Don’t Let A Second Home Ruin Your Retirement

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There are many things that can ruin a retirement plan. Bad returns are usually not one of them, but having a second home can be.

Before you even consider purchasing a second home, make sure that you are on track for your retirement. If you already aren’t on track for retirement, then buying a second home will make the situation far worse. If you are on track, you still may not want to get one.

The younger you are when you purchase a second home the more it costs. You should consider not only what the home costs, but what the home will cost in upkeep and what that money could have been worth had it been saved and invested in the markets. Make sure that you can afford a second home before shopping for one.

Dan Moisand, writing for Financial Advisor Magazine in “Vacation Homes: Heaven Or Retirement Hell? ” describes the allure:

No one “needs” a vacation home, but there are many reasons for wanting a second home. The three I have encountered most often are locking in a place for a future retirement, the joy of sharing with family and friends, and easier vacations. …

Ah. Those precious grandkids. This is probably the most common vision among retirees for a second home. “I could see our grandkids playing on this porch,” says a client during a rental stay in a beautiful locale. Next thing they know they are shopping for a house.

A second home is not an investment. An investment is one that pays you money sufficient for the assets invested. If it doesn’t pay you money or the money is insufficient for the assets invested, it is not an investment. It is simply part of your lifestyle spending.

Increasing your lifestyle decreases your chance of successfully retiring in two ways. First, increasing your standard of living increases the amount of money you will need in order to retire. At age 65, for every dollar you increase your standard of living you will need about 23 times that number in order to retire.  Second, when you increase your standard of living you aren’t putting that money toward your retirement. So all of the future compounding is lost. Assuming you purchased a second home and your investments had a 5.63% annual return over inflation, every dollar spent on the second home could have been 5.16 times that amount thirty years later.

What is more, there are more expenditures than simply the initial purchase price. In fact, the costs of purchasing a second home will be far more than you anticipate. Moisand explains:

The easiest way to cut through the anecdotes is to get a hold of tax records. Have the seller complete a Form 4506-T, Request for Transcript of Tax Return. The client will fill one out if applying for a mortgage. They should get one from the prospective seller.

A seller’s financials are often available for commercial property, such as vacation rentals. With a copy of the tax return or the financials, you can review all the expenses the seller experienced rather than just assuming that the home’s income will cover them.

In addition to those listed expenses, also include in your own calculations the lost opportunity costs to your retirement accounts.

An Example: $500,000 Purchase of Second Home

For example, imagine purchasing a $500,000 second home with $100,000 down and a 30-year fixed mortgage for the remaining $400,000.

For the mortgage, we are assuming a 0% interest rate because we are factoring out inflation. In other words we are assuming that whatever interest rate you can currently get is equal to future inflation. This may be an understatement, but understating the costs of a second house won’t look any rosier. With a 0% interest rate over 30-years, this is a monthly payment of $1,111.

Property taxes are assumed to be $1.20 per $1,000 or $600 per year. Home maintenance is assumed to be about 1% or $5,000 each year. These are total annual costs of $5,600.

For this example, we will use 5.625% for the return over inflation of the stock markets. By ignoring inflation, we put everything in today’s dollars.

Similarly, we will also assume that your second home maintains the same value. In reality, your second home is going up by inflation, but we have factored inflation out of both sides of the equation.

It sounds attractive to purchase a home with free money. But you still have to put $100,000 down and you begin making payments that include a large portion of capital. That capital could be put to work in the markets.

Assuming a 5.625% real market return, the $100,000 down would have grown to $516,418 over 30 years. With the same return, if the $1,111 monthly payment were invested each month rather than spending it towards the mortgage, then it would have grown to $1,016,889 over 30 years. Similarly, the $600 per year of property taxes would have been $45,760 and the $5,000 of upkeep would have been $381,333.

In total, this is $1,960,400 of lost investment gain over the 30 years. When you net this with the $500,000 value of the home, that is $1,460,400 of opportunity cost.

Paying cash for the $500,000 makes it worse as the amount put as a down payment suffers having to overcome 5.16 times growth in the markets. Making gradual payments over 30 years puts some of those payments later reducing opportunity cost. Paying cash for a $500,000 house costs $3,009,185 over 30 years, which is $2,509,185 over the value of the home.

Renting versus Landlording

In order to solve the monetary problems with purchasing a second home, some people will try to rent the property for extra income. Moisand has this wisdom to share:

Local realtors will likely tell the client it is easy, and will relay high occupancy rates and average weekly rental rates during peak season. Clients multiply that average rent by some number and see the vacation home as low cost, low risk or even a money maker.

Time to call “time out” and regroup. What was going to be a vacation home is morphing into a small business, and vacation rentals are not a great business for most homeowners. We do not rent our Montreat house. It has been rented in the past, but we found the business of renting to be more of a hassle than the rents were worth. We are not alone in that assessment.

A report from HomeAway, a vacation rental site, estimated that vacation rental owners spend an average of nine hours per week marketing or managing their properties. Further, it indicated that rents don’t even cover 75% of the mortgage payments for about half of vacation homeowners renting their properties.

That’s just the mortgage and doesn’t include maintenance or management fees. The study shows the average homeowner is able to rent just one-third of the year. All the expenses of owning a home continue year round.

Renting your home constitutes a small business. Spending nine hours a week on managing your property is nine weeks you could have been vacationing. While planning a vacation takes some time, it takes a lot less time than managing a rental home.

Upgrading a rental home takes time and effort. When we first started going to the beach, rental homes were simple. Over the years we have noticed how much is now expected that wasn’t expected when we first started. Roughly in order of year, we have seen upgrades to include: air conditioning, washing machine, sheets and towels, coffee maker, kitchen remodel, big screen television, game system, hair dryer, wifi, cable package, surround sound, welcome basket, streaming service, kid-friendly equipment, pet friendly environment, beach supplies, outdoor games, barbecue, backyard pool, premium bedding and pillows, hot tub, outdoor lighting, movie room, eco-friendly guest soaps and amenities, and COVID disinfectant and cleaning.

If thinking about that list of upgrades made you tired, running a rental house business probably isn’t for you. But if you would like someone else to handle all of those amenities and just show up expecting them, then renting someone else’s home is for you.

When you buy a vacation home you think you will travel there and enjoy it much more than you probably will. Yes, many couples talk about how nice it would be if all you had to do was to put a few things in the car and go. But with our busy lives, it is still difficult to drop everything and go. Furthermore, when you do get there, you will spend much of your time and effort repairing and upgrading the property.

Moisand talks about some of the effort which must be put into a property that you own rather than one which you are only renting.

When you buy a vacation home, you get rid of some inconveniences but take on new ones like maintenance, upkeep, taxes, utilities and all the other elements of the joys of homeownership. …

For many people, being the renter is far easier than being the owner. Renters only pay for what they use, and the rest of the year they spend no time, energy or money on the property.

The vacation home I rented ten or twenty years ago is very different than what I would rent today. There are different places I would go today than I went in the past. Families change and the ability to easily change with them is valuable.

When you consider the lost opportunity costs of buying a second home, you can afford to take some nice vacations over 30 years for $2 million.

Don’t let a second home ruin your retirement.

You may still decide to purchase a second home, but now you will do so knowing exactly what impact it may have on your retirement lifestyle.

Some people can afford a second home. But the choice is between a second home or renting someone else’s home and retiring either earlier or richer.

The cost of a second home is large. Large enough that it can ruin your retirement plan.

Photo by Adam Cai on Unsplash

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President, CFP®, AIF®, AAMS®

David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. In addition to his financial writing, David is a co-author of The Haunting of Bob Cratchit.