For every cottage fantasy, there is a harsh financial reality

As mortgage rates rise and the housing market cools, financial advisors say it’s critical for buyers to weigh the unexpected costs and pitfalls that come with that waterfront home.

The largest share of vacation home purchases close between the fall and early New Year, which is typically the off-season for the primary home market, said Danielle Hale, chief economist at Realtor.com. For example, in the Lake Tahoe area, August and September are traditionally two of the busiest months of the year, as buyers dream of spending the winter holidays in a new home and sellers try to avoid winter maintenance on the property months. said Brit Crezee, a Realtor specializing in this area.

Home prices rose during the pandemic in second-home markets like Phoenix, Naples, Fla., Myrtle Beach, S.C. and Las Vegas, even more than the rest of the country. The typical property in second home markets sold for $516,423 in April, up 19.9% ​​from last year, according to the most recent data available from Redfin.

The beach home bonanza appears to be ending, many economists said. Second-home sales are slowing significantly from last year’s boom, falling below pre-pandemic levels (February 2020) for the first time in two years, partly due to high prices and rising mortgage rates, said Daryl Fairweather, chief economist at Redfin.

Many Americans still envision a second home as a source of family memories, wealth, rental income and tax advantages if all goes according to plan. These buyers don’t always realize the risks, such as problems with renting the house, family disputes over the property, and unexpected expenses.

“Vacation homes can quickly turn into nightmares if you don’t know how to manage them properly,” said Tony Robinson, a short-term rental investor and the co-host of BiggerPockets’ Real Estate Rookie, a real estate investing podcast. real estate for beginners.

Here are four of the biggest risks of buying a vacation home:

Don’t bank rental income.

Tim Bauer said he quickly learned to prepare for the unexpected after buying a ski cabin in Red Lodge, Mont., that he planned to rent out when he wasn’t using it to offset costs.

While 2021 was an amazing year for rentals thanks to pent-up demand due to the pandemic and remote work arrangements, this year a massive flood in the area resulted in the cancellation of almost all cabin bookings for June and July.

He lost about 20 percent of the annual revenue for the two-bedroom cabin that he rents for, on average, about $215 a night.

“It’s important to have a cash reserve to be prepared for slow times and unexpected events that can cause demand to slow or even stop demand altogether,” he said.

Mr. Bauer, a financial planner, maintains a separate checking account for the cabin with a cushion of about three to four months of expenses.

Relying on rental income to pay your mortgage and other expenses can be risky for other reasons as well. Local rules for short-term rentals are subject to change. Darin Eppich, a real estate agent in Los Angeles, recently had a client decide against buying a vacation home in Palm Desert, California, when he learned that the city had strict rules restricting short-term rentals.

The lake house can start a family feud.

Many cottage owners want the property to stay in the family for generations and depict scenes of relatives meeting at home long after mum and dad have gone.

But not all family members feel equally invested in that vision and may not be interested in keeping the property, said Pam Lucina, chief fiduciary officer of Northern Trust Wealth Management.

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Ms. Lucina has clients where family members discuss how to split expenses and who can stay home during the peak weeks of the season.

“This is becoming a huge source of conflict,” he said.

Create guidelines before there is tension, including a plan for how to manage the property after the original buyers die, Ms. Lucina said. Ask your intended beneficiaries if they want the property and if they have the resources to pay for maintenance, taxes and other expenses, he said.

Hidden costs lurk.

Always budget for surprise expenses.

Jeff Barrens has been vacationing for the past decade with his wife, Christy Barrens. The couple bought a rental home in Jackson Hole, Wyo., last summer. A few days before closing, they learned that in order to qualify for fire insurance, they would have to make expensive changes to the house, including a new roof and improved landscaping.

The Barens encountered some expensive surprises when they tried to get fire insurance for their vacation rental in Jackson Hole, Wyo., including the need for a new roof and landscape improvements.

“It’s the things you can’t control that can have a significant impact,” he said.

Jamie Lane, vice president of research at vacation rental research firm AirDNA, recommends that hosts typically set aside 5% to 10% of the home’s annual rental income for unexpected expenses, which can include pipes, water damage and a new roof . The percentage they need to save usually depends on the age of the property, he said.

The return on your investment is not guaranteed.

Karen Altfest, a financial planner in New York City, recommends that clients spend no more than 15% of their net worth on the value of a vacation property to reduce financial stress.

Sam Dogen with his daughter at his vacation home in Lake Tahoe.


Photo:

Sam Dogen

Sam Dogen, creator of the Financial Samurai website and author of “Buy This, Not That,” said people need to understand that their property may not appreciate as much as they expect, especially in the current market, where some experts expect prices to will be decreased. .

Mr. Dogen bought a two-bedroom condo in Lake Tahoe for about $715,000 in 2007. The asking price was $810,000, so he thought he had a deal. However, the property ended up plummeting in value by about 40% over the next several years due to the financial crisis.

Today, the property is still worth less than what he bought it for, he said.

“It was a bad investment,” he said.

Despite predictions of a cooling housing market in 2022, US home prices are still hitting record highs, even as mortgage rates have risen in recent months. The WSJ’s Dion Rabouin explains what’s driving demand, evidence of a slowdown on the horizon and what it could mean for the economy. Composite photo: Ryan Trefes

Write to Veronica Dagher at Veronica.Dagher@wsj.com

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