Why (and How) You Should Be Buying a Vacation Home

The vacation home landscape has changed significantly since the arrival of websites such as Airbnb in 2008 and the rebranding of Vrbo in 2019. Not only has a spare bedroom become a cash cow, but people are also learning that second and third homes can yield a return on their investment. Rather than paying for pricey hotels on vacation, buying a vacation home can allow a homeowner the opportunity to enjoy a new city and become a seasoned real estate investor at the same time.

Although the flexibility of having multiple homes allows owners to pull off geographic arbitrage and unlock a variety of tax benefits, many people are intimidated by having another mortgage (and managing a rental property). But the reality is that owning a second home can be a highly lucrative venture and, in most states, really straightforward. This guide will explain the benefits of buying a vacation home as well as three options to consider before you make a purchase.

Investments Benefits

There are many reasons to own real estate property, explains Christopher Liew, a CFA Charterholder and the founder of Wealth Awesome, where he shares tips on money, travel, career, and real estate. He says that buying a vacation home, in particular, offers tax incentives, potential property appreciation, higher rental income (in comparison to long-term leases), ideal venues for gatherings, and the freedom to renovate or furnish anytime. While the latter two reasons reap benefits that might be hard to quantify, the former three are all about crunching the numbers. Here's a closer look at two important benefits of vacation rental investing.

Tax Incentives

The tax component can vary significantly based on where the home is located. For United States taxpayers buying U.S. properties, the IRS website can explain everything from property depreciation to tax breaks for clergy and those in the military. There are a lot of breaks on the books, which can make mortgage payments and even visiting rental properties tax-deductible. For those buying abroad, it is important to keep in mind the tax regulations in both your home country and the locale where the property is located.

Appreciation

Simply put, appreciation considers how much the property will be worth in the future, whenever the owners might decide to sell or refinance it. Using historical data, it is relatively easy to guestimate a modest appreciation rate and build a vacation rental business around those figures. The reality is that short-term rentals, which typically range from a few days to a few months, outpace the income from long-term rentals, which typically extend beyond a year.

Homes in major tourist cities like Miami, Lake Tahoe, New York, and San Diego see well-located residences rent out better as vacation getaways rather than a family's home base. After crunching numbers specific to your market, it is easy to see that owning a furnished vacation home in a good neighborhood could be very lucrative.

Mortgage Rates and Down Payments

There's a lot you should know before applying for a mortgage. However, getting a loan is not as cumbersome as some might think: It just takes patience—and paperwork. Mortgage loan rates are lowest for those who have a good credit score and who plan to live in their homes all year round. Often, these owners can put down as low as 5% of the asking price in a downpayment. An investment property, on the other hand, can be purchased even while someone else is living in it, but the downpayment is usually between 20 and 30% down and those rates often reach 2 to 3% above primary residences.

With this in mind, many people who have lived in their primary residence for over a year see great financial benefit in buying a new home for themselves at lower rates and putting their existing home on the short-term rental market. Otherwise, if you crunch the numbers correctly, buying a second home outright could still yield great returns.

Melinda Satterlee of Marathon Wealth Management says that each person should review their own finances to see which mortgage product is best over the long term. "When you use someone else's money to buy, you may be able to increase your returns. For example, if you discovered that the rate of return on real estate has been 7% a year and you're able to get a 4% rate for your loan, you will earn the 3% difference from the bank's money," Satterlee explains.

Vacation Homes vs. Hotels

Even with all the cheap hotel deals out there, hotels are still consistently inconsistent. They shut down, get new owners, and book up. Furthermore, their prices are in constant flux, making them cheap buys for a weekend away in one season and extremely cost-prohibitive in another. Also, the rules around additional guests and pets can make it hard to feel completely at home. And we've all heard timeshare horror stories.

Lisa Ann Schreier, who calls herself the Time Share Crusader, reminds future buyers that there is a big difference between buying a vacation home and a timeshare. "First, a timeshare is never an investment, and purchasers can expect little or no resale value once it's paid off," says Schreier. "If there's still an outstanding loan on the timeshare, there's almost zero chance of being able to sell it."

Timeshares are typically purchased for a week or two per year, and sometimes there's the vague promise of exchanging it for access to another destination. In short, for people who want to constantly return to the same place, buying a vacation home is a smart bet.

Ways to Buy a Vacation Rental