Should you buy a Vacation Home?

A vacation home is a wonderful luxury. But should you own one, or just rent it?

You are sitting on the beach in a tropical paradise. Amadore, your waiter, brings you one tropical drink after another. The sound of the surf lulls you to sleep in your hammock. You have the beginnings of a great tan. And you've had day after day of great vacation sex.

Wonderful vacation. Want to ruin it entirely? Pick up the local paper.

There are two ways to ruin a perfectly good vacation. One is to read the local paper and read all about the insane local politics and the local idiots. Believe in, in any vacation destination area, the locals are all loco. You'd think they'd be happy living in paradise, but they are not. In fact, they generally are more malcontent than normal people. Talk to them and they will dredge up a list of grievances against the local government, the mayor, their neighbors, the developers, the department of environmental conservation, the tourists, the hotels, the cruise ships, whatever. They simply have nothing else to do but complain about how bad they have it. Chances are, they never even go to the beach anymore, or enjoy the amenities of the resort area. Do you want to end up like that?

So do yourself a favor, stay out of the local politics, and if a "local" (defined as some tourist like you who moved there 6 months ago) tries to engage you in conversation, quickly back away.

The second way to ruin a perfectly good vacation is to look at buying real estate there. It is a very typical reaction. After all, you are having such a good time, enjoying yourself. Why not own a "slice of paradise" as the local real estate agent's sign says?

To begin with, you will basically ruin the rest of your vacation. No more mimosas on the beach, but instead trudging from one open house to another, spending time in stuffy real estate agent's offices, and scrounging listings in the paper. So much for good vacation sex, too. Just as you get the wife in the mood, she'll start thinking about granite counter tops.

The first thing that will aggravate you about buying vacation real estate is the pricing. Even if demand is slack, the locals put crazy prices on things, convinced that interest in property equals demand, and that "rich tourists" are stupid and will pay insane prices without thinking. And since many people fall for this scam, the prices become self-fulfilling. So thousands of people end up paying more to own a vacation condo that it would ever cost to rent it, and they really don't understand why.

What are the pros of buying vacation Real Estate? Well they sound like a lot at first, but when you take the cons into account, they more than cancel out.

1. You always have a place to go on vacation: This is true, but now that you have two mortgages to pay, you rarely have time off from work to go there. You'll end up "house poor" times two. If you are like most "salary slaves" out there, chances are you'll get only two weeks a year, tops to enjoy your vacation home.

2. You can rent it out and make money, which helps defray costs: This is also true, but guess what? The peak times for rentals are also when you want to use the property. So if you want to use the property on labor day weekend, go ahead. But you've just killed your most profitable rental week. Using the property "off season" is one solution, but hey, what's the point of that?

Also, no matter how you do the math, the costs of real estate agent's fees, damage to the property, cleaning costs, etc. cut into the rental income. And even if you can rent for nearly every week of the year, the overhead costs still end up higher than what you would pay to rent the same house for the few days a year you get to use it.

In other words, you pay for the privilege of owning a place - more than you would to rent the same place. The renters are the smart ones, the owners are the fools.

3. The home may appreciate in value as an investment: This can also be true, or as we learned recently, entirely false. A beautiful vacation home on the outer banks with a view of the ocean might appreciate in value, unless the market crashes as it recently did. Or if a developer puts 500 homes on the property next door, depressing prices. Or worse yet, if someone builds on that "unbuildable lot" in front of you and destroys your view.

Housing prices can go up - and they can go down. In the case of vacation homes, way down. When the recession hit, the first thing people unloaded were luxuries - vacation homes, RVs, boats, motorcycles - things they did not "need" and were a major drain on cash flow. And vacation condos are even worse. They can soar in price and crash just as hard.

For beach properties, throw in hurricanes, floods, and storms, which periodically batter such areas. Yes, you have insurance (usually three policies, fire, wind, and flood, costing thousands of dollars a year). But after a major storm, prices drop.

And even if prices go up, up, up, expect another pleasant surprise: The tax man will nail you with an increased assessment. Suddenly, your $2000 a year tax bill is $5000 a year. And as an out-of-State owner, you don't qualify for the homestead exemption the locals get.

4. You can buy the home now, rent it out, and have it paid for as a retirement home when you retire: This is another option, and several friends of mine have done this. Does it work? Well, sort of. Again, you have a negative cash flow for many, many years, as the rental costs don't keep up with the mortgage, taxes, insurance, repairs, agency fees, maintenance, etc. And when it is time to retire, chances are, you'll have to gut the house and remodel it, as after 15-20 years of renters, the place is probably ready for a new everything.

Now, in some instances, this scheme might work. For example, you buy a place for cheap and hang onto it for many, many years. But in other scenarios, if you pay too much, well, you could end up having squandered tens of thousands of dollars over the years for nothing.

You have to do the math to find out which is the best alternative. In some instances, it may simply be better to take all that negative cash flow money and put it in the bank, or use it to pay down your existing mortgage. When you are ready to retire, you can just go and buy the retirement home you want - where you want - and not be locked into some decision you made 15 years ago. The isolated beach house you bought in 1995 might be a crowded, noisy, spring break community in 2015.

5. You get a tax deduction on interest paid on vacation home mortgages: Again, this is true, but again, don't confuse a deduction with wealth. You cannot deduct your way to wealth, just as you cannot eat your way to slimness. The tax deduction is just another factor in your "do the math" part of the problem. And unfortunately, government incentives like this often do not pan out to real advantage. Rather, the market adjusts by increasing prices to offset the benefit of the deduction.

While it is a good idea to take advantage of deductions when they are offered, altering your finances to get a deduction, when it provides no advantage or financially stresses you, makes no sense whatsoever.

As I noted before, there is a tax credit for buying an electric car. Buying an electric car and parking it on your front lawn makes no sense. It does not make you wealthier or save you money. On the other hand, if you plan on buying an electric car because you want one, the tax credit is something to take into consideration. And guess what? The electric car people know about the tax credit and have adjusted their prices accordingly. Funny how that works.

You should live your life the way you want to live it, and not look at the tax code as some sort of Bible for proper living. And in this regard, perhaps the "teabaggers" have some sort of point. Offering deductions, credits, and incentives for certain behaviors is a way the government has of manipulating people's behavior, and one wonders whether the government should be in that business.

And in effect, it ends up subsidizing one person's behavior by another's. The person who doesn't install new energy-efficient replacement windows ends up, in effect, subsidizing the replacement cost of the neighbor who does. We have to wonder whether these tax incentives are really all that fair.

But taking politics aside, you have to crunch the numbers. And tax deduction or not, oftentimes a vacation home ends up costing you thousands and thousands of dollars a year in cash flow and real costs. Renting the same vacation home, on the other hand, could cost far less.

So what are the advantages of renting a vacation home? There are many:

1. You can go to a different place every year: Some folks like to vacation at the same place every year. That's fine, but if you want to see more of the world, owning a vacation home will tie you down to a specific place. And since the cost of owning a vacation home can stress your finances, you may not be able to travel abroad or do other things you want to do in life.

2. Less worries: If you own a vacation home, there is always the worry about a storm, fire, damage, a burst pipe, or some other problem. A broken appliance will materialize just at the time when your credit card is maxed out. When you rent, your worries evaporate the moment you hand the keys back to the rental agent and get your security deposit back.

3. Less cost: As noted above, even if you pay $3000 a week to rent a home "in season" it can often be less costly than owning the same home. to own that home, you may be shelling out $20,000 a year in real costs, and using it less than a few weeks. You'd be better off renting!

4. Flexibility: If you own a vacation home, that monthly payment and expenses trudge on and on, with no letup. If you lose your job or need money for something else (child's college) you don't have any flexibility in spending, unless you want to sell the vacation home, which can be costly, difficult, and sometimes take years. If you rent your vacation spot, you can make instant decisions about spending.

So there are pros and cons of owning a vacation home. What many people fail to do is do the math on such a purchase. They look at the vacation home and say "Gee, I can afford the payments" (often based on rosy rental scenarios) but they don't ask themselves "Hmmm... would it simply be cheaper to just rent the same house year after year?"

And the same is true for primary residences, particularly condos. People for some reason think that owning a place is a sign of status, while renting is some sort of mark of shame. But if it costs $1500 a month to own a condo, and only $900 a month to rent it, chances are, it is better to rent, particularly if you are only going to live there for a few years.

And on that note, we should discuss time shares and vacation condos. Time shares, as I have noted in the past, can be an utter rip-off. People on vacation see posters inviting them to a seminar. Or worse, are enticed to a "vacation" at the time-share which is little more than hours of high-pressure sales pitches.

The lure is that you can "buy" a part of a vacation home ("just the weeks you want!") for a tantalizing small amount of money, usually $25,000 to $50,000. The catch is, of course, is that there are fees for cleaning, etc., and like any other condo arrangement, these fees can be raised over time.

Just for laughs, we looked at one such resort in the Keys. They wanted nearly $30,000 for a week "time share" and $800 a week in maintenance fees, with no guarantee that the fees would not go up. $800 a week in and of itself is a good down payment on a motel room (which is really all the time share was) and if you threw in the payments on the "purchase" price, you were actually paying more than someone would to rent the same place.

Plus, if you multiplied $30,000 time 52 weeks, you'll see that the timeshare people are selling each motel room for the equivalent of 1.5 million dollars (!!!) or enough to buy a really, really nice house in the area. While they may be selling you only a "part" of the home, in terms of time, they are jacking the price up considerably as part of the deal. Such a motel condo might sell for $300,000 outright, making its weekly value only about $6,000. Why would you pay five times as much?

Timeshares are nearly impossible to sell, too. Most of the companies hawking "timeshare resales" are merely con artists hoping to milk another mark for yet more money.

The timeshare people will argue that you can "trade" weeks at one resort for weeks at another - for a small fee, of course. But when you factor in all the costs, it really is cheaper and more flexible to just plan a vacation from scratch, decide where you want to go (instead of picking from a list or going to the same place every time).

Vacation Condos have all the problems of timeshares and vacation homes, with the nightmare of condo boards and politics thrown in. If you rent a place or go to a resort or hotel, you don't have to think about the condition of the roof or how you are going to pay for it. In the dictatorship of a resort or hotel, the decision to replace the roof is made and completed without a lot of hemming and hawing. In a condo, such decisions are only made after many loud and noisy arguments, bad blood, and generally, when the roof finally caves in. And of course, you have to pay a special assessment for it, because most of the members want "low condo fees".

Hotel Condos are also an interesting gimmick. We have some here on the island and no matter how I do the math, they never work. The condo is rented out as a hotel room by the resort, so basically you are owning a part of the resort. The resort takes a huge chunk of the nightly rack rate, and you have to maintain the condo in a generic, motel-like appearance.

Worse yet, since the resort is operating as a hotel and needs the rooms to make money, you are limited in the number of days you can actually stay at the place. So if you stay over a certain period of time, you have to pay the hotel for lost revenue. As an eventual retirement home, they are not an option.

And while I have "cranked the numbers" on these "investments" many times over the years, they never made sense in terms of cash flow. It was always more expensive to own one of these places than to merely rent it.

And that's the rub - paying more for the privilege of owning real estate, as opposed to renting it, makes no sense whatsoever.

But, I suspect that like with primary home ownership, there is a status "cost" involved. People will pay extra to own, because they want the bragging rights of home ownership, which has some psychological benefit to the owner.

So that's how I see it. Owning a vacation home can be a nice luxury, but it can be a great way to squander cash. But do the math first. Buying a vacation home could be a costly mistake.