If a family plans to use it just two weeks a year, they're paying $1,700 a day. And that's not including inevitable costs such as buying a boat and other toys for the water. Compare that with $5,000 for a really nice yearly vacation elsewhere, and the economic realities of vacation home ownership become starker.
Real estate traditionally appreciates about 3% a year over the long haul, so it's reasonable to question the staying power of the recent upswing in vacation home prices. Much of that was fueled by sharp increases in oceanfront property led by the mid-Atlantic region, where values have doubled during the past four years, says National Association of Realtors spokesman Walt Molony.
But not all vacation regions are booming. Pat Horan, managing partner of Horan Associates in Towson, Md., says he has a client who bought a home in Aspen two years ago for $1.2 million and is now putting it on the market in the $800,000 range. "He tells me it's a buyer's market out there in the higher-end segment."
A good number of Horan's clients are business owners who've sold all or part of their operations and have cash to spend. When it comes to second homes, they're more into the vacation than the investment aspect, but they wouldn't mind making a few bucks if they decide to unload it. "My advice to them is to try not to overpay for property because it'll be harder to get a profit if they ever sell," says Horan.
In a place where there's lots of inventory, such as Florida, he recommends patience and a willingness to explore estate sales and auctions. This requires doing some homework with the help of an appraiser, but it could lead to a sweet deal.
And even if one is able to buy low and sell high, Uncle Sam always waits for his share of the profits in the end. Peter Traphagen, a partner at Traphagen Investment Advisors in Oradell, N.J., advises some of his clients thinking of selling their vacation homes to move into them to capitalize on rules allowing for exclusions of up to $500,000 (for married couples) or $250,000 (for individuals) on profits from selling a primary residence lived in for two of the prior five years.
One Traphagen client is a couple who live in a $1 million home in northern New Jersey and want to sell a vacation home at the Jersey shore they think can fetch $850,000. Their cost basis on the shore house is $500,000-the original $200,000 plus $300,000 in renovations. They plan to move into that home for at least two years to qualify for the exemption on the anticipated $350,000 profit, while renting their primary home for $4,000 a month to business executives on temporary assignment in the New York area. If they sell for the desired amount, the exemption would save 26% on their state and federal taxes-roughly $80,000. And they'd get a nice chunk of rental income, to boot.
Although most people buy second homes mainly for vacation purposes, many also hope to use rental income to pay for the property or at least to help defray the costs. This is where things can get tricky. If a home is rented 14 days or less in a year, rental income is tax free but rental expenses aren't deductible. If a home is rented more than 14 days, there are different permutations regarding taxes and deductions depending on whether the homeowner's use is greater or lesser than 14 days (or 10 % of the number of days rented).
Then there are personal negatives to renting a vacation home. "My second home is sacrosanct to me," says Barbara Steinmetz, president of Steinmetz Financial Planning in Burlingame, Calif. "It is my oasis and only for my family's use. That's a point I try to make to clients when I say if you're going to make your second home truly your second home, once you rent it out people start invading your turf. They invade your sheets and dishes, and your personal things get exposed to others."
Her vacation home is in Scottsdale, Ariz., a place where Steinmetz loves to relax but has no intention of retiring to because of the hot summers. Yet it's a place she says she'll enjoy for years, and it's in a desirable area where price appreciation should remain steady. Ultimately, her long-term approach to the property will pay off if she ever sells it or passes it on to her kids. She says those are the ingredients for a successful vacation home investment-a house in a desirable area that's used by an owner who has a long-term outlook on the property. "Buying a vacation place for a quick buck isn't the way to make money in real estate," she says.