BUYING REAL ESTATE TO IMPROVE LIFESTYLE IS AWESOME!
Who has made foolish decisions with their money? My young adult life. For sure. But, mind you, I was in my early thirties and knew everything.
Remember when I said in a previous post about how I died? It’s what led me onto my journey of lifestyle real estate in 2005. Well, I made a lapse in judgment because of FOMO.
After a few years of being on the island, real estate was fantastic, everywhere. I was helping people accomplish their dreams of owning their piece of paradise with idyllic white powder sand beaches with stunning turquoise waters enveloping the second largest reef system in the world. Yes. It was paradise.
My wife and I decided to stay for longer than we thought and jumped into the real estate market at what some would consider the height of the market. Yes, we lost almost everything. We just had our first child and lived on a rock in the middle of the ocean. It was not good.
However, in lifestyle real estate, a third of the properties sold are usually vacation rental properties. And in the Caribbean, when tourism stops, everything stops.
Long story short, it took our young family a few years to dig ourselves out of that mess with the help of smart money coming in when the market was down to pick up dream homes for a 60% discount.
When investing in lifestyle real estate located within a tourist-focused location, one thing to consider is how that market would react if we had a financial downturn again caused by something not in your control? In hindsight, when caught up in the emotion of “living a lifestyle,” the analytical side of your brain goes on vacation too.
Thankfully, many locations around the United States still had good tourism dollars flowing in, especially in well-heeled places. Those with money still traveled and enjoyed a lifestyle.
However, those who purchased vacation property in the wrong location within the township at the wrong time got hit. And hit hard. Those that got hit hardest were the ones who got themselves too far over their skis in other areas of their life.
But all that aside for now, what does that have to do with the current state of things? Owning a second home for personal use or vacation property for short-term rental income is a great luxury. However, it is a luxury that can be an excellent investment if timed correctly.
Three things ought to affect your decision from the get-go.
1. Time horizon of ownership
2. Current market dynamics
3. Are you over-stretching your financial obligations.
In this post, I will discuss number 3 on this list and whether this decision ought to be guided by solid conviction or a dream that could become a nightmare.
Lifestyle property ownership is a reality many enjoy, though it is not for everyone. So, if you are seriously looking into such a venture now, have a real, no-bullshit pros and cons discussion with your spouse and financial advisor.
Anybody who ever wanted more out of life but jumped in blindly based on emotion, with total disregard of the expense involved, needs to tap the brakes. Consider the pitfalls, especially if you are already living outside of your means.
Don’t let the old proverb of “Fortuna audaces iuvat”, Fortune favors the brave rule your life. On the contrary, Fortune favors the brave when risk is calculated or its pure luck.
Many buyers are being sold on the packaging and doing things without thought. And, when the emotions are involved, miscalculations are made.
Suppose you are financially well off and within your financial means to cover all of the expenses, liabilities of additional properties. In that case, you should be golden. In addition, you will likely have a financial adviser that keeps you on track.
Those who make poor decisions around finances and what they can afford without professional direction or experience will be the ones who miscalculate when buying a second home or vacation property.
(For more about the differences between a Second Home and Vacation Property, read this post.)
For argument’s sake, let’s say you are relocating to a location-based lifestyle from a state such as New York or California. Property values are much higher. You sell and do very well. In that case, overextending is less of a concern as you will likely be able to purchase more house for less money.
(However, there are other challenges with relocation found here.)
I HAVE TO SAY; THIS IS NOT INVESTMENT ADVICE. SEEK ADVICE FROM LEGAL REPRESENTATION OR FINANCIAL ADVISOR.
OK. If you come from a state with similar pricing to where you want to move, then understand where it stands with market valuations. If you are looking to invest in a property of more than $750,000, less than 20% down, you should be cautious at this time.
Over the past six months, there has been FOMO (Fear of missing out) in the lifestyle markets. As a result, cash buyers are willing to pay more for a property, pushing up prices everywhere. So it’s a Sellers Market.
In a Seller’s market, people buy lifestyle property clouded by emotion versus logic.
Good lord we know money is super cheap to borrow right now. I saw 1.87 percent this morning. I get it, but let’s touch on a few things you may not have realized.
FIRST THINGS FIRST:
Off-the-rack average real estate agents will always tell you it’s a good time to buy. So what is the right choice? Well, find a better agent for sure.
Riding the emotional wave excitement that comes with lifestyle real estate can be so intoxicating, people sign documents without considering the challenges they could face. As a result, I continually have to become the ‘reality checker’ for my clients, who are bright-eyed and excited to move forward.
Please don’t think of me as pessimistic, because living a lifestyle does require optimism and enjoying life to the fullest. However, my worldly experience provides another insight for making property decisions. Clients use the information I offer, which they may not have considered. It has saved some from making disastrous mistakes. Those that are financially well off, with a longer time horizon, such as a legacy property for generations to come, are a more favorable story.
BIG TIP: DO NOT TAKE FINANCIAL ADVICE FROM LENDERS
Your good judgment with the help of a financial advisor and/or accountant can certainly guide you with how far you can stretch with your purchase.
NEVER base your decision about whether you can afford it or not on the advice of lenders alone. A lender is there solely to help you qualify and close your loan with the best rate possible. They are NOT financial advisors or babysitters, and their contribution to the entire deal is to ensure the deal works, not to decide whether it’s viable for you financially.
Basically, if they get unconditional approval for the loan, they sell it off to a Fannie Mae or Freddie Mac, or package up and sell to some other party. The lender gets a piece of the pie from every deal they get through and closed, and many will work the system. Sometimes they will use unethical ways to get it done because, after eight weeks of work, they don’t get paid until the recording of the property happens.
It doesn’t matter how much red tape and federal regulations are brought into the fold; I still hear stories, and am constantly amazed by some deals that close.
Often a lender will say YES, they can pre-approve you for a loan: “I don’t see any problems with the file, I’m certain we can get this done for you.” Honestly, they have no bloody idea what will be and not be approved.
Six weeks later, after multiple emailed documents and personal information being shuffled around, you find out that you do not have a lending agreement. Your credit score has gone down, and you are hundreds (if not thousands) of dollars out of pocket, due to home inspector’s fees, specialists, wire transfers, and so on – not to mention your precious time wasted and the stress you’ve gone through.
Many lenders will bait you with “sure, no problem” and then try to work it out in the hope that luck goes their way. Find the right lender!
FINDING THE RIGHT LENDER
Private lenders, local banks, credit unions, and national banks all have different lending programs with different rates available. Make sure you find a straight, no BS lender; these can be difficult to find, so ask a real estate expert who is within the top 4% in the area who can refer a reputable local lender.
There is a caveat here; when purchasing in a resort town, try to use a local lender, although it may cost you 0.25 of a point more. They know the lay of the land, what is possible, and what is not. In addition, the appraisers are more likely to know how dynamic and segmented the market can be.
I have seen deals go south because a buyer was adamant about using a national bank or an online lending company. Large banks have so much red tape, federal accountability with strict policies and procedures to follow. This makes it time-consuming around contractual dates.
In addition, metropolitan banks find it difficult to understand the dynamics of the lifestyle property market; it can kill a deal before it starts.
Then you have the underwriters. Underwriters can make it even more difficult by requesting more documentation and information. They need yet another statement or yet another document to put additional pressure on the deal and load more stress on you. Then it’s time to close; they ask for the same document a fourth time. Finally, after the fifth week of providing everything you have triplicate, you are usually ready to say those two infamous words: “F*** it”.
BORROWING WITHIN YOUR BOUNDS
Beach, ski, golf, yachting, mountains, lake, desert, or farm & ranch. It will have its own set of dynamics, pros, and cons wherever you wish to purchase.
If you are a buyer cash buyer investing in a legacy property for generations of the family to enjoy, great! The operational costs may be less of a concern.
However, many people reading this will be interested in Yield/ROI, either buying something as a ‘getaway’ each year or purchasing in the location where they want to retire—the numbers matter. Therefore, the purchase price tends to be less concern, so long as the statistical historic target yields work.
Are you borrowing 80% or more? It would be best if you were especially wary about the WHAT, WHERE, WHY, and WHEN before purchase.
Market factors outside of your control can be a serious concern. For example, a major drop in the market will mean that people tend to limit vacations. That may limit your potential revenue on a property. Do you have contingency plans set up? For example, if rentals dropped from 60 percent throughout the year to 30 percent, could you cover the running costs, including the mortgage of the property? In addition, HOA dues, loan payments and interest, and management fees add up.
What if the main water burst? This happened at a condo and, the HOA members had to pay an additional $3,000 each to cover the fix. How does this affect your bottom line.
You can drive yourself stark raving mad by all the ‘what ifs’, so just be realistic. As you run the numbers, focus your due diligence on the following areas, to make sure you don’t overstretch:
- Using a local vacation rental company versus an online vacation rental company.
- HOA and property management costs
- Property taxes: Vacation homes can be taxed at a higher rate if you are not a permanent resident.
- Vacation rental versus personal use
- Income taxes and write-offs
- Location to amenities (affects rental capabilities)
- Change in rates
- Change in tourism patterns
- Change In market dynamics
- CC & Rs (Covenants, Conditions, and Restrictions): nightly rentals approvable
- Long-term versus short-term rentals
- Selling versus holding on
- Mortgage: do you have a contingency plan if the market does change?
2021 Updated excerpt from the book the 2017 publication of “Castle to Kingdom”
Andrew Storms is a 16-year expert in Lifestyle Real Estate. After 8 years with the #1 Engel & Volkers office in the world, he now resides in South Florida with Engel & Volkers Delray Beach. Andrew is the Founder of Kealink.com, author of “Castle to Kingdom” and has been featured on HGTV, USA Today, Wealth TV, and House Hunters International.