By Eric Rosenberg, WCI ContributorA vacation home can be a fantastic lifestyle purchase, giving your family a place to get away and relax while enjoying the comforts of home. In addition to skipping the hassles and costs of booking a hotel or Airbnb, some savvy owners rent out their vacation home to others, turning it into a source of cash flow. Here’s a closer look at the pros and cons of owning a second home and what you should consider before making this six-figure purchase.
Is a Vacation Home a Good Investment?
If you’re considering buying a second residence and think it would be an enjoyable option for your household, you may be wondering about the finances of a vacation home and whether it’s a good investment. The answer is nuanced and comes down to several factors about the specific property and how you handle the financing.
- Property maintenance and appreciation: A general consideration with any home purchase is the specific property, whether it’s your primary residence or a vacation home. The location, negotiated purchase price, and maintenance costs significantly influence whether you can make money from the home in the long term. If you overpay, buy in an area with flat or falling home prices, or need to perform expensive maintenance regularly, it could become a money pit. If you get a good deal in an up-and-coming area, you could be on track for a lucrative investment.
- Taxes and insurance: Property taxes and homeowners insurance are a must. Some states and counties levy high property taxes, while others are comparatively a bargain. Further, some high-risk areas could have you paying high insurance rates or require you to add on expensive earthquake or flood coverage.
- Financing costs: If you buy a vacation home with a loan, you’ll be subject to current market interest rates. Monthly interest costs can be significant depending on your property value, down payment, interest rate, and points.
- Rental income: Renting out the home using a service like Airbnb or VRBO could earn you more than your expenses. Rental demand, cleaning costs, and additional wear and tear influence whether renting is worthwhile and how much money you’ll make.
Every home is unique, and there are no guarantees in real estate. But if you understand real estate well, a second home can potentially work out as a profitable investment.
[FOUNDER'S NOTE FROM DR. JIM DAHLE: The problem here is usually that people wear different hats when choosing a home they will occupy vs. an investment property. Many who buy a second home with the justification that they will rent it out when they're not there are surprised to find out it doesn't actually cash flow. A second home, like a first home, is, in many respects, a consumption item (you pay it) rather than an investment (it pays you). Even the “saved rent” dividends that a home “pays” are typically much less significant on a second home. A general rule of thumb is that if you won't be spending at least three months a year there, you're better off renting than buying. But if you can afford a second home (especially if you can pay cash for it) and want a second home, then it's just like any other consumption item with a possible benefit of future appreciation to help offset the cost.]
More information here:
Your Guide to Short-Term Rentals
With Uncertainty Swirling Around Airbnb, Is a Short-Term Rental Collapse Imminent?
Can You Afford a Vacation Home?
To decide if you can afford a vacation home, consider your budget, savings and investment goals, and what your desired vacation home would cost.
A home is a significant expense. Like your primary residence, a vacation home requires many short-term and long-term costs. Becoming “house poor” from a vacation home certainly isn’t worthwhile.
Be very realistic about what you would spend on the second home. Factor in a mortgage payment (including taxes and insurance), utilities, internet, maintenance, upgrades, furnishings, appliances, and unexpected repairs. It would be a shame to have buyer’s remorse shortly after sinking so much money and paying closing costs because you didn’t budget properly.
Like a boat or car, the only way to be absolutely sure you can afford a second home is if you can pay cash for it, but at a minimum, make sure the cash flow required by the additional expenses does not prevent you from saving adequately for your other financial goals.
Pros and Cons of Owning a Second Home
If you’re on the fence, weigh these pros and cons of owning a vacation home as a medical professional.
Why Buy a Vacation Home?
- A reliable escape from home: A vacation home is a comfortable place to go whenever you’re free from work. You can set up a wardrobe at your second home, making it a quick escape without packing a suitcase.
- Set up roots in a favorite location: If you love skiing, boating, or visiting a specific place, buying a home there gives you a foothold and effectively guarantees you’ll return again and again.
- Sharing with family and friends: Some owners like sharing their second home with family and friends or using the home to host loved ones for the holidays. You can use it and share it however you choose when it's your home.
- Earn additional income: If you rent it out, the home can become an income source, helping pay some of the costs or even earning a profit in some situations.
Cons of Owning a Second Home
- Monthly mortgage payment: Even when you’re not there, you’ll have a mortgage payment as long as your property is financed with a loan.
- Taxes and insurance: Even if you buy the home in cash, you’ll still need to pay property taxes and insurance indefinitely. If you buy somewhere with an HOA, plan on those costs, too.
- Maintenance and repairs: Homes require ongoing maintenance. Weather, regular use, and critters can all lead to expensive repairs. Climate-related damage is always a risk, even when you're not using it. Lawn care may be necessary.
- Security and damage: If you’re not living in a home, it could catch the eye of criminals looking for a low-risk smash-and-grab. If a pipe bursts when you’re away for weeks or months, it can cause severe damage you won’t discover until your next visit.
Buying a Vacation Home and Renting It Out
Renting out a vacation home leads to additional pros and cons. On the positive side, it could possibly make you enough money to cover all ownership costs. If you can own a vacation home and earn a profit, you’re making a sound financial decision.
However, renting out the home generally means more money and work for you to have the property cleaned, and people you don’t know will stay in the home, potentially causing damage or drawing noise complaints from the neighbors. You won’t want to leave valuables or clothes for your next visit if others spend time there, and it could be booked when you want to use it. Peak rental season could overlap with your family’s school vacations or holiday weekends.
Taxes on Vacation Homes
We’ve already mentioned taxes, but it’s so important we’re going to discuss it again in a dedicated section. Average annual property taxes can range from around $600 per year on the low end to more than $5,000 per year on the high end. But that’s for the average-priced home.
Buying an expensive home in a high-tax county could cost you $10,000-$15,000 or more in property taxes annually. Fourteen counties in California, New York, New Jersey, and Virginia have a median property tax rate over $10,000.
When a home is used as a second residence, you can generally deduct property taxes, though limits apply. If you already live in a state with high taxes, you’ll likely hit the limits and may be unable to deduct some or all of your property taxes.
If you use the home as a business, you can deduct taxes as a business expense. So, for rental property owners, you could possibly deduct the entire amount as a business expense. The rules here are complex, and they depend on how much you use the property and how often it’s rented.
You can take tax advantages in other ways as well, including depreciation, 1031 exchanges, or the short-term rental loophole.
Should You Use a Doctor Mortgage on a Second Home?
Doctor loans or physician loans are specialized mortgages for high-income earning doctors with variable incomes, little credit, or unfavorable debt-to-income ratios, thanks to student loans. If you qualify for a doctor mortgage, it could be helpful for getting a second home.
Be aware, however, that doctor loans often incur higher interest rates than traditional mortgages. Just because you qualify for a doctor loan doesn’t necessarily mean it’s the right choice. Your best option is to shop around and compare rates, including traditional and doctor mortgages, to determine the lowest-cost borrowing option for your financial situation. Many doctor mortgage loans are only available on your primary residence, but if your second home could be your primary residence for a while, perhaps you could still use a doctor mortgage loan for it.
More information here:
Home Loans for Doctors: Physician vs. Conventional
Other Alternatives to Buying a Vacation Home
If owning and maintaining a second home is too costly or overwhelming, you definitely don’t need to buy one. One of these alternatives could be a good choice:
- Fractional ownership: If you know someone else considering a vacation home, you can go into it together, splitting the costs and dividing up different days to use the property. You can buy it with three or more others to lower costs, but you’ll also have to give up more days.
- Long-term rental: If you want to stay somewhere for a while but don’t want to buy, you can get a long-term rental one or more times per year.
- Stay in a hotel: There are no recurring or long-term costs for staying in a hotel, and someone else does the cleaning.
- A vacation home fund: While many consider this a “dumb doctor deal,” it is an option.
Vacation homes are not for everyone, but they can be a good choice for some high-earning doctors wanting a place they can visit regularly or a real estate investment opportunity. Stay focused on the costs and potential payoff to decide if it’s a good option for your needs.
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Have you ever bought a second home? Was it a good decision? Did you make money, or did you end up losing on it?
EXPENSES
No matter what you think expenses will be more than you plan. When you don’t live in a place, it just costs more for everything. Repair people don’t do the same job when you are not there…little things become big things because you were not there to notice it. Coastal areas cost more bc salt air ruins everything quickly (think new ac every 5-7 years in oceanfront barrier islands).
INCOME
Yes you can rent and offset some expenses. Plan on over 50 percent of that going right back to various expenses And if you do this your other expenses will go up. Bed spreads, carpet, sofas could be on a 5-7 year replacement schedule. Interior paint every 7 years as well as all that move in and move out tears a place up. For summer, plan utility expenses as whatever your ac costs running 24/7 as it will be on with doors and windows open all the time. Renters have an unbelievable ability to break things.
Having owned a bunch of short term rentals, I can honestly say to be successful from a business perspective they need to be in the same vicinity of where you live or work so you can check on them on turn over days, make sure repair people do the work right etc. management companies don’t oversee this well, they just don’t care about your wallet.
I personally don’t think hybrids where it’s your get a way and a short term rental work well. You will get frustrated with how renters treat your home. Make it either a true second home if you can afford it, or buy a short term rental as a business where you live or work and run it as a business.
1- we have a lower cost alternative: if you don’t mind being almost (or definitely) a camper when you vacation, an RV or for us a larger boat you can stay on is an option. The slip/storage or RV park fees will be lower than rent or mortgage of a home. You can also much more easily move (and maybe even store the vehicle at home) or quit ownership. Now our boat is worth more than $10K though I won’t use it for an off shore funeral pyre for spouse if I am widowed, which was my plan before getting the new boat.
2- long distance ownership second home or boat can be nerve wracking and expensive. After moving before selling our old house, just like with a boat, the second best day of owning it was the day we sold it.
But now I’m in my 60s sometimes, and if the air conditioning on the boat is broken, we are paying for a hotel for part or all of our stay anyway.
I remember a lot of posts online and discussions in real life about how “a vacation home is definitely a good investment and will make us money.” Always struck me as mental gymnastics to try and justify a potentially reckless purchase.
Anecdotally, I have noticed a decrease in this specific talking point. I suspect rapid appreciation of desirable vacation areas and higher interest rates are the cause.
Although you briefly mentioned it (one word…depreciation), getting a cost segregation study done on a vacation home and rapidly depreciating the value of the home over 1, 5 or 7 years can get you a giant tax refund if you have a large tax bill from your income as a physician.
This can be a huge tax advantage (>6 figures) to owning a rental home that would have been nice to mention in more detail. Otherwise good article. Thanks
One important point to note on this is that bonus depreciation is currently being phased out and is at 60% this year (40% next year) unless the Senate decides to push through the $78 billion dollar tax bill that they’ve been sitting on since the House passed it in January. Then it would go back to 100% and the tax savings would be huge again. With the material participation requirement, you have to start factoring in the value of your time compared to the 60% depreciation savings.
It sure would be easier to get it all right every time if the rules didn’t keep changing.
The essay on vacation homes hits a lot of important points, but it skips a key option: timeshares.
Unlike owning a second home, timeshares give you the freedom to explore different locations without the big commitment of upkeep and high upfront costs. You can vacation somewhere new every year, so you don’t get stuck going to the same place all the time. Plus, timeshares save you from worrying about property maintenance, taxes, and expensive insurance.
Timeshares are a great way to have a hassle-free vacation, guaranteeing you a spot in popular locations without the long-term financial and maintenance headaches.
It’s another 10 months until April Fools’ Day.
I don’t buy junk. That’s what timeshares are
We purchased our Hawaiian vacation home in late 2020. Working in the ER during the pandemic temporarily put my brain in YOLO mode I guess. How has the purchase worked out from a financial perspective?
Despite putting 42% down as a down payment and renting it out consistently, we have had negative cash flow each year. Operationally, we lost 1.91% of the purchase price in 2020, 0.42% in 2021, 2.06% in 2022, and 0.24% in 2023. This does not include the principal payments on the mortgage and does not include the value of our personal use, which has averaged about 60 days a year.
Fortunately, home prices in our neighborhood have risen, more than compensating for the operational loss. We bought at a good time during the pandemic before home prices started to take off, and we have a 3.25% mortgage.
I calculated how much the down payment would have been worth had I invested in an 80/20 blend of VTSAX/VBTLX instead of purchasing the home. I then calculated my returns from the vacation home, including appreciation (minus potential selling costs). In a straight-up comparison, the investments won 15% to 13.7%. These are total returns through the end of 2023, not annualized. If I had included our use of the house at fair market value, the results would have changed in favor of the vacation house, 17.4% to 15%.
I would not consider these results to be typical. We got lucky with the timing of our purchase which allowed us to buy at a good price and to secure a low-interest loan. We also lightly renovated the house, which is included in the negative operational returns. I think the bottom line is to think of your vacation home as a treasured place for your family to enjoy, not as an investment. The memories we have created are worth more to us than any opportunity cost of the money.
Wow. 60 days a year. Thanks for tracking those numbers so carefully and sharing them.
I generally try to keep good financial records, however, I can’t take credit for this one. We use a full-service property manager and they handle all the bookkeeping. I get a spreadsheet at the end of the year outlining all revenue and expenses. I just have to keep track of anything we do personally to the property that isn’t through the management company. On the downside, they take 25% of revenue. However, since we live in Texas, it would be almost impossible to manage the home without them.
I posted detailed year-by-year returns for this property with a breakdown of all expenses at https://businessisthebestmedicine.com/the-realities-of-using-your-vacation-home-as-a-rental/.
Nicely detailed costing – thank you. Did you include the costs of travel to and from Hawaii for the personal use?
Sanjay,
I did not include travel. I decided that we would spend money on traveling to a vacation destination even if we rented a house or stayed in a hotel, so I didn’t think it was relevant to the vacation home as an “asset”. Additionally, we use it more of a “summer home”, so my family usually only travels to and from Hawaii once per year. It’s great to escape the summer heat in Texas! I usually have to fly back a few time to work, but I use airlines miles linked to my credit card.
I think you make a great point though. When considering a vacation home, you should factor in how much you will use it and the cost of travel. We’re a family of 5, so if we wanted a vacation home to spend weekends and holidays, we would have to be able to drive there, otherwise it would be prohibitively expensive.
Great post. I appreciate your comparison on what your return would have been had you invested in the market. It left me wondering though… if I were in your shoes and had chosen to put my money into the market, then the returns I made would just be used to help me buy stuff… like a vacation home (shoulder shrug).
So, my question for you is: When you make this comparison and purchased your vacation home instead of investing, did you mean that you chose NOT to invest in your taxable account? In other words, did you take money from your retirement contributions that year (i.e. 403b/401k, 457, HSA, and backdoor Roth) accounts to fund this purchase?
Thanks so much.
It is the only investment in our portfolio that came with a pool and a hot tub! And memories. And ski-in, ski-out.
We bought into a rare bird in 2003 – a “Condo Hotel” in a ski area. The condos in the building are run like a hotel by an onsite management company. They do get about 50% of the rental revenue, but they deal with absolutely everything. We have never managed a booking, shoveled snow, done a turnover cleaning, painted a wall or replaced broken items. They do all that. Some owners in the building think they are being ripped off. We think we are getting white glove service and we are grateful for it.
We paid all cash when we bought our condo. There is no mathematical model where it would have worked with a mortgage. Having paid cash to buy, we still need to pay the monthly HOA fees, property tax and insurance.
– We ‘lost money’ in the years we were there every weekend while we skied as a family
– The break even point seems to be when we use it for 20 or less nights in the ski season
– It does bring in some revenue in the years that we are barely there.
For the first 18 years or so, the equity lagged behind what we would have made in index funds. We would have lost capital if we had sold then. But the whole ‘work from home in a resort town’ has finally – after 20 years! -caught the value up to index funds over the same time. Even during those 18 years, I would still have said I was happy with our decision to buy. For us, this enriched our family life and experience. It cost money, but brought happiness.
There are a handful of these properties in Lake Tahoe. Sam at Financial Samurai has written extensively about his ownership of a similar condo.
Nice article and spot on regarding the annual costs. My experience was simple and lucrative. In 2018, Built a 4-bedroom, 4 bath, 2 car garage home in ski resort area in the mountains of Colorado for $670,000, all cash. Luckily built just before the pandemic caused huge increases in the cost of materials and building. Current similar sized homes in my area are selling for $1.4 million and rising every year. Where the prices level off at is anyone’s guess, but I am thinking I will have a nice profit should I ever sell. As with most real estate investments, timing is everything and we simply got lucky with our build. My annual costs are about $15,500 per year and includes of course property tax, home insurance, HOA fees, and utilities (gas, electric, water, internet). Of note, the HOA fees include annual lift tickets for our family of 5 for winter skiing and summer mountain biking as well as unlimited golf – all of which we take full advantage of.
I agree with many here that if you can’t pay cash for the vacation property, the cost soars due to mortgage interest rates and I would not have built if I needed a mortgage. I am not one to rent out the property as I have had too many friends with properties lament the damage that renters inevitably cause to a vacation rental place.
THE ABSOLUTE INTANGIBLE BENEFITS – and cannot be understated…. are the memories my wife and I have made with our three teenage children. Lasting, lifelong memories of skiing, mountain biking, canoeing, hiking with them and their friends that tag along…. PRICELESS, and to my wife and me, worth every penny we spent!