Vacation Homes: Deal or No Deal?

Prices are attractive, but it's still tough to make the numbers add up.

Sometimes an investment opportunity seems so tempting that you can barely contain your enthusiasm. Consider, for example, the melted-down prices of rental properties in resort areas around the country. If you were to pick one up for a song, surely the rents you could collect would underwrite its use as a vacation chalet or future retirement home.

But buying a vacation rental property involves real estate, so you can't just go online, pick it and click it as you could, say, a stock. At an absolute minimum, you need supreme patience, an innkeeper's disposition and high tolerance for negative cash flow.

You can sum up the allure of vacation investment property in one word: price. Prices for luxury cabins in the Smoky Mountains, comfy fishing retreats on midwestern lakes and nearly everything in Florida have yet to recover from the real estate crash. "It would cost $150 a square foot to build these cabins today," says David Bryant, of Eden Crest Properties, which sells and manages large, amenity-filled vacation homes in Pigeon Forge, Tenn., in the foothills of the Smokies. Yet Bryant's listings today are priced at about $100 per square foot.

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But there's plenty of downside to the investment equation. Rents are low and new customers are scarce. Crazy Eddie himself couldn't have dreamed up the insane deals on many short-term vacation accommodations: Try $75 a night for a four-day weekend in February at a four-bedroom villa in Orlando that ostensibly goes for $2,000 a week during the winter high season. That's sweet if you're the renter, not so sweet if you're the landlord.

And while you can buy a beautiful place near Disney World or on a Tennessee mountaintop for much less than it cost three years ago, when prices were near their peak, you won't catch any breaks on operating costs. The tab today for insurance, maintenance, utilities, security and marketing is at least what it was a few years back, and probably more. For example, figure on spending $300 a year for a Web site to list your property (you'll probably want to advertise on several) and $100 a month or more for movies, cable and Internet. After all, you'll be competing with the hotel industry but without its marketing and financial muscle.

Despite the pitfalls of being a landlord, many investors are willing to give a vacation home a shot without so much as a back-of-the-envelope calculation. The idea may make sense if you fit into one of these categories:

You want to acquire your future retirement home during a raging buyer's market and defray part of your costs before moving in. Meanwhile, the tax laws let you occupy a rental property yourself for at least 14 days a year and still have Uncle Sam subsidize your loss if rents don't cover your expense.

You're moving from a resort area or tourist destination but can't sell except at a low-ball price. In such a situation, it might be more profitable to rent the place on a short-term basis to vacationers rather than sign a tenant to a bargain-basement one-year lease.

You're a bottom-fisher with a wad of cash and you're willing to gamble that local property values will revive before developers undercut you by overbuilding condominiums and golf communities all over again.

Tales from the trenches

Mark and Betsy Lidke fit into the first category. In 2003, the Lidkes paid $440,000 cash for a two-bedroom townhouse condominium on Longboat Key, an island off Sarasota, Fla. The community offers private bayside beach access, professional-quality swimming pools and tennis courts, first-rate landscaping, and great views. The couple thought they'd use the place a few times a year, rent it out the rest of the time and move in when they retired. Now Mark is just hoping they don't lose their shirts.

Because of a downturn at the Minneapolis advertising agency that Mark owns, the couple have cut back on spontaneous getaway travel and are reluctantly selling the condo. Problem is, no one has offered anywhere near the $350,000 they are asking. So for now they are essentially in the vacation-rental business full-time.

The Lidkes' experiences reflect all the ups and downs of making a go of a vacation property. Until this year, they had a guaranteed anchor tenant: The elderly woman who sold them the unit agreed to rent it back for six months a year. That made the deal work because it guaranteed the Lidkes a base income to cover taxes, condo fees, and management and utilities costs, which total $16,000 a year. But because of health reasons, the woman can no longer stay in the condo, so the Lidkes have scrambled to find other tenants. Using an online listing service and asking $3,500 to $4,000 a month, depending on the season, so far they have rented the unit for four months in 2010 (their community doesn't permit weekend or weekly rentals). "A cash generator? Maybe not," says Mark, 58. "We're just aiming to break even."

Even if the rental income offsets their costs, the Lidkes still have an uphill battle. The hidden variable is the cash they tied up to buy the property. Even at today's paltry rates, the $440,000 they poured into the condo could produce $16,000 a year in tax-free income if it were invested in low-risk municipal bonds. So they really need to rent the condo eight months a year just to break even. That's a tall order given that even in a healthy economy, vacation traffic in coastal Florida slackens in the summer and fall, when hurricanes are a constant threat.

The gloomy vacation-rental outlook extends beyond Florida. An artist from Massachusetts who owns six luxury coastal properties in New England says that "in this economy, the whole basis for this business is under question." The units rent for as much as $5,000 a week during the peak summer season. The artist, who asked not to be identified, says that managing the properties has pretty much turned into her full-time job. She cannot afford to hire maintenance help or a rental agency -- she does the work herself. And owning rentals on Cape Cod brings its own special problems: long dead periods with no renters, plus high taxes and utility costs.

John Romano, who owns (opens in new tab), a Web site that serves both property owners and vacationers, hears plenty of war stories. The owners of some luxury resort rentals who had counted on collecting monthly rental income of $10,000 when they bought their properties are now hoping for half that much, says Romano. The old rule of thumb that renting a place for 20 to 25 weeks would cover overhead has been replaced by one demanding 30 to 40 weeks. Vacationers realize that it's easy to go online, see photos of a rental, read the comments of previous guests and deal directly with the owner. As a result, travelers play off owners against one another, which begets more discounting. Owners who "have jumped into this are getting desperate about making their mortgage payments," says Romano.

How to make money

Romano thinks that because of the plunge in home prices, patient investors who buy vacation properties today can still do well over the long run. But even with lower home prices, making the numbers work is no sure thing. Concentrate on properties that you can rent out year-round. Look for homes with the space and amenities to appeal to free-spending renters holding events such as family and college reunions, business meetings, and weddings. Big groups share expenses and are critical to helping owners turn a decent buck. It also helps if you have enough cash to make a big down payment, which reduces mortgage costs (but don't forget to factor the lost investment earnings into your calculations).

You can find plenty of well-priced properties that meet these criteria in places such as the Ozarks and the Smoky Mountains of North Carolina and Tennessee. David Stephens, a buyer's agent from Knoxville, Tenn., says the typical investment "cabin" he shows in and around Pigeon Forge is really a private estate. It may contain 5,000 square feet of space, six bedrooms, game and media rooms, a large open kitchen, a heated pool and 360-degree views. Dozens of these places, which sold for more than $1 million during the real estate bubble, are now on the market for $500,000 to $750,000. Summer is the high season, but it's possible to rent in this area all year, including the periods around Thanksgiving, Christmas and college spring breaks. The community is within driving distance of a number of metropolitan areas. Traffic from would-be buyers, some of them from the West Coast and foreign countries, is "astonishing," says Stephens.

But are the deals astonishing enough for you to pull the trigger? It depends on many factors (see All About Rents, Costs and Taxes to consider how a deal might play out).

Ultimately, it's the personal-use feature that lures many buyers, says Stephens. They arrive for a short vacation, become smitten with the area and are soon putting down a deposit, reasoning that if the deal comes close to break-even, they're getting a part-time vacation retreat for themselves and an eventual retirement lair for a bargain price. And even if you run an operating loss, the cash you collect in the interim helps defray part of the money you were willing to spend anyway. Then, you've locked up a piece of paradise and shared its cost among a collection of guests who, if all goes well, will become your regular customers and maybe even your friends.

Jeffrey R. Kosnett
Senior Editor, Kiplinger's Personal Finance
Kosnett is the editor of Kiplinger's Investing for Income and writes the "Cash in Hand" column for Kiplinger's Personal Finance. He is an income-investing expert who covers bonds, real estate investment trusts, oil and gas income deals, dividend stocks and anything else that pays interest and dividends. He joined Kiplinger in 1981 after six years in newspapers, including the Baltimore Sun. He is a 1976 journalism graduate from the Medill School at Northwestern University and completed an executive program at the Carnegie-Mellon University business school in 1978.