What you Should Know Before You Buy

By Alan Morgan

Real estate prices continue to skyrocket.  You’ve seen it happen all around you and although you have no desire to sell your home you keep wondering, “Should I get in on this?”  Perhaps you’ve considered buying a second home for vacations such as at the beach.  To help cover the expenses, you will rent it out part of the time.  You figure, that will make it more affordable and you could make a bundle on the appreciation!  Tempting as this scenario may sound, before you jump in, you need to take into consideration several facts about buying a second home.   

1.     Define Your Goals

Do you want a rental property or do you plan to truly use it as a second home for personal use?  Your goal will help determine if you need to have an annual positive cash flow, or if you can take on the expense of the home in exchange for the personal benefits it provides such as a place to vacation. 

 2.   Estimate the Expenses

Do the math to determine an accurate estimate of your total monthly and annual expenses associated with the second home.  If you plan on renting it out, come up with an estimate of the annual revenue you could expect.  When estimating expenses, include the following:

·         Payments: If you have a mortgage, include the monthly mortgage payment plus insurance and property taxes.

·         Condo or homeowners association fees: These can total more than you think, especially for condominiums and even for single-family homes within a country club, waterfront, gated or pool community.  I’ve seen condo fees run from a low of just under $200 per month to as high as over $500 per month for more luxurious properties. 

·         Potential special assessments: This applies to condos and neighborhoods that have a homeowners association.  Typically, the HOA must reveal to you at the time of purchase any known upcoming special assessments, but after that you’re on your own.  Older condominiums often have special assessments to replace anything considered common elements, such as roofs, exteriors of any of the buildings or other structures located on the property, elevators, and resurface parking lots.  Properties in potential hazard areas (think hurricanes, tornados, wind, flood, etc.) have a propensity to have special assessments. A special assessment can devastate your finances as they can amount to thousands of dollars per homeowner and, often times, the homeowner is legally required to pay the amount immediately upon notice of assessment.  I owned a property where I learned post-purchase the HOA typically had an annual assessment of a few thousand dollars, and it wasn't even due to any special circumstances! 

·         Liability insurance: If you plan on renting the property, you must protect yourself with liability insurance.

·         Maintenance costs: Anticipate a higher maintenance cost that expected, especially if you rent out the property.  Also keep in mind, f you don’t live near the property, handling repairs yourself become more difficult if not impossible.  This means you will likely need to contract work out. 

·         Utilities: These include electricity, cable TV. telephone and water. You have to pay these whether or not you rent the property so include them in your estimate.

·         Net income: If you rent out your property, keep in mind your rental income fall short of your expenses.  Ask the prior owner or management company to show you the rental income statements for your specific property for the prior 12 months. 

·         Rental fees and commissions: You will want to hire a management company to take care of the business of renting out your property. The company who handles your property will charge management fees and/or commissions.  Rental commissions can range from 10% to 50% of the rental income.  If you use one of these management companies, you will need to go through the company to reserve your property for the days you desire. 

·         Real estate taxes: Keep in mind that with strong property value appreciation in many markets, your real estate taxes will be considerably higher than what the prior homeowner paid.  Find out what the tax rates and apply that to your purchase price.  Also keep in mind, second homes do not qualify for  homestead rebates that many states offer homeowners on their primary residence.

·         Special taxes: Some states levy special taxes on rental properties.  For example, in Florida owners of rental properties pay an annual tax on the contents of the property including everything from window treatments to the dishwasher to mirrors in the bathroom.  Property owners pay this tax separate from the real estate taxes. 

·         Taxable income: Always check with your tax professional, but the IRS (and your State where applicable) will likely consider any income you receive from renting out the property as taxable income.  You will want to maintain detailed records of expenses to help offset the income tax liability. 

·         Tax write-off: If you use the property strictly as a second home, never a rental, most likely you can deduct the mortgage interest and property taxes on your income taxes.  Always check with your tax professional. 

3.     Value for Your Dollar?

Now that you have an estimate of all the expenses, you have to decide if the value (personal use or rental income) outweighs the out of pocket expenses.  Consider the number of days you will realistically use the property.  Next, find an equivalent property you could rent for your own use during those times (home, condo, or a hotel).  You may find that you can rent a property substantially less than the cost of owning, and it is certainly a lot less worry. 

I recently came to this conclusion on a beachfront condo I owned in Florida.  I found I used the condo a lot less than I had expected, yet I still had a large monthly outlay of cash.  I realized I could rent a luxury hotel room with a much better view of the ocean for 5 days every month for the same cost of maintaining condo.  In reality, I would never go anywhere 5 days every month, including my own condo, so the actual cost would be much less. 

Certainly consideration must be given to the property’s appreciation.  I made a nice profit when I sold this property, but if I look at the costs of carrying the property over the same period it appreciated, plus the work I put into the property and all the worries, the appreciation really didn’t add up to much.  Also keep in mind there is no guarantee real estate values will continue to increase, especially at the rates seen recently.  Values could decline, at least for some period of time. 

Please do not take this article coming out against buying second homes or rental properties.  In fact, I highly recommend it under the right circumstances.  However, do not take this financial decision lightly and do not assume you will make an easy profit.  If you understand your goals, do your homework, and find the right deal, buying a second home can be a fun and profitable experience. 

Alan Morgan has been a real estate investor for nearly two decades. His rental properties have included traditional, short term, and vacation rentals that he has marketed on his own as well as through rental agencies located on the properties. Alan resides in Florida where he currently owns two vacation rental properties and works as a mortgage professional.  You can reach Alan at amorgan@enhancedcontact.com.