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Do Holiday Homes Make Good Investments?

Date: 11/01/2018

Here’s an illustrative case study to help flesh out the theory…

Ben and Brittany are hard workers and look forward to their annual two week Christmas / New Year holiday at their favourite beachside destination – a three hour drive from the property they are currently renting as their principal place of residence. They love it there, and are always commenting about how nice it would be to have a holiday home for their (planned) kids and (hoped for) grandkids. They see a ‘shack’ for sale for $500,000 (which is about half of the value of the place they’re renting) and, although it’s a stretch, if they rented it out when they weren’t using it to help pay the mortgage, they might be able to afford it. Besides, they’re sure it will make a good investment because it will appreciate in value over time.

What should they do?

Around this time every year a question may pop into your head… is it a good idea to buy a holiday home? After all, it’s summer holidays and the weather is warm, so the idea of having a holiday retreat to escape to is very appealing – so the romance of the proposition may have you reaching for the computer to see what’s available, and for how much.

However, before making an emotionally charged purchase, here are six ‘reality reminders’ to consider:

1. Pleasure Or Profit?

Robert Kiyosaki, author of ‘Rich Dad Poor Dad’, says that your home isn’t an asset but rather a liability.

I disagree. A home, or a holiday home, meets the accounting definition of an asset since it holds future value. However, a choice needs to be made about whether the property is a lifestyle, or financial, asset. 

Lifestyle assets are purchased for pleasure. The returns are enjoyment and happy memories.

Financial assets are purchased for profit. The returns are (net) rent and/or capital appreciation.

A distinction between these two purposes is needed because the motivation and psychology for purchasing, holding, and eventually selling real estate differs depending on whether you’re holding it for pleasure or profit.

For instance, if you own a financial asset that consistently loses money, then it should be sold and the money redeployed. On the other hand, a lifestyle asset that loses money might still be kept, provided the perceived enjoyment exceeds the actual cost.

Just be careful where and when you have mixed motives. That is, buying a lifestyle asset for perceived financial benefits, or purchasing a financial asset for perceived lifestyle benefits. The lack of clarity might mean you end up with a conflicted asset that doesn’t perform to its maximum potential in either a lifestyle or a financial capability.

For Ben & Brittany, they seem to be unsure about whether the investment is being purchased for lifestyle (i.e. enjoyment), or financial (i.e. monetary) purposes. The holiday home seems to be a lifestyle asset with financial upside, yet enjoyment compromises will need to be made in order to afford it, and the added financial pressure may offset any enjoyment.

If they are buying for enjoyment there shouldn’t be any added financial pressure, and if they are purchasing for profit, the question needs to be asked “is this the best capital growth property we can find?” Another consideration is how will this purchase affect their ability to purchase a home or other investment property.

2. Use

How often do you think you’ll use the holiday home? The risk is that you overstate your use based on how you feel when you purchase it – i.e. it’s fine when you’re on holiday and the location is in peak season, but, once you own it, you may find it harder to consistently get away. Work commitments, birthday parties, school sports, etc. have a habit of invading the time you otherwise hoped to get away.

Consider this: if you planned to visit the property every other weekend then you’ll be occupying it 52 days a year. That might sound like a lot, but what you’re also saying is that the property will be unoccupied 85% of the time (i.e. 313 days).

If you decide to rent the property first and then backfill the empty periods by using it yourself then, as mentioned above, you’re choosing to compromise your enjoyment because it will be in more demand during the choicest times – usually school holidays. You may also find it hard to plan a family vacation, as you’ll want to keep it available for rent until the last minute.

Remember too that shoulder and off-peak seasons will see an increase in the available properties for rent at a time when demand drops off, so rental income will decrease. Furthermore, that peak rental time will be when the property is at its best. Using it yourself at that time will really hurt your potential return.

Finally, sometimes people purchase a holiday home with a view of renting it out, but, after a couple of bad experiences, they become reluctant to continue – either because the property is soiled or damaged, or because the idea of having strangers sleeping in your bed and/or using your household items is a turn-off. For this reason there is a tendency to furnish holiday homes rather sparsely and, while practical, the lack of ‘home touches’ makes it less of a holiday home and more of a holiday rental

While Ben & Brittany will hope to use it more, at the moment they’re both hard workers and so are unlikely to have a lot of discretionary time to drive three hours each way to their holiday home. Furthermore, to maximise their return, they’ll want to rent it out during peak-season, which coincides with the times when they presently visit that location and want to use it themselves.

3. Management

Unless the holiday home is nearby, you’re going to need some sort of local management oversight to advertise rental availability*, and to arrange for rental, access, post-use inspection, cleaning, replacement of consumables, etc.

* For sure, the internet has made it easier for tenants to book direct with the owner, but this self-management option does not solve the other problems of managing access, checking the property is left in good condition, cleaning, etc.

Good management doesn’t come cheap, and holiday rental management is usually charged at a premium for the extra services provided. If the plan is to self-manage, then this will require time and expertise.

Ben & Brittany are three hours away, and so any need to ‘pop down’ and do something to the property will be six hours of driving, plus the cost of petrol, wear and tear on the car, etc. Given they’re busy people, they’d be sensible to use a local property manager, but this will eat up a fair chunk of their peak-season rental profits. 

4. Ownership Onus

Being the owner of a holiday home carries with it extra fiscal responsibilities – like being charged council rates and land tax, paying usage costs such as cleaning, maintenance, utilities, etc. and, of course, sourcing and paying insurance – which can be difficult to obtain in areas prone to flood, bushfire, or if the property will be vacant for substantial periods of time. 

Given they currently rent their principal place of residence, and also their holiday accommodation, Ben & Brittany may be unaware of the potential type and cost of likely ownership expenses. As such, it will be important for them to do a thorough due diligence in order to complete an accurate financial analysis. The risk is that they’ll over-estimate the income, and under-estimate the expenses.

5. Resale

Holiday homes can be easy to buy, but harder to sell. This is because the available pool of buyers is often limited to fellow holiday home owners, and those looking to downsize and permanently move to that location.

Holiday homes are a discretionary purchase. When interest rates rise and/or economic conditions decline, the justification for owning one diminishes. Hence, during such occasions, housing supply of holiday homes tends to increase as the number of interested buyers diminish, and this will put downwards pressure on prices and increase the time it will take to sell. 

Ben & Brittany have a multi-generational timeline for ownership, so they’d be smart to consider purchasing it in a structure (i.e. company or trust) that would allow for continued family use without passing on ownership to any particular sibling.

6. Flexibility

Once you own a holiday home you become committed to using it to get ‘value for money’. One downside to this is that you may not be able to afford, or want, to go elsewhere for future holidays.

Going to a destination because you want to is different from going to a destination because you have to. The former is a choice. The latter is an obligation. Being obliged to do something detracts from its enjoyment.

 Ben & Brittany only have four weeks vacation a year, and to get value for money they’ll want to spend as much time as possible at the holiday house. One opportunity cost would be in missing out on the vacations they might have had elsewhere.

Conclusion

If you’re considering buying a holiday house for profit, then you need to ask whether it’s the best rental and/or capital appreciation opportunity you can find. A good question to consider is whether you would buy the property even if you assumed you couldn’t use it.

Alternatively, if you’re thinking of buying the property as a lifestyle asset, then assuming you can afford it, you need to realistically evaluate whether the actual and opportunity cost and commitment of ownership will outweigh the enjoyment you’ll gain from using it. Now the question to consider is – would you buy it if you found you couldn’t easily rent it?

The worst place to be is conflicted – stuck in the middle between purchasing for pleasure and purchasing for profit. Instead of getting the absolute best of either, you risk having the worst of both.

While it may seem like an attractive proposition, I believe Ben & Brittany would be better advised to continue renting their holiday accommodation and looking to either invest elsewhere for profit, or, if they want to purchase a lifestyle asset, buy a home where they’d spend more time living. Later in life, once they’re more financially secure, and, assuming they still have the desire, they can then purchase a better holiday home with more fiscal and family certainty.

That’s my say, but what do you think – do holiday homes make good investments?

Profile photo of Steve McKnight

By Steve McKnight

Steve McKnight, the founder of PropertyInvesting.com, is a respected property investing authority as well as Australia's #1 best-selling business author.

Comments

  1. Michelle

    Excellent summary Steve. This has absolutely been our experience with owning a holiday rental property. When we are doing our financial analysis on the property , we find it useful to divide the expected loss (yes, despite our best intentions, it’s always a loss), by the amount of nights we expect to stay there, and consider if we think that is a reasonable rate for what we would expect to spend on holiday accommodation per night. That can be a real eye opener if it’s high!

  2. Southern Battlers

    Great article, when my wife & I got married (34 years ago) there was a shack in the family that my mother-in-law & her sister had built on a secluded beach in the 1950 era. It was a bit of a oddity in that the land was rented off the local council for a yearly fee (an absolute song), but the trade off was the plot was Roadside Verge & as such could be claimed back if or when the local bridge crossing a creek needed upgrading. Over the years the family had many great times down there that added to the growing history that we all look back on.
    In the late 90s’ my wife & I began our investing in rental properties, which gave us a new perspective on what to do with hard earned money. Over that time many freehold properties came up for sale in this beach community, but knowing what we had learned over the years with the cost of maintaining a shack we could not come to buying one. The council finally gave us our marching orders a few years back & we had to pull the old place down (actually white ants had done most of the work for us). Our children have all grown up & left home, so we sold up the our family home & have built a new house down the coast from the old shack. From time to time we have rented a shack & had family gatherings in our old beach holiday spot, which is 30min drive by car or 1hr by boat if the pull still gets us.
    You are right in what you say in that if a holiday house(shack) is bought it is very difficult to separate emotional use from financial investment. There is always someone who needs to rent their shack out to try & re coupe their costs, which a few times a year works out far cheaper than owning it yourself. If you are looking for an investment property the practical criteria is very focused & intentional. As with our children if I was advising Ben & Brittany I would tell them to get their own home sorted out first (buying), then us the equity in that to step out into investing.

    Hope this has been of some help.

    Patrick & Jenny, South Australia.

  3. Profile photo of Simonp

    That really is a brilliant summary, Steve. We bought a holiday house we “fell in love with” a little over an hour away from where we live. I thought it was a lousy investment, but my wife had her heart set on it, and pleasing her has been my best investment throughout our lives. Realistically it only rents out about 3 to 4 weeks a year, all during school holidays, which pays the rates, but nothing else. Fortunately our kids are no longer school age, so we tend to enjoy it outside of peak holiday periods. Being available for rental all year gives us some tax advantages, but it will never be income generating. Capital gain has been acceptable, value doubling in 12 years. Was it worth buying? In financial terms, no, but to see the smile on my wife’s face and hear the sigh of relaxation as she puts her travel bag in the bedroom is more than worth the purchase price

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