VACATION PROPERTY AND TIMESHARES: STRATEGIES AND PITFALLS
Have you ever taken a vacation that was amazing? Maybe you visited a location so unique and so wonderful that you knew you would want to return again and again. Maybe it was that place at the beach or the slopeside condo where you could ski. Whatever and wherever it was, you just had to go look in the windows of one of the local real estate shops to see how much a little piece of heaven would cost you. The next thing you know, you are talking with a realtor. Shortly thereafter, you find yourself signing a contract to purchase a beach house, cabin, or condo—a “vacation home.”
Fast-forward a few years. Now you’ve spent a fortune refurnishing, remodeling, and stocking your second home. You’re starting to realize that now you need two of everything, and that somehow things seem to break when you are gone for a while even though no one’s been using them. You realize how much you are spending on airfare or how long the drive to this place really is when you’ve made the same trip 30 times. You also realize that you stopped exploring other new and exciting places you once planned to visit because it’s been cheaper to stay at your vacation home than to rent a condo somewhere else. Plus, you feel guilty that your place is vacant 90 percent of the year.
What you once thought would be “the” place for you and your children and grandchildren to gather and create memories seems more like a very expensive, money-sucking, problematic place where you spend most of your time fixing what’s broken and cleaning it because no one does that as well as you do. After all, doesn’t everyone want to go on vacation to be a handyman and cleaning crew knowing you’ve paid for everything in between?
Let’s face it. For most people, I’ve done a pretty accurate job of describing what ownership feels like when you’ve purchased a second home. It’s great in the beginning, but once the reality hits, it’s just not that much fun. You’ve tied up a lot of money. You continue to pay even more. Face it. A second home is really a very expensive toy that you will eventually get tired of playing with, especially when it continues to break and cost you money to own.
If you are considering a vacation rental, I want to make a few suggestions and give some cautionary points. First, please keep reading below as I give options to those already in a pickle, for lack of a better word, with a vacation home. I will discuss the particulars of making a vacation rental profitable. But nonetheless, here are a few important considerations:
Before buying a vacation rental, assume the worst when it comes to rental income. I’m not saying they can’t be a bad investment for cash flow OR that you might even break even with the operational costs or mortgage—HOWEVER, you should be at least willing to live with bad cash flow; otherwise, it’s probably not a good idea. Ask yourself the hard question: could you afford it if the real estate market crashed or if the economy took a nosedive and rents disappeared? You need to be able to live with that answer. My wife and I bought a vacation rental for investment in 2006. How do you think that went? That’s right, hard questions and hard answers.
If you’re OK with my last point and still feel it’s going to be a great rental property, read carefully the section below on Vacation Rental Strategy.
Consider a partnership with family or friends. I have set up a lot of LLCs to own a shared vacation property where owners split expenses and use by 25 percent, 50 percent, thirds, or various combinations. A quality LLC Operating Agreement can outline weeks for use, taking turns regarding management, and how costs will be shared. It could make it much more affordable, and you won’t feel so guilty when you aren’t using the property.
RANDY LUEBKE
If you are going to partner with family or friends, make sure you have clearly defined terms regarding use and costs, including repairs. I’ve seen some nightmares regarding damages to the property or simply the costs to put on a new roof. If you don’t have the procedures for a worst-case scenario in writing, they may not be your friends any longer or family reunions will be extremely uncomfortable.
Options for Those Already with a Vacation Home
Now that several years have gone by and the reality has set in, the extended family is still enjoying the property on your dime, while meanwhile you are setting up your own personal intervention session with your financial advisors, assuming you know you need a change, what do you do? You essentially have four options:
1. Run the numbers and sell. You might take a loss after all the improvements and selling costs, or more than likely, you at least feel like it’s a loss after all the blood, sweat, and tears you put into the property. Perhaps those nights at the Ritz Carlton would not have been that expensive after all. Bottom line: don’t get emotional about the property and selling. If the numbers don’t make sense—get out!
2. Keep it no matter what. But you really do like your vacation home. You love the area and you enjoy yourselves after a couple days, once you’ve completed all the necessary work. Maybe the opportunity cost is worth it. That’s OK, just be real with yourself, enjoy it, and quit complaining. Your guests at the home don’t appreciate the ranting.
3. Partner with family or friends. I mentioned this above to those considering buying a vacation home. Maybe it’s time to call up some of those that signed the guest book and make them an offer they can’t refuse. They could come in for 50 percent, 25 percent, or any variation thereof. It’s a great way to share costs and an LLC will shield you from the liability of others while the property and the Operating Agreement will define the rules of ownership, use, and shared costs. Bottom line: it’s their turn for an intervention. Tell them they can’t keep using the cabin if they don’t share in the costs and you’re going to sell if they don’t buy in. It just might do the trick and be the perfect equation for your pocketbook.
4. Time to create some rental income. Rather than sell, you decide to rent it. After all, it’s vacant most of the time anyway. Now, I know this can be uncomfortable for some of you to realize tenants are going to be sitting on your couch and using that Sleep Number bed you put in the master bedroom for those long weekends, but hey, why not cash in on that downtime, generate some income, and mitigate some of those expenses? This might be a viable option and help make the numbers work just enough so you can keep the home for your use during those special holidays. But are you ready for what this entails? Please read further regarding the Vacation Rental Strategy below.
Buying a vacation home that’s also creating rental income can be a fantastic idea if all the pieces come together. Please don’t assume that just because you want to vacation in the area, and it appears there are lots of nightly rentals, it’s going to be a success. I have had a lot of clients sorely disappointed with their vacation rental strategy. I strongly encourage you to do extra research and due diligence on the property and area, even more than you would with a typical rental property. There are a lot of unique aspects to a vacation rental property.
First, consider looking for a vacation rental that is already a part of a rental group. Maybe it’s a condo in a community or building that has a built-in rental booking and cleaning service. There are several benefits of this in that it already has a track record with a “rent roll” (showing prior days and income of rent), it is clearly zoned and currently being used as a rental, and it will of course come furnished with rental-friendly furniture. You might pay a little bit more for a property already creating cash flow, but at least you are buying a known commodity, or otherwise stated, you clearly will know what you are getting into.
Next, if you have a property that you hope to use as a nightly rental, keep in mind you just got in into the hotel business. Not only do you have to consider the amount of hotel/motel space in town, you now have to market your home with the other rental units in town. I suggest you immediately play “renter” on several websites and see what your options are in quality and price. See where your property measures up, and see if you are OK with the rental rates your property would demand.
Don’t forget repairs and the type of furniture and fixtures already in your property. You thought that a lot of things broke while you were gone and not using your home. Wait until you see what breaks when strangers use it. If this is a new property you are purchasing, get some advice from other vacation rental owners on what type of furniture and fixtures to buy that can handle the wear and tear. If you are starting to rent a property you’ve already furnished for your personal use, you will more than likely have to start transitioning your furniture into more durable-type pieces.
Now comes the booking, cleaning, check-ins, checkouts, linens, towels, and other supplies. This is where you will start to work with a vacation property rental manager and create a system for the property. I’m sure you know there is a growing number of entrepreneurial property owners renting out vacation homes to travelers. Evolve Rental Key Network shows that profits can be as high as $23k to $27k in annual net incomes across several vacation rental platforms for the typical rental. You’ll want to find the right platform for your type of property and area, using services such as Homeaway, Airbnb, VRBO, AirBand, Bookings, Tripadvisor, etc. if you can provide a vacation rental to visitors who prefer to become (or try to become) a part of the community rather than a visitor or tourist.
A word of caution, however: Many communities HATE having vacation rentals in their neighborhood. After all, they purchased a home where they are living year-round. They like to come and go, and everyone enjoys a level of regularity in their home life and surroundings. The last thing they want is “party family,” or worse “party friends,” moving in for a few days who are coming and going, staying up late, and making plenty of noise. Also, some people don’t want vacationers who have no respect for the people in the community and may leave garbage on your lawn, around the neighborhood, or anywhere they choose. The potential for crime is also a concern.
RANDY LUEBKE
Before buying your rental vacation property, make sure you confirm what the local rules are regarding nightly rentals in that specific neighborhood. Don’t make any assumptions, and don’t stop there! Call the city or local jurisdiction that manages this issue and see if there is legislation in the works and if they are holding hearings. You can even check the local paper in the area to see what the rumblings are. Several of my clients have bought properties that were zoned for rentals at the time, and then had the carpet pulled out from under them with legislation that came down shortly thereafter prohibiting nightly rentals in the neighborhood of their new property.
As a result, many people have purchased second homes with the anticipation of renting them only to find resentment and opposition from the locals. Moreover, if those locals can become organized and grab the attention of the local government, sometimes they can pass ordinances to ban short-term rentals altogether, blowing a great big hole in your business model. It’s important to look at local laws, including HOA rules, as to what your options are for a vacation rental and the rules you need to follow.
Regrettably, I also have to mention taxes. Sorry. All of that incredible net income and profit comes with a cost. Remember how I stated above that you are now in the hotel business? Well, that’s exactly how the IRS sees it as well. Thus, you have to report this rental activity on a Schedule C, and not Schedule E (as you would with a typical rental). It’s not the end of the world, but you need to implement a little creative tax planning to handle the tax impact (a topic beyond the scope of this book). A simple meeting with your tax advisor should address this issue.
Also, don’t forget the hospitality tax that many local jurisdictions are implementing. If a local city or township doesn’t directly prohibit nightly rentals in your area, they can very well impose a hefty hospitality tax to discourage the rentals in that area or simply as an effort to cash in on the fun as well. Make sure you research this issue carefully before jumping in with both feet.
Bottom line: the point of this section is that as an entrepreneur, you should understand that owning a vacation rental is clearly owning another business. You may find that there is value in having a nice place in your favorite vacation spot and not having to worry about where you stay when you visit, but just make sure to do your homework and run the numbers.
Then, there are timeshares. The concept behind a timeshare is brilliant. As most people understand their second home will be vacant 50 weeks a year, why not buy only a week or two instead? That seems very practical in comparison to owning it all by yourself. Moreover, you will have an HOA and a professional management team to take care of the maintenance and repairs. You will have the comfort of knowing that you will return time after time to a place you liked and you won’t have any of those bad surprises, checking into the hotel overlooking the air conditioner banks. Plus, you can trade your weeks with others and stay virtually anywhere in the world. You’ve got the flexibility to travel, and compared to whole ownership, the timeshare is a bargain.
All that being said, I have discovered three things that make the difference between happiness and a headache. One, buy your timeshare in the place you want to travel to most in the event that renting it out does not produce a net benefit to you (in which case, you’ll be the one using it most). Second, don’t count on being able to swap it out with others. Many think that the timeshare will open up all these other potential properties to use—guaranteed. That’s not always a realistic perspective. Make sure you can live using that specific timeshare if you have to and be comfortable with the cost.
TIP FOR FINANCIAL FREEDOM
Don’t buy a timeshare from the retail market.
Third, and most importantly, buy it used, and not new—period. There is a used timeshare market out there that you may not be aware of. For instance, a new timeshare has to pay a large commission to the sales team. That’s a reality. However, many times people who did purchase a timeshare want out, and you can capitalize on this! Perhaps they don’t like owning even two weeks, or it’s the expense of the HOA over which they have no control that gets to them. Whatever the situation, they want out and are now faced with some major hurdles. Top on the list is how do they find a buyer? After all, they are only at their condo two weeks a year. How would they show it to a prospective buyer? What almost always occurs is a market for resales.
RANDY LUEBKE
For some of the larger developers like Marriott, for example, there is a team in place to sell timeshare units. It’s literally almost like having a Multiple Listing Service (like buying and selling a standard home) to market your timeshare. The big difference is that the commission you pay to sell is much higher than you would pay for a traditional real estate transaction. I could go on, but I think you get the picture. Don’t buy while the circus is in town and everyone was there in attendance. Once the circus has moved on, you could have a very illiquid asset to sell. HOWEVER, you can visit countless websites selling timeshares of owners with buyer’s remorse willing to sell at a deep discount from what they originally paid. I have personally purchased a timeshare at a 90 percent discount from its original price, and the owners were happy to sell it.
The resale market is exactly where you want to buy your timeshare! Often, those discounts can be substantial. Why? Because the owner doesn’t use it enough and wants to get out from under it. You can save thousands of dollars and see what the market really thinks that timeshare is worth. Don’t trust the high-pressure salesman at the resort when they give you a 90-minute pitch in a conference room overlooking the pool. Been there, done that!
TAKEAWAY 1—If you already own a vacation home that is costing you, consider four alternatives: Keep it and know the true opportunity cost, sell and cash in—hopefully not at a loss, split up the ownership with other owners, or turn it into a vacation rental property.
TAKEAWAY 2—A vacation rental property can be a good investment, in fact a very profitable one, but it can be extremely tricky. It’s important to do even more research and due diligence than you would with a standard rental.
TAKEAWAY 3—If you follow my two rules of buying timeshares, 1) buy where you love to travel, and 2) buy used on the resale market. You will likely be very happy with your purchase, and you will also get the use and the value you anticipated. Leave out either one, and you will likely regret it.