There’s exactly one situation where I love vacation homes—when good friends own them. Vacation homes are a lot like kids: You will spend lots of time with them, you won’t regret having them (on most days), and you will drastically underestimate the costs and energy that will be involved. We all know how much we typically spend per night for a luxury vacation rental or hotel room. So before you buy that second home, perhaps you’d like to know what your equivalent “nightly rate” might be.
A Lifestyle Asset?
A second home, when rented out full time, has a fighting chance of being an “investment” if it can produce market-rate net cash flows. A vacation home, often referred to as a “lifestyle asset” by the financial planning industry, more closely resembles a “travel” expense (if you really must label it). A little rental income and some appreciation can reduce the overall costs, but it still ends up being a cost, not an investment. Let’s look at two scenarios to see what your annual vacation home expense might be. And to make it more fun, I’ll convert it to a nightly rate.
What’s Your Nightly Rate?
Let’s assume that the annual costs associated with a vacation house would be 3% of its value (taxes, insurance, utilities, furnishings, maintenance, travel, etc.). If you also assume that the property can rise in value by 3% per year, it’s a wash, right? Not quite. Say you’re making a cash purchase of a $500,000 condo. If you were able to invest that cash in a way that could produce a 6% annual return, that would be worth $30,000 per year. Let’s call that your opportunity cost.
- Pure Second-Home Scenario
With no rental income, your opportunity cost of $30,000 essentially becomes the annual cost for your vacation home. If you use it for, say, 50 days per year, your nightly rate is $600! What kind of 50-day trip could you take for $600 per night?
- Mixed-Use Scenario
You’re thinking, “I’ll rent it out when I’m not there!” Take a realistic crack at the income you’ll receive annually after factoring in the costs of a management company (usually 35%) or the dollar value you (should) assign to the time you will spend wearing a landlord hat. If your net rental income totals $10,000 (my friend’s is $20,000 in Mammoth), your annual vacation home expense drops to $20,000. For that same 50 days, your nightly rate is $400. What kind of travel experience could you enjoy for $400 per night?
Diversifying Experiences
An ex-partner of mine owned a beautiful Michigan lake house. Every summer, we ran back to the comfort of a simple and wonderful life away from the big city, complete with bonfires, swimming, cookouts, rinse and repeat. But what I also remember is that we never traveled anywhere else during our four years together. Because the house was there (and mostly paid for), it became our default vacation choice. Get clear about your long-term travel wish list before committing to a place that could very well hijack those plans.
When It Works
For some, it’s just not about the money … and it doesn’t need to be. My friend stores his gear and clothes at his Mammoth condo, so he can pop in with nothing more than a briefcase and hit the slopes the next morning. And yes, a bit of rental income subsidizes some of the costs. The experience of the perfect lake house or cabin in the mountains can be priceless, and if a second home doesn’t negatively impact your other goals, I am all for it—especially if you’re one of my good friends. To you, I promise to contribute in the kitchen, leave no footprints and always bring great wine. Salud!
