Make an Offer on a Property
On a cash basis, you will probably not make money during the early years of vacation-home ownership. But over the longer term, you may earn a substantial profit. To help you in evaluating and bidding on a second home, I will assume that you are treating this property purely as a vacation home and will rent the property for less than fourteen days per year. If you decide to rent out the property for a significant amount of time during the year, you must consider this purchase a rental property. I suggest you read Chapter 9 to learn the ins and outs of buying rental property.
When you are ready to make a bid on a vacation home, keep in mind that your objectives are different from those in buying a primary residence.Valuing a vacation property should be based on two criteria:
(1) Can you afford to carry the property every year (can you pay the monthly carrying costs)?
(2) What price appreciation do you expect in the years ahead?
To begin, let me illustrate the cash flows of a simple vacation home. Unlike rental property investments (where investors try to leverage their acquisitions with low down payments), the down payment on vacation properties is usually higher and can vary a great deal. This is because most people purchase vacation properties for enjoyment rather than for investment. They are willing to put more money down toward the purchase to keep their monthly mortgage costs down.
Let's assume that you want to purchase a two-bedroom, two-bath vacation condominium in Naples, Florida, for an asking price of $250,000.Your purchase strategy is to put 20 to 40 percent down and finance the remaining balance with a 30-year, 7 percent mortgage loan. How much do you bid for the condo? Do you bid the asking price? Do you underbid or overbid? Of course, the price you eventually pay has a great deal to do with market conditions (e.g., is the market tight or sluggish?).
But to make an intelligent, informed purchase decision, you need to follow the procedure below to run the before tax cash-flow calculations, then estimate the tax benefits from vacation property ownership.
Before-Tax Cash Flows
Before entering the bidding process, you should know how much you are willing to pay to carry the property. If you have fully paid off the loan on your primary home, you may be willing to pay more per month. For example, let's say you are able to handle up to $1,000 per month. So the maximum price you can bid will be a price that generates a negative monthly cash flow of $1,000. Prices lower than the maximum will cost you less per month, improving your financial position.