Dale Ishida Suezaki and Taylor Easley are financial advisers at Morgan Stanley, 329-7979.
Have you ever visited a friend’s vacation home and thought or said, “Wouldn’t it be nice to have a place like this?” Or perhaps you are the host who has heard that comment and smiled knowingly, because you know it is very different, both financially and psychologically, to be the owner rather than the guest or the tenant in a vacation property. The successful purchase of a vacation home should be the result of a healthy balance between emotions and economics.
A vacation home can provide a setting for wonderful experiences with children and grandchildren. Time spent there can refresh the mind and body. The sense of ownership and familiarity with one place over time can be grounding and comfortable.
But the delightful experience of visiting a warm beach on a winter holiday should not lead to the impulsive purchase of a condominium. Memories of a family cabin can tempt you to idealize life on a lake and disregard the realities of maintenance. Do you want the owner’s responsibility of utility bills, plumbing repairs, termite contracts, cleaning, long-distance maintenance and the worries of hurricanes, forest fires and marketability? Or do you want the renter’s freedom to hand the keys and upkeep back to someone else as you leave with the option to vacation elsewhere?
To determine if you’re financially ready to be the owner of a second home, do some simple math.
c Add up the money that you would invest in buying and furnishing a second home — let’s say $200,000.
c Determine your expected annual expenses for insurance, utilities, taxes and maintenance — perhaps $10,000, after tax. That is your cost of vacationing there every year as an owner, in addition to the amount invested.
c Now calculate what income the same capital investment ($200,000) could generate annually if invested in the financial markets instead of a second home — 3 percent, 5 percent, 7 percent or 10 percent? Let us pretend $10,000 after tax. It is important to note that due to the volatility of investing in the financial markets, it is possible that a person could lose value, or not gain as much value as expected, from investing in the securities markets. These examples are hypothetical and are for discussion purposes only.
If the return on your investment would cover the cost of renting similar property intermittently during the year, then your annual cost of vacationing there is virtually zero, because the expected return on invested assets would cover the rent.
Alternatively, depending upon the level and diversification of your investments, you could buy a home without liquidating investments by pledging assets from an investment account. This scenario enables you to finance up to 100 percent of your home’s value using eligible securities in your investment portfolio and your home as collateral. That means you can enjoy home ownership, while continuing to hold or trade securities — so your assets keep right on working for you.
If the value of the pledged securities in your account drops below the agreed-upon level stated in your loan documents, you will be required to deposit additional securities or other collateral (such as cash) to stay in compliance with the terms of the mortgage. If you do not deposit additional collateral into your pledge account within five days, your mortgage lender can direct the institution at which your securities are held to liquidate securities in your pledge account without contacting you, and you will not be entitled to choose which securities will be sold in the event such actions are necessary. Thus, in deciding whether the 100 percent financing feature is right for you, you should consider the degree to which you are comfortable subjecting your investment in a home to the fluctuations of the securities markets.
In the first ownership scenario, you have a block of capital invested in property that costs you money every year to enjoy. As a renter or pledged investor, you could have the same block of capital invested in the financial markets, where, depending on many circumstances, you may be able to earn a return.
Fortunately, there are alternatives to outright purchases and renting. Time-shares allow you to purchase a slice of vacation time that you want to own, such as one month a year. You can also purchase a condominium or house that you rent out when you are not there and contribute the rent to defraying some of the ownership expenses. You may find a home in a rapidly appreciating area that may make you a profit if you are willing to sell in a few years. You could even buy a second home to enjoy on vacations now, with the plan to retire there and sell your first home.
If you do make the financial commitment to a second home, ask yourself if you are willing to spend all or most of your vacation budget going to one place repeatedly? If you enjoy going to the beach in general, is it this particular beach that you want to return to every time? Does this place provide a wide enough range of activities for your family?
As 78 million baby boomers age to their mid-50s, the demand for second homes has intensified; many people have taken advantage of current attractive mortgage interest rates and a relatively flat stock market to justify these purchases.
Be sure that your vacation home purchase is based on sound economic principles and a careful assessment of your particular circumstances.
c In 2004, 2.82 million second homes were sold nationwide, compared with 2.42 million in 2003, a 16.3 percent jump according to the National Association of Realtors survey. The investment-home component rose 14.4 percent to $1.80 million sales in 2004 from $1.57 million in 2003, while vacation-home sales rose 19.8 percent to $1.02 million in 2004 from $850,000 in 2003.
c American Demographics Magazine predicts that by 2010, about 10 million Americans will own two or more homes.
c The typical vacation homebuyer was 55 years old and earned $71,000 in 2003, while investment property buyers had a median age of 47 years old and earned $85,700, according to the NAR survey.
c The mortgage interest on a second home, which you use as a residence for some portion of the taxable year, may be deductible if the interest satisfies the same requirements for deductibility as interest on a primary residence, as well as other requirements. Real estate taxes paid on your primary and second residence may be deductible. Deductible real estate taxes include any state, local, or foreign taxes on real property levied for the general public welfare. Deductible real estate taxes do not include taxes charged for local benefits and improvements that increase the value of the property.
c The Tax Relief Act of 1997 changed the law so that couples are exempt from paying capital gains taxes on profits of up to $500,000 on the sale of a primary residence, thereby freeing liquidity for a second home purchase.
These articles are published for general information purposes and are not an offer or a solicitation to sell or buy any securities or commodities. Any particular investment should be analyzed based on its terms and risks as they relate to your specific circumstances and objectives. Morgan Stanley does not render advice on tax or tax-accounting matters.
Dale Ishida Suezaki and Taylor Easley are financial advisers at Morgan Stanley, 329-7979.