Author Topic: Mustachian to buy vacation rental?  (Read 3170 times)

Mr Saver 2000

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Mustachian to buy vacation rental?
« on: September 27, 2016, 08:32:32 AM »
So my wife and I are paying down our mortgage very heavily, we are adding about $3,000 additional principle payments per month.  At this pace we should have the mortgage paid off in about 26 months.  We also have a “rental” home that we will starting paying down after our primary residence is paid off.  This should only take 5-6 months to pay off after our primary is paid off.
I say “rental” because it is a house that my wife owned before we got married and we weren’t able to sell it so decided to rent it.  It is about cash flow neutral each month with some tax benefits.

So my question is what to do with the almost $5k per month that was going to mortgage payments.  My dream is to save this money up for 2 years and use it for a down payments on a vacation rental in Breckenridge CO. The purchase price for a vacation rental in Breckenridge might be $750K+.  Running the numbers I believe it would be a cash flow loss of about $15k per year but after taxes it might be closer to cash flow neutral. As with our other mortgage we would try to pay it off as aggressively as possible and could probably have it paid off in about 15 years.
After this is paid off, we would both be able to retire and live of the rental income and our savings / retirement funds. 

So back to my question, is it a dumb idea (from a Mustachian perspective) to go for the vacation rental? Instead we could max out our 401ks at $16k per year and save the rest.  Running the numbers we would retire at the same time in our early 50’s with Net worth of about $3.5M.
Obviously we would get a lot of personal use out of this vacation home as well.  This figure isn't really quantifiable however.

boarder42

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Re: Mustachian to buy vacation rental?
« Reply #1 on: September 27, 2016, 08:50:07 AM »
compounding bad real estate decisions doesnt make a lot of sense to me.

1. paying down your mortgage bad at today's rates - lengthens time to FIRE and safety in FIRE
2. your rental sounds like a bad one AND
3. You're going to dump more dollars into a bad rental
4. buy a ridiculously priced vacation rental?  cmon now

these all appear on the surfact to be mostly emotion based decisions.  you should look into the math behind them all ... learn it and then make all future decisions based on math.  b/c its not emotional its black and white.


mcneally

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Re: Mustachian to buy vacation rental?
« Reply #2 on: September 27, 2016, 05:00:40 PM »
My dream is to save this money up for 2 years and use it for a down payments on a vacation rental in Breckenridge CO. The purchase price for a vacation rental in Breckenridge might be $750K+.  Running the numbers I believe it would be a cash flow loss of about $15k per year but after taxes it might be closer to cash flow neutral.

You'd be taking an extremely aggressive tax position if you're losing so much money that it saves you $15k in taxes (read: what you're considering is most likely against the tax law but you may or may not get away with it). If you use a vacation rental for more than 14 days per year, you aren't allowed to deduct ANY losses. If you let any friends or family use it for less than fair market value rates, those days count as days of personal use. If you're not planning to use it personally, what would the appeal be? Far less likely, but the IRS could also argue that it is an activity not engaged in for profit if you're losing a lot of money every year and it's not clear how you could possibly make money (seeing as how going in you expect it to lose tens of thousands per year). That and managing a remote rental could be a big hassle.

SwordGuy

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Re: Mustachian to buy vacation rental?
« Reply #3 on: September 27, 2016, 05:21:15 PM »
You really need to learn how to evaluate rental properties before you buy them - especially ones that cost THREE QUARTERS OF A MILLION DOLLARS.

But it's financed so that brings the tally up to about $900,000.

If you can't reliably rent that house out at a MINIMUM of $7,500 a month it's not worth looking at as a rental.

And that's a minimum.  You need to be aiming for $15,000 a month.  Month in, month out.  Even when there is no snow.

Now, you might choose to buy it on speculation that its value will go up faster than the stock market or a better performing rental would.  But that's not a rental property, it's a speculation property that you rent to cut expenses until it's time to sell.

Check out https://www.amazon.com/Estate-Investor-Financial-Measures-Updated/dp/1259586189/ref=sr_1_1?s=books&ie=UTF8&qid=1475018437&sr=1-1&keywords=frank+gallinelli






Blindsquirrel

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Re: Mustachian to buy vacation rental?
« Reply #4 on: September 27, 2016, 06:24:28 PM »
 No, just hell no. Bad investment.

waltworks

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Re: Mustachian to buy vacation rental?
« Reply #5 on: September 27, 2016, 09:29:49 PM »
Step 1: Sell your "cash flow neutral" house.
Step 2: Don't buy anything else.
Step 3: Read some threads on the RE forum and/or some books on rental real estate and figure out what the F you are doing. Alternately forget RE and just dump your money in index funds.

-W

chasesfish

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Re: Mustachian to buy vacation rental?
« Reply #6 on: September 28, 2016, 06:18:45 AM »
Almost always, the answer is hell no.

The nice thing about vacation property though, if there's another massive real estate bust, they can get so cheap they will be cash flow positive at some price.

Kitsune

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Re: Mustachian to buy vacation rental?
« Reply #7 on: September 28, 2016, 07:29:45 AM »
How much time would you spend in a vacation home yearly?

'Cause even if you get 6 weeks vacation, you could either rent a house OR stay at a luxury hotel for the full time, at the costs you're considering.

Or, yknow, stash in investments, FIRE, and sell you primary residence and move full-time to your dream vacation destination.

We figured out how to do that while continuing to work (adds 20 minutes to our twice-a-week commute, but means we live in our dream location and next to my in-laws while having and raising kids...) so bonus points if you can do that... But I really fail to see how 3 houses, even cash-neutral houses, bring more happiness than other things you can do with that money.

Fishindude

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Re: Mustachian to buy vacation rental?
« Reply #8 on: September 28, 2016, 07:39:49 AM »
I see nothing wrong with purchasing a vacation home, but wouldn't do it until you have your primary residence and the rental paid for free and clear.
Whether this particular Breckinridge unit makes sense, is up to you to run the numbers and decide.   Vacation homes are expensive toys, but unlike things like boats and cars, if you buy right, you should just about always be able to sell and get most of original purchase price back. 

sparky28

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Re: Mustachian to buy vacation rental?
« Reply #9 on: September 28, 2016, 07:51:27 AM »
Just want to mention that the standard 401k contribution limit for 2016 is $18k, not $16k.

I agree with the posters above, this math doesn't look good.

tralfamadorian

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Re: Mustachian to buy vacation rental?
« Reply #10 on: September 28, 2016, 08:01:31 AM »
Is it a good mustachian idea? Probably not. 

But you need to run the numbers to know for sure-

On one side you have both tax deferred and taxable index funds investments made in lieu of the real estate investment and the cost of renting a similar place to your ideal Breckinridge vacation property for the time period you would be interested in using it each year.

On the other you have the costs of purchasing the property- downpayment, mortgage, HOA, taxes, 1%/year CapEx fund, vacation property management(This can be as high as 40-60% especially in places like Breckinridge.  I would highly recommend calling a few management companies to find out what they charge before you make a final decision.  This could drastically skew your cash flow negative from 1.2k/mo to 3k+/mo).  In the plus side you own the property, its potential appreciation and the non-monetary feel good with which it is associated. 

You didn't ask but regarding your mortgage payoff's.  I would highly suggest paying them off in one chunk if pre-payment is what you want to do.  If 25 months into your 26 month payoff you have a catastrophic event and are unable to pay, the bank will not care.  They will take the property regardless.  But if you park that money and save it, you have the cushion to use it to continue to make payments for an extended period of time- years- if something happens.  YMMV.

totoro

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Re: Mustachian to buy vacation rental?
« Reply #11 on: September 28, 2016, 08:15:47 AM »
We have a vacation rental. 

It has grossed $40,000 this year (booked until December) and we stay here one week per month.  Our total expenses including the mortgage principal amount but excluding personal taxes are $24,000 per year.  We pay tax on the $16k profit plus the mortgage principal pay down amount which is about another $10k.  Our actual useable cash flow is like $6k a year after tax because, of course, we don't see the mortgage pay down in our hands each month. You actually have to make quite a bit above expenses to see cash flow in the bank account on a financed property if you don't count mortgage pay down. 

The house has also appreciated $120k since it was purchased 7 years ago. And it was purchased with 10% down plus closing so our return on $40,000 has been a place to stay with family regularly all expenses paid for seven years plus about $60,000 paid down on the mortgage plus an average net of $3k annually in our pocket (first years were lower than now) plus the 120k appreciation less capital gains tax in the end when sold.  I believe that is about a 50% annual return on investment after taxes not counting the shelter benefit.

We still have a mortgage on our primary residence as the rates are so low and we have rental income to deduct mortgage interest as an expense (rules are different in Canada).  I wouldn't wait to pay off a low rate residential mortgage to invest in a rental property if the numbers work myself.

So vacation rentals can work but it needs to be a business decision unless you have so much money that it doesn't matter or you are willing to work longer to pay for it.   A $750,000 property will likely be much harder to make money on than a much less expensive property in a good area imo and I do not believe you've done the math properly, but I could be wrong.   Maybe you reasonably believe the place will be subject to significant appreciation or the rents are crazy high year round for vacation properties.

Real estate has been good for us.  I'm not sure why so many people are telling you to sell the cash flow neutral property.  That might be a good move, but it might not if you believe the market will recover in your area or if there is a way of suiting it or you have other logical ways to make it work for you that you have not identified here.

In any event, if you have not used a spreadsheet that calculates all the variables for you I recommend you do.  There are some available on biggerpockets.  And make sure you have your taxes sorted out property and understand things like recapture of depreciation.

waltworks

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Re: Mustachian to buy vacation rental?
« Reply #12 on: September 28, 2016, 09:11:16 AM »
EVERYONE who bought real estate in the US 7 years ago did great. That doesn't mean anything about buying real estate that will lose you money (most likely, at least - the OP seems pretty unfamiliar with how to calculate this) at an all-time high (which, trust me, Breck is at - I live in another ski resort town 6 hours west, and ski towns are NUTS now).

Also keep in mind that resort towns in the west tend to enforce nightly/short term rental rules (which in many cases means you either have to pay a ton in lodging taxes/fees, or in some cases means it's simply illegal).

Could the OP do great? Sure. Is it likely? No.

-W

totoro

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Re: Mustachian to buy vacation rental?
« Reply #13 on: September 28, 2016, 09:35:41 AM »
EVERYONE who bought real estate in the US 7 years ago did great.

I live in Canada.  We never had a crash seven years ago.  At the time I bought prices were considered to be high.  Appreciation has been about average since then, not extraordinary, and I have also improved the property which has increased its value.

That is an aside as appreciation/depreciation is pretty location specific and unpredictable in the short term.  Generally not a reason to buy unless you are the gambling type.  The questions to ask when you buy a vacation rental are:

1. Does it pay for itself from day 1?  If not, you are buying with high risk, particularly if you are hoping for appreciation, and you sure as heck better have the monthly cash flow to backstop it.  I won't consider anything that does not pay for itself, including the mortgage principal amount.
2. Are vacation rentals legal here?  If not, you could be shut down. 
3. Am I prepared to be a landlord for a vacation rental?  There are many details to take care of and a high standard to maintain.
4. If I am not nearby do I have a great team of cleaners, managers and maintenance people who are available to assist and have I budgeted for this?


frugaliknowit

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Re: Mustachian to buy vacation rental?
« Reply #14 on: September 28, 2016, 09:41:35 AM »
I wouldn't say "It's a dumb idea".  At the same time, unless you can prove to yourself that the risk/return (return with your time and aggravation considered) is better than adding to your portfolio of index funds, then yes, it is a less than optimal /non-mustachian idea.


waltworks

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Re: Mustachian to buy vacation rental?
« Reply #15 on: September 28, 2016, 09:42:33 AM »
Appreciation in Canada has been about average? Interesting take...

Agree with all your other points. If it doesn't make money now, it probably never will. And vacation rentals in ski towns are fraught with legal/management cost perils.

-W

totoro

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Re: Mustachian to buy vacation rental?
« Reply #16 on: September 28, 2016, 10:13:32 AM »
Appreciation in Canada has been about average? Interesting take...
-W

Appreciation in the small town I own a vacation rental in has been about average over this time period.  Appreciation in the city I own my primary residence in has been far above average the last two years after about seven flat years.

Appreciation, like in the states, is not a national phenomena.  It is local in nature.

In some markets in Canada like Vancouver and Toronto appreciation has been way above average and they are in bubble territory - with tonnes of foreign investment propping up the bubble.  Just like in some towns in the US but unlike the rust belt and other areas or most of the East Coast up here - some of these towns have depreciated in value in real terms.