A Place to Call (Our Other) Home – Part Two

by Sequoia Financial Group
by Sequoia Financial Group

Part Two: Is the Risk Worth the Reward?

Adding a vacation rental property to your assets is a unique investment opportunity. Still, there are inherent risks associated with real estate investments and the real estate industry, each of which could hurt a real estate investment’s financial performance and value.

Some of these risks include a deterioration in national, regional, and local economies; tenant defaults; local real estate conditions, such as an oversupply or a reduction in demand for rental space; property mismanagement; and changes in operating costs and expenses, including increasing insurance costs, energy prices, real estate taxes, and the costs of compliance with laws, regulations, and government policies.

General real estate risks

Risks inherent in any real estate investment include:

  • Lack of liquidity: Selling real estate takes more time than other types of investments. If you must sell the property quickly, you risk settling for a price below fair market value.
  • Market risk: Factors such as an overall economic decline, adverse changes in tax laws, or a decrease in demand can influence real estate values. The value of your home is not guaranteed to go up, and it could go down.
  • Financial risk: Fluctuations in interest rates can also affect the value of real estate.
  • Real estate expenses: Costs associated with the purchase, sale, maintenance, and management of real estate can affect profitability

Risks specific to vacation home rentals:

Besides the risks that are inherent in any real estate investment, renting your vacation home has unique risks, including:

  • Specific economic factors, such as high unemployment, high gas prices, or other factors, can directly affect the vacation rental industry by discouraging vacationers from taking trips.
  • Natural phenomena: Bad weather, lack of snowfall, fire, beach erosion, and other natural disasters can affect the demand for seasonal rentals.
  • Wear and tear: There will be some wear and tear, just as there is wear and tear in your own home. Unless your vacation home is maintained, it will produce less and less income, so keeping the property in top condition at all times is vital.
  • Property damage or loss by tenants: Unruly tenants may damage or steal your property.
  • Overbuilding: If the area becomes a popular tourist destination, the vacation home you love now for its beautiful view could look out onto other vacation homes in a few years.

Tip: Having adequate and appropriate insurance can help offset some risks.

Other Tradeoffs

Vacation home mortgages may be more difficult to obtain

Lenders may be less willing to make a second home loan than a principal home loan. This is because the finances of a second-home buyer are likely to be stretched thinner. Because of the increased risk of default, vacation home loans tend to require more money down, carry higher interest rates, charge more points, and impose other restrictions.

Renting vacation property requires effort

Before purchasing a vacation rental property, you must decide how to provide for its management and maintenance. You may do this yourself or hire professionals to do it for you. Either option has its drawbacks. If you manage the property, ensure your schedule accommodates the time commitment. Some of the necessary tasks include:

  • Placing ads, listing the rental, and creating a website
  • Talking to prospective renters
  • Checking references and credit reports
  • Sending and receiving correspondences
  • Setting and collecting rents
  • Cleaning up between renters

If you maintain the property yourself, you will need some handyman skills. If you hire professionals, you give up a certain degree of control, their salaries will cut into your profits, and you may lose certain tax advantages.

Income and capital gains from rental property may be subject to investment tax

Net rental income (income minus expenses) and net capital gains from the sale of rental property will be included when calculating whether your total investment income is subject to the 3.8% tax that applies to individuals with an adjusted gross income (AGI) above $200,000 and couples filing a joint return with more than $250,000 AGI.

There are several risks associated with adding a real estate investment to your portfolio, but ultimately, you’ll have to decide if the risk is worth the reward. Luckily, a Sequoia Financial Group advisor is just a click away to help you determine if it’s the right move for you and your family.

The views expressed represent the opinion of Sequoia Financial Group. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and nonproprietary sources that have not been independently verified for accuracy or completeness. While Sequoia believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Sequoia’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in equity securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. Past performance is not an indication of future results. Investment advisory services offered through Sequoia Financial Advisors, LLC, an SEC Registered Investment Advisor. Registration as an investment advisor does not imply a certain level of skill or training.