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Question
Hi!

My wife and I are in our 30s and are looking to make a change to our lifestyle and invest in a home that will hopefully help cover it's own costs.  We currently own a single family home near Helena, MT which we plan to sell in spring of 2014 for $290,000 or more. We then would cash out on $100,000 of equity to put down on a new mortgage. We plan to invest in a nice home on larger acreage nearby a very popular seasonal tourist area of Montana.  The draws are lakes/beaches, Glacier National Park and a popular winter ski resort.  We currently own a seasonal business running a full service fishing lodge in Alaska during summer where we reside from June - Sept. each year.  Therefore we would have a vacant property to rent out for the summer season.  Also, we would consider renting the new property over holidays and peak ski seasons in the winter while we're on vacation ourselves.  We have spoken to many people in this area that have successfully run vacation properties and pulled a significant profit.  We're not looking to get rich, but rather make enough to cover our expenses of taking on a larger investment that will also be compatible with our dreams of a more self-sufficient lifestyle in an area we would love to live.  Before we commit to this, we're just looking for ideas, suggestions, feedback and thoughts prior to making this life change.  Thanks!

Questions:

1)Option #1: In shopping the market, we have found the most desirable properties in the $500,000 range.  With $100,000 down and an annual income of $120,000, is this too much of an investment?  These properties are nice, on larger parked out acreage and are newer, turn-key properties with growth potential. Also, we assume that if we have rental income, we would be diluting the monthly expense of owning this large property.

2) Option #2: Our alternative would be to buy a nice 10 acre lot in a good location and build a nice, but small 2 -bedroom cabin on the property.  We could then live in it and rent it out when we're away.  Our initial investment then would be around $250,000.  As we profited from the smaller investment, we would eventually build another larger cabin or home on the property with potential to rent both properties when we're away, and one of the cabins year-round even when we're home.  The drawbacks I guess would be that we would have to build first and wait until construction is done prior to moving in/ renting.  Also, long term, with building costs, we assume our total investment would be still about $500k, just smaller monthly payments initially as our initial investment is less.  Is this a better way to approach vacation rentals?  Are bigger homes more attractive and more profitable in the rental market, or would nice cabins for 2-6 people be a better angle?  Lots of this area is riddled with luxurious 3000 square foot homes for a pretty penny/night.  We though maybe cabins would put us in a niche market as far as price point?

3)  So, this really won't be a true vacation property for us as it actually will be a primary residence for us as well.  But, we'll be renting it out as a vacation rental on a per diem or per weekly basis on certain dates when we're away.  What tax issues should we be aware of?  Even if we're paying taxes on income, can we dilute that income by deducting property improvements similar to a B&B model?  We ordered a tax guide, but are always interested in hearing other's experience with tax and tax deductions regarding a property like this.

Through all of this it seems to us we should have no problem renting it out most of the summer as based on other homes in the area that rent out regularly on homeaway.com or VRBO.  Even though the supply of vacation rentals in the area is big, the demand is as big or bigger. We are assuming we could by a nicer, larger, more expensive property but actually live there on the cheap as potential rental income would dilute or eliminate mortgage costs.  Is this being too optimistic?  We run a full-service property in Alaska with chefs, guides, cabins, restaurant, etc. and do all our own website building, marketing, managing, staffing, etc.  So, in comparison, this investment seems quite easy for us to manage.  Thanks for your input and other suggestions you may have. We appreciate it!!

Answer
Hi, Jason,

Well, you have asked a number of very important questions.  First, some observations that pertain to the scenario you have proposed.  You will be interested to know that, for fourteen years, I did what you are proposing to do.  I vacation-rented the houses I lived in and essentially lived for free.  In order to make that happen, several things have to be in place.  One, the house has to be in a location that is desirable to vacation renters.  Two, the property owner must recognize that he/she is taking on another job, and that job is the marketing, renting and maintenance of an income property.  And three, the house has to be set up as a vacation rental, as opposed to as your primary residence.  It has to be a home that you can get in and out of easily without making your guests feel that they have invaded your privacy by using your home.    

I will address your questions in the order that you asked them.

With regard to your Option #1, I am unclear as to whether you are saying that you have $120K of income before any vacation rental income, or if you are estimating that your vacation rental income will be about $120K.  I think you mean that you will have $120K in income plus potential rental income.  Assuming that, you will want to total your monthly expenses to determine what it will cost to carry the house, and ask yourself if you could do it without renting the house.  If the answer is yes, then, no problem; the rent generated will be gravy.  If the answer is no, and you need to rent the house to be comfortable, then you need to realistically determine what you can generate in rent and how often.  Don't forget to take into consideration what it will cost you to move out and make the house available for your guests.  What will your expenses be?  Do you have to pay for another place to stay?  Do you have to eat out?  

Your Option #2 sounds interesting, and does give you flexibility with regard to your initial investment.  You don't say how old you are, but I'm guessing, since you are considering this option, that you are young enough that this option would have time to mature and eventually pay off for you.  I would suggest that this option should be investigated carefully, as far as building and renting something that is very different from other homes in the immediate vicinity.  While you may not have competition for renters, you will want to be sure that the smaller rentals will be marketable in an area of larger, more luxurious homes.  Also, be sure that the property is zoned for two homes on one lot, and find out what your rights would be, should the zoning change prior to your getting the second home built.  

And you didn't ask, but I'll offer this, anyway.  Be sure you know how the communities you are considering feel about vacation rentals.  Be sure VR is a permitted use for the homes/lots you are considering, and find out if there are any rumblings of any changes to local statutes with regard to your being permitted to rent your property by the night or by the week.

As to the tax issues (item 3, above), I am not a CPA, so I am not permitted to give you tax advice.  Ask your CPA if, under the circumstances you envision for yourself, if you will be required to report the income (probably yes, based on what you describe) and ask if you can deduct a portion of the expenses of running the home that are proportional to the time it is rented.  Ask if the improvements you do to get the house ready to rent are deductible against the income you will generate.  And finally, be sure to discuss with your tax advisor what the implications of the rental will be when you get ready to sell the house.  

If you are correct about the demand for vacation rentals in the area you are considering, you will probably be fine, especially given your experience in the hospitality industry.  If you have additional questions, please let me know, and let me know how your adventure turns out!  

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Jan Leasure

Expertise

I can answer questions about the ins and outs of vacation home ownership and the rental of vacation homes. I have managed residential rental property since 1983, both for myself and for others. I have taught property management and provided seminars and training at the local, state and national levels.

Experience

I am a licensed real estate broker in California. I have managed vacation homes for myself and for others for over 25 years. I currently am the managing broker at Monterey Bay Property Management.

Organizations
I am a member of the National Association of Realtors, the National Association of Residential Property Managers, and the Vacation Rental Managers' Association, among others.

Publications
Articles I have written currently appear at www.CaliforniaLandlordSolutions.com and have appeared in a number of real estate and property management publications.

Education/Credentials
Bachelor's degree, two masters' degrees, and most importantly, the School of Hard Knocks!

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