaller investors-as stocks became in the 1990s-some financial professionals see a timing issue similar to what happened at the peak of the tech bubble in the late'90s. Low interest rates make the cost of capital so cheap that instead of purchasing equities at depressed levels, some people are borrowing money to buy real estate at very high prices and with the wrong expectations. Often they blithely assume that rising home values are an inalienable American right, or they underestimate the logistics of renting out their property for extra income, or both.

"There are two types of people buying vacation homes," says Michael Dubis, president of Touchstone Financial in Madison, Wisc. "There are those who buy them solely for vacation purposes, and those who buy them because they want to put their money in a place that's doing better than the stock market."

Dubis is no killjoy, but he's quick to point out potential pitfalls of owning vacation homes to clients with limited free cash and a need to borrow to pay for their second home. "If it's just for a vacation property it's a speculative use of capital, not an investment," he says. "If it doesn't produce cash flow there's no investment value, only quality of life value. You're not only speculating that someone will pay more for the property then you did, but you're leveraging for the use of that property."

Dubis is very familiar with the northern Wisconsin lake country, where prime lakefront property that went for $100 to $150 a foot in 1990 now goes for 10 times that much. The market there is so hot that he's heard stories of people buying property sight unseen. When clients tell him they want to buy a lakefront vacation home, Dubis asks them how many days a year they plan to use the place and then he'll crunch the numbers. Using as a base a modest lakeside cottage worth $250,000 with a $200,000 mortgage, or $14,700 a year for 30 years, he tacks on a conservative estimate of $4,000 in taxes, plus 1% each for maintenance and operations expenses (a combined $5,000): That totals almost $25,000 a year for a personal vacation getaway.

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