Primer for physicians: Economic ramifications of owning a vacation home
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Work hard, play hard. Physicians, young and old, enjoy time off and vacationing.
Whether it is a ski home, a beach home, or simply a quiet getaway with a view, wouldn’t it be nice if the economics of vacationing with family and friends also had a financial benefit? As hard as it may be to believe, owning a second home, when done strategically, can realize a financial benefit to your bottom line — all while providing a tremendous vacation asset for you and your family to enjoy. The vacation home could become a retirement home for surgeons in their later years. In this column, we examine the pros and cons of owning a second home and offer strategies for physicians, including millennial physicians, to consider for optimal financial benefit of a vacation asset.
Advantages
Leveraged appreciation . There are both financial benefits and disadvantages to owning a vacation home. Like any real estate asset, vacation homes, whether condos or stand-alone properties, allow you to benefit from leveraged appreciation due to mortgage financing. Typically, a 20% down payment cash investment, which is common for purchasing second homes, allows you to accrue all the additional equity your property gains in appreciation. On the flip side, however, leveraged depreciation also occurs if your second home is losing value.
Tax deduction . Owning a second home also affords the opportunity of earning rental income while having the ability to write off certain expenses. If you rent the home out for more than 14 days per year, your property is considered a business for tax purposes and you must report the rental income on your tax return. If you use the vacation home personally for more than 14 days or more than 10% of the number of days it is rented, you can deduct rental expenses up to the amount of income but cannot deduct losses. These expenses include hosting fees, cleaning fees, repairs, property taxes, mortgage interest, property management fees and more. If your personal use is limited to 14 days or 10% of the time the home is rented, expenses are deductible, and the rental property could even create a passive loss.
Your own getaway spot . One of the biggest advantages of owning a vacation property is the flexibility to use it as often and for as long as you like. Buying a vacation home in an area you or your family frequent regularly allows you to avoid paying expensive lodging fees during repeated travel. Such flexibility also allows you to potentially use your second home as a future retirement property if you are at the tail end of your career.
Disadvantages
Property management . Unlike financial securities, a real estate asset requires continual management and maintenance. A vacation home is probably one of the most hands-on investments you can make due to the year-round time commitment. Professional property management services are helpful in easing the burden of turnover tasks, repairs, maintenance and other hassles, but often come at a high cost. Short-term property management services often charge 15% to 40% of all rental income. Some properties, like condos, require less time commitment and property management can be built-in through the condo association. However, this too often comes at a high expense.
Must market property to have traffic . Getting renters to come to your property, particularly the right type of vacationers who will take care of your treasured asset, is no easy task. A good marketing strategy would include listing your home on all the top vacation home rental platforms, optimizing your listing with appealing photos, having pricing to attract your target audience and, most importantly, staying abreast of pricing trends in the vacation area so you remain competitive.
Lenders will charge more for financing . It is no secret that lenders often charge a higher rate of interest and frequently offer a lower loan-to-value to those purchasing vacation homes than to first-time home buyers. Therefore, expect to pay a premium on your mortgage rate and be prepared to make up to a 25% down payment on your property.
Location, location, location
Understanding the pros and cons of vacation asset investing is paramount to any sound decision making. If you choose a property in a location, you and your family will use many times during the year, it will more likely justify the time commitment required in cultivating your second home. Location is also critical for determining the appreciation potential of your property. If your target location has natural barriers or zoning restrictions that limit residential real estate development, your property is more likely to appreciate if the area remains popular for tourists.
Buffet’s acquisition cost principles
Be sure to ensure the price for which you acquire the property is financially sound with your pro forma models including all maintenance, taxes and financing costs. As Warren Buffet said, “It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” Top vacation rental properties, like companies, are often highly priced, but may be a better investment than a cheap property in an undesirable destination.
Conclusion
Despite being in a completely different track, physicians can benefit significantly from real estate investing, particularly in geographic areas they and their families may frequent. Be sure to do plenty of homework, modeling out the financial aspects of owning a second home to see if this makes sense for your situation.
References:
The pros and cons of investing in vacation rental properties. www.millionacres.com/real-estate-investing/rental-properties/pros-and-cons-investing-vacation-rental-properties/.
Wealth Planning for the Modern Physician and Wealth Management Made Simple are available free in print or by ebook download by texting OT21 to 844-418-1212 or at www.ojmbookstore.com. Enter code HEALIO at checkout.
For more information:
Sanjeev Bhatia, MD, is an orthopedic sports medicine surgeon at Northwestern Medicine in Warrenville, Illinois. He can be reached at email: sanjeevbhatia1@gmail.com.
David B. Mandell, JD, MBA, is an attorney and founder of the wealth management firm OJM Group. You should seek professional tax and legal advice before implementing any strategy discussed herein. He can be reached at mandell@ojmgroup.com or 877-656-4362.
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