Real Estate as an Investment...
   


HOW TO PAY FOR A SECOND HOME                                                                                                   
Tax-code changes, easier financing and baby boomers' wealth are fueling a rise in second-home purchases nationwide. If you choose to buy, remember that your continuing expenses will double, too.
By Marilyn Lewis (MSN Real Estate)

The appeal of second homes is universal. Russians have their dachas, Swedes their stugas and Native Alaskans their fish camps. There are 6.8 million vacation homes in the United States -- one for every 11 year-round homes.

For many people, the second-home dream has predictable components: golden summer light, kids squealing and splashing, family and friends together, quiet moments, long walks, refreshing naps and time to goof off. Others just want a place to golf or ski, to swim or sail, or simply a change of scenery.

As suburbanites and country mice snap up condos in the heart of the city, urban dwellers are buying second homes in the mountains, near the shore or down a country lane. Thanks to aging baby boomers and changes to the tax code, second-home sales are an increasing share of the real-estate market.

THE BIG BANDWAGON

The second-home market, which includes vacation homes and investment properties, was a big component of the recent real-estate boom. The National Association of Realtors, or NAR, reports that 40% of all real-estate transactions in 2005 were for second homes; about 12% of all houses purchased were vacation places.

With wealth accumulated from work, home equity and investments, middle-age Americans are transforming rural areas, small towns and resort communities in their pursuit of recreational havens, landing pads for retirement and investments to diversify stock-heavy portfolios. Now, 7% of baby boomers own vacation homes. But middle-age folks from the 77 million-person baby-boom generation aren't the only buyers. Gen-Xers and even 20-somethings are getting second homes.

Still, because of their huge numbers, boomers buy most vacation homes. They are said to be more likely than other generations to own their own homes. An NAR analysis, "Baby Boomers and Real Estate: Today and Tomorrow," says:

• Boomers hold 57% of all vacation homes.

• About 21% of vacation-home owners have two or more vacation properties.

• Boomers own 58% of rental properties.

The question is, how do all these people buying vacation homes swing it financially?


THE CASH OPTION

For a surprising number, the "how" is simple: Pay cash.

A recent NAR-Harris Interactive Poll said 32% of vacation-home owners paid cash, and that 82% of vacation homes are already paid off.

Where do buyers find money for a down payment? The same survey said:

• Half used savings.

• 19% cashed out equity or took sales proceeds from their first homes.

• 23% used cash from the sale of other real estate.

Little St. George, Utah, population about 65,000, has become a magnet for vacation-home buyers. There, the median price for a house is about $350,000. Real-estate agent David Ellis says St. George's relatively low prices, red-rock vistas and proximity to the Grand Canyon and other parks draw urban refugees, many of whom have cashed out longtime family homes in expensive Southern California markets and beyond.


The recent real-estate slowdown also has affected St. George, but Ellis says vacation homes still are selling well. He estimates that 10% to 15% of his business is in vacation homes, and that about half of all his clients pay cash. "There is a limited number of people who, crazy as it is, are financing their second homes," he says. In fact, homes are selling better in the $1 million-plus end of the market, which includes plenty of vacation homes, he says.

Who has this kind of money? "The largest numbers are coming from Southern California and northern Utah, and there's a pretty strong migration from Nevada," Ellis says. "I've had clients from Michigan, Wisconsin, New York, Florida and Texas -- all over."

The big picture, explains NAR spokesman Walter Molony, is this: The second-home market is driven largely by a 1997 tax-code change allowing a couple to exclude up to $500,000 ($250,000 for singles) in home-sales gains from taxes.

"For the first time, this freed people to make housing choices based on their needs and desires rather than on avoiding that tax consequence," Molony says. Before, the incentive was to trade up. Now, downsizing is popular with boomers selling big family homes that have appreciated mightily. With pockets full of cash equity, many can buy both a smaller home and a vacation house or investment property.

FINANCING IS NOW EASIER

Not long ago, when financing second homes, mortgage bankers demanded higher down payments, bigger interest rates and higher insurance fees. Today, says David Hehman, the CEO and co-chairman of EscapeHomes.com, which helps people plan and buy second homes, extra costs have mostly been erased by competition. Some lenders may still charge a one-eighth point extra because lenders see risk in a home that's not constantly monitored by the owner. Still, in years past, Hehman says, a second-home borrower would have paid a quarter- or a half-point extra.

Robert Jangaard, a Whidbey Island, Wash., resident, financed the construction of a recreation home at Lake Wenatchee, near Leavenworth, Wash., a couple of years ago. He and his family escape there to ski, golf and hike in the Cascades. Jangaard says his bank asked nothing special for the second-home loan -- no extra points, fees or bigger down payment. "It's not harder. In fact, it gets easier the more you borrow," Jangaard quipped. "It's all based on how well you know the banker and how familiar they are with your situation."

But, points out Dave Martin, a mortgage banker with First Horizon Home Loans in the Seattle area, you must have enough income to qualify for both your principal residence and your second home, if you are financing both. Martin financed his family's vacation home in Chelan, Wash. He, too, he found no difference in the requirements or costs of the loan.

You will pay more, though, if you will rent out the second home. Investment property, as it is considered, is financed and insured at higher rates. (Renting out your property may change the affordability question in your favor, of course.  See "Make Your Vacation Home Pay For Itself" below.


TIPS FOR FINANCING

For those financing a second home, EscapeHomes.com's Hehman offers this advice:

• Apply for financing in the town where you are buying. Bankers there may give better terms because they appreciate the market.

• Caution: You'll pay for two of everything now -- new roofs, yard maintenance, appliance repairs. Budget to cover maintenance, property taxes and insurance.

• Don't kill yourself financially, especially on a vacation place. "The most important thing is pure enjoyment and peace of mind. That's why you’re buying a second home,” Hehman says.

• Try Internet loan sites to get lenders essentially bidding on your mortgage.

THE FRIENDS AND FAMILY PLAN

A number of people who can't foot the whole bill are doing what their parents and grandparents had done: going in with family or friends on a vacation home.

The big issue is: How will you share? There are as many ways to divide up the pie as there are ingenious thinkers in the group. By brainstorming and negotiating, invent a system that reflects your philosophies, resources and needs. A strapped partner could throw in more labor than others; older family members with more means might pay a larger share and be spared some of the more intensive chores.

The important part is putting your agreements down on paper. Make contracts to cover financing, maintenance and even how the house will be shared. You can always ease off later if these feel too formal. But tightening up a sloppy, unhappy situation can cause pain and resentment.

And this is your place for fun, remember?




MAKE YOUR VACATION HOME PAY FOR ITSELF

Don’t listen to the naysayers. Rentals can cover your second-home costs if you're careful when you buy and you follow these 3 simple rules.
By Liz Pulliam Weston (MSN Money)

The conventional wisdom is that you can't make a vacation home pay for itself. Renting out your second home for a few weeks a year can help defray your expenses, sure, but most people find their properties fall far short of making a profit.

One former stay-at-home mom, however, is convinced that most vacation homes can generate positive cash flow, paying for themselves even before the potential tax benefits and appreciation are taken into account.

Christine Hrib Karpinski says she's built a small empire of profitable vacation properties, along with a sideline business in teaching other people her techniques. She recently self-published a guide, "How to Rent Vacation Properties by Owner: The Complete Guide to Buy, Manage, Furnish, Rent, Maintain and Advertise Your Vacation Rental Investment."


Karpinski sells the dream that vacation homes can be affordable for just about anybody who's willing to put in the time and effort. Her  basic tenets include:

• Vacation homes need to be rented 15 to 17 weeks a year in many areas to break even. Karpinski bases that estimate on the assumption that one month's mortgage payment would equal one week's rental income in the peak season. More expensive homes would need to be rented longer.

• Internet advertising is essential. You need to reach the widest possible audience of potential occupants to keep your place solidly rented. Karpinski posts each of her properties on three to five Web sites, at a cost of $100 to $150 per property per site.

"We put $8,000 down on one property in the Panhandle (in 1998), and we've probably received $200,000 in positive cash flow and tax benefits," Karpinski says. "Plus, that place has appreciated nearly $500,000 … and it hasn't cost us a penny out of pocket."

(You can write off mortgage interest and property taxes on a second home even if you don't rent it out; if you do, you typically can deduct a portion of your other costs, such as utilities and maintenance. In addition, you can write off up to $25,000 in rental losses if your modified adjusted gross income is under $100,000. That particular tax break is phased out as your income climbs, and disappears entirely when your MAGI is $150,000.)


SECOND HOME OWNERSHIP IS ON THE RISE

Karpinski's certainly picked a growing market in which to promote her vision. The National Association of Realtors estimates that 445,000 second homes were sold last year, up 24% from 2001, as baby boomers in their peak earning years sought vacation properties (and alternate investments to their faltering stock portfolios). The association believes that nearly 7 million properties nationwide are now second homes.

The vast majority of these homes were purchased primarily for recreation, and only 15% of the owners surveyed rented out their properties even part-time.

That percentage is likely to climb, though, as soaring property values make buying a second home a more expensive proposition, says David Hehman, CEO of Escapehomes.com, an online marketplace for vacation home sales and rentals.

"More and more people are looking to rent to defray costs," Hehman says. "The economics of owning are a lot harder if you don't rent."

BEWARE BAD MANAGERS

Unlike Karpinski, Hehman believes a good property manager is all but essential if you'll be renting out a vacation property, which typically is at least a couple of hours' drive from the owner's primary home. He advises talking to several real estate agents and other owners to find one that charges reasonable fees, aggressively screens potential tenants and stays on top of maintenance and repairs.

A bad property manager can be a nightmare, however. Consider the experience of Gayla Berry, who hired a property manager for her first vacation rental, a condo in Destin, Fla., a six-hour drive from her home in Jackson, Miss. The company rented the property for far fewer weeks each year than Berry needed to break even and once let the condo to a group of rowdy young people who set off the sprinklers in the master bedroom.

"The property manager kept telling me they'd take care of the damage," Berry says. "When I finally went down there, the beer cans were still in my condo."

What really irked her, though, were high bills for carpet cleaning and minor repairs, such as $25 for cleaning a VCR head, on top of 30% commissions.

"It's like they try to nickel and dime you to death," Berry says. "You wonder if one of their brothers or sons owns a carpet-cleaning business, and you don't even know if the carpet's actually being cleaned."

YOUR PURCHASE PRICE IS CRITICAL

With Karpinski's encouragement, Berry fired the property manager a few years ago. Last year, she purchased a second unit that she also rents. Berry says she invests an average of five hours of work a week placing Internet ads, handling e-mails and taking care of any maintenance issues.

Both properties are booked solid through the summer and more than pay for themselves, Berry says.

"I don't have a mortgage on the first (condo), but my yearly expenses like taxes, insurance, light bill, phone bill and cleaning are $6,000, and the rents (total) $22,000," Berry says. "Even if I had a mortgage, it would be paying for itself."

But again, the price you pay for your property is critical. Marti Swift of Louisville, Ky., owns two units in the same Destin complex and both break even, but prices have nearly doubled to $550,000 since she bought her second unit last year.

Even by managing the properties herself and keeping them rented 75% of the year at $1,100 a week, she couldn't find a way to make a third purchase in the complex work, so she's bought two cheaper properties elsewhere.

Still, what started as a way to afford a vacation home has become a part-time business, Swift says, and she credits Karpinski's help in making it possible.


4 BIG QUESTIONS TO ASK YOURSELF

If you're considering buying and renting out a second home, ask yourself the following questions:

1/ Are you ready to do the research? You'll need to come up with a lot of numbers, including an estimate of how many weeks the property is likely to be rented and all your monthly costs (including, but not limited to, mortgage, insurance, property and sales taxes, advertising, maintenance, repairs and cleaning). Talk with a number of real estate agents and other owners in the complex or area about their experience with rentals so you can more accurately gauge the demand and income potential.

You'd be smart to get a tax professional's help to sort through the potential write-offs and what they could mean for your bottom line. You'll also need to research any local laws, covenants or property restrictions that could affect your ability to rent the property.

2/ Are you willing to give up the use of your property during the peak season? This is the conflict that keeps many vacation homes from being profitable. Demand for your property is likely to be the highest in the weeks your family most wants to be there.

3/ Are you willing to put in the necessary work? You'll be the one posting advertisements, answering e-mails and phone calls, screening tenants, hiring cleaning crews and calling plumbers. You may need to make some unscheduled, last-minute trips to the property if there's an emergency (although Karpinski says most problems can be handled over the phone).

4/ Can you hold on if things get tough? Real estate prices are booming in most resort areas, but there's no guarantee that trend will continue. If appreciation slows or even reverses, it could take many years before your property rises in value enough to offset the substantial costs of buying and selling the property.

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