Advice on second home before a first home

[chieftain]

I'm seeking advice, as I'm pretty good with finances but have never bought real estate and am hoping to buy a house. A few introductory details:

-Married with one child
-40ish
-Total investments and cash: $1.3m
-Current distribution: 90% index funds, 5% bonds, 5% cash
-Yearly household income: $90k

We live in a high cost-of-living area but currently rent our apartment for $2000, well-below market price. We don't have a lease, though, and if we were to have to move, a comparable apartment would likely be twice as much.

We're considering looking to buy a house two hours away, in a rural, but still relatively high cost of living, desirable vacation rental area. Our hopes are to use this as a second home for now, and rent it out via Airbnb to help cover the costs. If we were eventually forced to move from our current apartment, this could potentially become our primary residence.

What advice do you have on things like coming up with a budget for this house, how to invest in this wisely, what to look for in a place to be used partially for rental income, etc.? Thanks!

[waltworks]

Go read Paula Pant's series on AirBnB/nightly rentals first. TL;DR - it's a lot of work/stress unless you want to outsource everything, and if you do that, it's not necessarily profitable (and the series was written when housing was 50% cheaper than it is now).

In general, buying anything in a vacation area to use as a nighty rental and also as a place to go for vacations is a way to lose a lot of money, especially right now. That said, figuring out costs and probable rental income and running the numbers will tell you a lot more.

-W

[chieftain]

Thanks for the suggestions. I should add: one thing that we've considered is to buy a place that has a separate structure that could be rented out even if we are staying in the main building. Not sure how that changes the math, but perhaps it makes it more feasible?

[Fishindude]

Second homes are "toys" just like boats, cars and motorcycles.   The only difference is, you should see the value appreciate -vs- rapidly depreciate.
I buy toys with cash and make sure there I have enough of a cushion to keep them going.

You might get enough rental income to cover some of the costs, but you might also get some renters that tear the place up.   I would look at any rental income you could get as "help" but make sure that you could cover expenses with our without that rental income.   Sooner or later on any piece of real estate, you will get hit with a big expense like a roof, furnace, etc. so you have to be prepared for that as well.

We've got a second home, value roughly $5-600k and here is our cost history of last four years, not counting utilities.
Big cost items in below numbers are taxes and upkeep / repairs.
2018  $12k
2019  $25k
2020  $16k
2021  $16k

[waltworks]

Thanks for the suggestions. I should add: one thing that we've considered is to buy a place that has a separate structure that could be rented out even if we are staying in the main building. Not sure how that changes the math, but perhaps it makes it more feasible?

It probably is an even worse idea. Then you've got space (that costs money) unoccupied even more than it otherwise would be.

I mean, house hacking/ADUs can be great. But in the context of your idea, it makes no sense - this is saying  you'll buy 2 vacation homes instead of 1, essentially.

-W

[clarkfan1979]

Thanks for the suggestions. I should add: one thing that we've considered is to buy a place that has a separate structure that could be rented out even if we are staying in the main building. Not sure how that changes the math, but perhaps it makes it more feasible?

I have a rental in Hawaii that is split into two units. We rent the 1-bedroom basement unit to long-term tenants (unfurnished). The same couple has lived there for the past 3 years. We get $1650/month in rent. We are probably $300 under market rent.

We rent the upstairs furnished for $3200/month. People typically stay 6-12 months. When they vacate, we use the house for ourselves as a vacation. We stayed for 6 weeks last summer and will be doing the same this summer.

When we stay at the house for 6 weeks during the summer we are forfeiting the $3200/month. However, we are still collecting $1650/month for the basement, even when we are staying there.

A small ADU could serve as a living space for a care-taker of the property, if it was a short-term rental. The caretaker gets a discount on the rent for mowing the lawn and cleaning the main unit in between short-term tenants. People do this all the time for expensive short-term rentals in Hawaii.

[Dicey]

I did this as a way to get started in Real Estate, because I couldn't afford to buy in my HCOLA. Instead, I bought in the lower COLA area where I grew up. In retrospect, it was not the best financial move.

Thanks for the suggestions. I should add: one thing that we've considered is to buy a place that has a separate structure that could be rented out even if we are staying in the main building. Not sure how that changes the math, but perhaps it makes it more feasible?

Did this, too. Bought my retirement home in 2003, because I just "knew" when I was able to retire the prices there would be out of reach. That was in 2003. Though it was never under water, prices languished for years. I loved the house and enjoyed my casita (still do), but it, too wasn't a great investment. Oh, and a separate structure makes your taxes more complicated. Mine is under the same roof as the main house. After eighteen years, the area is now on a tear. (Notice I didn’t say “on fire”, because…California. No joking around about fires.) Prices have gone up 20% in the last year! My prediction has finally come true.

Well, except that I also invested in equities, which have more than kept pace.

With the benefit of hindsight, I think I'd advise the following, assuming your rental situation is secure. I'd be a renter semi-permanently, stashing everything in equities, with some in tax-favored and some in taxable. I'd wait to buy until my location was no longer tied to a job. Then I’d take my sweet time finding something to buy in a place I could easily afford. Based on the great start you have, that could be in a lot more expensive place than you’d think.

[affordablehousing]

This idea sounds like what most of the non-bankers, non-techer friends of mine in New York did. Pretty much everyone bought a house in the Hudson valley. They are cool, a good spot to go antiquing, drink wine, wear sweaters and unwind. Financially? Probably not a great idea but you do know your life trajectory, how much you do or don't want a NYC place of your own, and the chances of a benevolent sale on your landlord's death are only known to you. They worked for John Wilson. I would encourage you to think of it as a toy, that takes money to maintain, but better than a boat or a car.

[Dicey]

This idea sounds like what most of the non-bankers, non-techer friends of mine in New York did. Pretty much everyone bought a house in the Hudson valley. They are cool, a good spot to go antiquing, drink wine, wear sweaters and unwind. Financially? Probably not a great idea but you do know your life trajectory, how much you do or don't want a NYC place of your own, and the chances of a benevolent sale on your landlord's death are only known to you. They worked for John Wilson. I would encourage you to think of it as a toy, that takes money to maintain, but better than a boat or a car.

This guy did that!  His blog is great, but alas, his posting schedule is non-existent these days. Still a ton of interesting content. Super frugal dude with great style and humor.

https://manhattan-nest.com/

[englishteacheralex]

Wow, awesome blog, Dicey!

[sonofsven]

Just fyi that there's talk (in my area at least) of push back against air bnb and short term vacation rentals. Not enough homes for the locals, neighbor complaints about noise and partying, etc.
What exists now may not exist tomorrow.

[draco44]

For me this would be too much hassle and I'd just keep saving money and eventually buy a primary home. It sounds like the math is squishy on this second home project. You may end up breaking even at best, with more stress in your life and no closer to owning a house where you are now. As for the idea that "If we were eventually forced to move from our current apartment, this could potentially become our primary residence," well, if you hadn't bought a second home that money would a long way towards funding a different rental in the same area where you are now until you save up enough money to buy there (if that remains a goal). I don't want to crush your dreams or anything, but to me this vacation home idea reads as more of a lifestyle decision than slam-dunk investment opportunity.

[chieftain]

Thanks for the replies, everyone. It's good to have some mustachian perspective—consensus, even—on this, and it seems like I should rethink this idea.

[Freedomin5]

We did this...twice. The first time, we bought a condo in an up and coming area of a large city, and rented it out long term. Our tenant has been there seven years, pays way below market rate for rent, and still, the rent is enough to cover all the costs, with money left over each month. Our tenant basically paid off our mortgage for us. Plus, the area has appreciated by about 10% per year, so our condo is now worth more than double what we paid. Our tenant has been entirely hassle-free and wonderful. Last month, we gave her three months notice that we would be increasing rent by 1% to offset some inflation, and she decided we were charging her too little and raised her own rent effective immediately.

We then bought a cottage in a very popular vacation spot, three years before COVID hit (ie, when prices were still reasonable), with the idea that we could block of several weeks for our own use and rent it out the rest of the time. That was not a good investment. Short-term rentals and Airbnbs are ALOT of work, and because the guests see it as a hotel and not their own home, they’re more careless with your unit. We  rented it out for one year and broke even after factoring all of the management fees and costs to replace all the stuff that was broken, ruined, or stolen. I think we had a higher rate of broken/stolen/ruined stuff because we didn’t live on the premises. We currently just let trusted friends and family stay, and they pay about 1/3 the market rate to help us cover the operating costs. We don’t make a profit on this place, though COVID has meant that this rural, nature-y vacation town has become immensely popular, and the value of our cottage has gone up around 50% since we bought it.

In your situation, I would run the numbers carefully, find a place in a good location, and find a good long-term tenant to take care of the place for you while paying you rent.

[affordablehousing]

Daniel Kanter! I knew that name was familiar. Oyster white! He solved the problem we had of the perfect off-white for us by writing about it just so. God bless him. Off-whites are so hard to settle on.

[havregryn]

We are in a similar situation in the sense that we are locked into a cheap, even if not ideal living arrangement in our primary place of residence due to outrageous property prices and we are also looking to get a secondary home. I keep going back and forth on that. I don't really expect to rent it out because that's just a lame excuse for a poor rental investment (if you have a permanent tenant in, you can't use it, what's the point then if the rental return is not good) but from a lifestyle point of view, I think it makes sense. It is a way to solve some of the challenges of our main living arrangement. For example, we can't receive overnight guests (and we're expats so there's a lot of people we'd love to see if we could house them). We might soon have to start paying for self-storage because we live small and it's 5 of us. Mortgage interest here is 1%, inflation is now 4%, makes me want to go buy something just to take advantage of our borrowing capacity.

It doesn't have to make perfect financial sense if it's not an investment but a way to optimize your lifestyle.

But I am worried that I may be overestimating how much we'd actually end up using the place vs. the cost of maintaining it. This was more of an issue pre-Covid though because we enjoyed travelling. I think covid and covid measures have mostly killed my desire to travel for the time being, making a secondary residence an additional necessity, I can't keep my kids locked in an apartment all summer.
I think we'll be getting something this summer or next.

[SeattleCPA]

Second homes are "toys" just like boats, cars and motorcycles.   The only difference is, you should see the value appreciate -vs- rapidly depreciate.
I buy toys with cash and make sure there I have enough of a cushion to keep them going.

You might get enough rental income to cover some of the costs, but you might also get some renters that tear the place up.   I would look at any rental income you could get as "help" but make sure that you could cover expenses with our without that rental income.   Sooner or later on any piece of real estate, you will get hit with a big expense like a roof, furnace, etc. so you have to be prepared for that as well.

We've got a second home, value roughly $5-600k and here is our cost history of last four years, not counting utilities.
Big cost items in below numbers are taxes and upkeep / repairs.
2018  $12k
2019  $25k
2020  $16k
2021  $16k

I think there's a "cost of capital" component to this, too.

E.g., if you have a mortgage, that's a cost (of capital). And even if you buy for cash, you've got for example, $200K or $500K or whatever tied up in a property where it may not be earning dividends or appreciating in value.

For what it's worth--and I have a second home--I think it's useful to look at a second home in terms of a nightly rate. So if you spend (say) 16K a year and only use it 16 nights, that's $1K a night.

P.S. I think the economics of second homes are usually pretty tricky to get to work. I've had two over the years...