The American Dream, as it pertains to vacation property, goes something like this:
You buy a vacation property at the seashore (or on the ski slopes, at the desert or at the lake). You and your family vacation at your private hideaway for two weeks each year. The rest of the year, you rent it to other vacationers and the rental income pays all the expenses.
Over the years, the property appreciates in value. You sell it at a pretty profit to augment your retirement income. Or you sell your primary residence and retire to your vacation property. Or you leave it to your children in your will so that future generations can share the enjoyment of your private paradise.
Is that dream possible? Yes.
Plausible? Perhaps.
Practical? You can make most of it happen. However, some factors are beyond your control. No one can foresee war, recession, inflation, or natural disasters that could impact your property. (Please note that these factors can also impact other types of investments such as stocks, mutual funds, and bonds.) Legislation can also affect your property value. While the Economic Recovery Act of 1981 encouraged buying vacation property with many tax incentives, the Tax Reform Act of 1986 reduced incentives. The pendulum has again swung in a favorable direction with the Tax Payer Relief Act of 1997. This legislation reduces capital gains tax from 28 percent to various lower rates.
On the other hand, you can control many of the factors that affect your property. When considering a purchase, the more sophisticated vacation property buyer will ask the real estate sales agent, “Will I have a positive cash flow?” In other words, will my rental income cover my expenses?
A good real estate agent will not answer this question. First, many state real estate commissions or regulatory bodies prohibit sales agents from promising or guaranteeing you a certain amount of rentals. How can they? Second, even if they had a general idea of the renal income you might expect (who can predict the future?), they would also have to know your actual property expenses which can vary dramatically.
To illustrate the point, let’s take a look at two highly simplified property budgets.
Note that Owner A has a higher mortgage payment.
Also note that the low rental income does not cover
Owner A’s monthly expenses. Owner A has a net
average loss each month of $400, the difference
between monthly expenses and average monthly
rental income.
Owner B has a positive cash flow of $600 each month.
The difference? Owner B has a lower monthly
mortgage payment (probably the result of a much
larger down payment on the property). Also, Owner B
gets one third more rentals than Owner A.
Other than that, their expenses are the same, except that Owner B pays $300 a month rather than $200 a month for management because the rental management company takes a commission on the additional one third rentals.
While this is a very simplified example, you can see that the two major variables in the positive cash flow equation are: mortgage payment and rental income. You have control over both of those.
Your mortgage payments will reflect your down payment, the interest rate, and the type of mortgage product you select (15-year, fixed-rate; 30-year, adjustable-rate; etc.). Remember that if you select an adjustable-rate mortgage, your monthly payments could go up or down in the future to reflect to reflect prevailing interest rates.
This article was excerpted from the book “Road Map to Your Vacation Property Dream”. If you are interested in purchasing this book or would like more information on it, please contact Christopher Cain at vacvalue@aol.com or (407) 365-3618.