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On Second Thought

Second homes are increasing in popularity, with more and more Americans looking to buy vacation property.

According to the National Association of Realtors, vacation-home sales accounted for 21 percent of all transactions in 2014, their highest market share since the survey was first conducted. Since 1989, the number of vacation homes has risen roughly 25 percent, to 5.1 million.

Which One Makes the Most Financial Sense for Your Second Home: Vacation or Long-Term Rental?

Second homes are increasing in popularity, with more and more Americans looking to buy vacation property.

According to the National Association of Realtors, vacation-home sales accounted for 21 percent of all transactions in 2014, their highest market share since the survey was first conducted. Since 1989, the number of vacation homes has risen roughly 25 percent, to 5.1 million.

For those who are planning to use the property for at least a few months out of the year, buying a second home may make sense. But maybe, after making your purchase you realized that you weren’t able to return to the vacation property as often as you had hoped. Or maybe you found the expenses were more than you’d estimated them to be. To help recoup some of the costs, you might be thinking of renting out the property as a vacation rental.

But there may be a better option: turning the property into rental housing. You can rent out your property for cash flow each month, using it to generate income while your tenants pay the mortgage for you.

The Advantages of Rental Housing

Rental housing offers a number of advantages over vacation rentals. While vacation rentals usually have a high season and a low season, with long-term rentals, there are no such seasonal fluctuations to contend with. Standard rentals also have fewer empty periods than holiday homes that often sit empty in between bookings. It’s difficult to depend upon consistent occupancy with vacation homes, and there’s a good chance that some months, you could end up paying the mortgage and other expenses out of pocket.

Then there’s the fact that vacation rentals are high maintenance. There has to be someone there to clean in between bookings, to greet guests and to provide information to them while they’re there. Often, management expenses for vacation properties are much higher than for standard rental properties. In some especially sought-after locations, the cost for a property manager can be as much as 30 to 50 percent of the rent, compared to the long-term property management fees that are usually between 8 and 12 percent.

If you’re looking for a way to recoup some of the costs of your vacation home, rental housing may be an avenue that’s worth exploring. Here are a few things that you should know about making the switch from vacation home to rental property.

Things to Do Before You Get Started

Do Your Homework

While making the move from holiday home to long-term rental often makes sense, it’s important to do your research up front, just so you’ll know what you’re in for. Long-term rentals often provide better yields, and a more consistent income compared to their vacation counterparts, which often fluctuate wildly depending upon the month. But of course, it’s important to remember that, with a residential unit, it would be difficult to use the home as a vacation getaway since the unit will most likely be occupied year-round. Make sure that’s something you’re OK with before making the transition. You’ll also want to ensure that there’s enough demand to keep your rental full, with minimal vacancies. If you can, try to get in touch with a local Realtor or property manager to see how much your property could rent for per month as a rental. You could also head over to Trulia and Zillow, to have a quick look at what other, similar rentals in the area are renting for.

Run an Investment Analysis

Next, check the financial viability of your property as a rental. Use a rental property investment analysis calculator to run a cost analysis, and see how much your expenses per month will be, and determine how much profit you’ll be making. While it’s true that vacation rentals tend to rent for a higher profit than long-term rentals, with the additional costs that they incur, they won’t automatically net more. Weigh both options carefully, taking care to list as many expenses as you can think of to get a fair and balanced picture. For long-term rentals, this usually includes the mortgage, taxes, insurance, maintenance and property management fees, as well as any potential HOA fees. Calculate in vacancies as well. While standard rentals often have a much lower vacancy rate than vacation properties, it’s good to factor in about 10 percent of the rents as a vacancy cost since this will help to cover the mortgage payment and utilities should the rental be empty for a short time in between tenants.

Understand the Tax Implications

It’s also important to note that the tax implications for a rental property are very different from a vacation property, and generally less restrictive. The key to maximizing your tax deductions on a vacation rental is to limit your personal use to fewer than 15 days per year, or less than 10 of the total rental days, whichever is greater. By limiting your use, your property will be considered a rental for tax purposes, which means that you’ll be entitled to the same deductions that you could have for long-term rentals. However, this 14-day maximum is something that may be problematic for those who want to spend more time at their vacation rental. With a standard rental, of course, you’ll be able to write off many of the expenses associated with the rental, including maintenance, repair costs, travel to and from the rental, and property management fees. Property taxes, insurance and advertising can also be written off.

Consider Doing It Alone Versus Outsourcing 

Finally, you’ll want to consider whether you’ll be managing the property on your own, or outsourcing some of the work. While you may be able to take on the management if you live relatively close to the property, for rentals that are out of state, it often makes sense to enlist the services of a property manager to handle tenant sourcing and screening, as well as any day-to-day issues that arise. They’ll also be able to keep an eye on your property for you, giving you peace of mind when you can’t be there.

Ultimately, the decision to have a vacation property or long-term rental comes down to which one will work best for your situation, depending on the local rental market and the market for holiday rentals. Be sure to do a careful cost and cash flow analysis of both options, and carefully consider which route will help you to reach your financial goals sooner.