Congratulations on saving enough money to buy a vacation rental property!
You’re following in the path of many other owners who’ve used their vacation rental properties to move toward financial independence. If you talk to vacation rental homeowners and financial advisors, you’ll find that healthy down payments, quality homes, and superb locations are only some of the reasons their investments are successful. They also have solid strategies to build and maintain emergency funds.
“Unfortunately, we are talking about a lot of unforeseen events,” said Adam P. Smith, president, The Colorado Real Estate Finance Group, of major unexpected expenses that often plague those that own vacation rental properties. “That’s the exact idea behind emergency fund – unforeseen emergencies. It’s hard to judge what will happen. You might be fortunate and buy an investment property that needs no major repairs or maintenance [for a time], but then it sits empty for months and you’ll still need to pay the utilities, the mortgage, and more.”
Some vacation rental homeowners get into deep financial water because they don’t budget for emergency expenses.
“Someone who puts every penny into their vacation home, has not emergency funds to fall back on, and lives paycheck to paycheck have very difficult financial lives,” said Jessica L. Merino, financial advisor and president, Merino Wealth Management, Chicago. “It’s important to make sure you can set aside money for regular maintenance and emergencies before you invest.”
So just how do you build an emergency fund that will protect you against the unforeseen at your vacation rental property? Consider these 6 ideas:
“Typically, I treat my vacation rentals like a business. So, plan for the financial costs separate from any personal finances,” said Merino. “Open an account specifically for the investment property and put any money earned from it into that account.”
Of course, you’ll pay expenses from that account, too.
You’ll want to know how much you need to budget for regular expenses such as furnace filters and lawn care. Those aren’t costs that come out of the emergency budget. That account is so you can replace a leaking hot water heater, broken garbage disposal, or damaged roof. A 3-year old, 5,000 square foot home will have different needs than an historic home. Expenses also vary among regions. For example, hailstorms are a major concern in Colorado, said Smith. Tornados and hurricanes are concerns in other areas. Know what to expect in the region where you buy.
It’s important to have the correct vacation rental insurance for your property. You need to know what damages or emergencies would or would not be covered under your policy. Carefully review and understand your homeowner’s policy, said Smith.
You may save your carpets by removing your shoes when you enter your home, but don’t expect guests to do so, said Smith. Another example is minor repair. When you see a screen is split, you repair it. Rental guests won’t necessarily do so. That means the damage may quickly grow, necessitating the screen needs to be replaced rather than repaired.
White recommends you save at least 25% of your rental proceeds for an emergency fund. “If my investment doesn’t translate into a 125% debt-service ratio, it is not a good investment,” said Smith. “The 25% rule protects you from maintenance costs, vacancies, and other surprise expenses.”
Merino recommended homeowners save even more, between 3 and 12 months of expenses in a reserve.
“So if it’s an investment property, we want to set aside a few months of expenses so that we can cover things for a set period of time,” she said. “Now if we’re anticipating that we may want or need to renovate, repair, or have other expenses, then we should also add that cost to our reserve or better yet, we can even start saving those funds separately to cover the expense. So if we know that we’ll need to update the HVAC next year for $5K then we should save for our 6-month cash reserve plus $5K. “
A vacation rental home can be a great investment that leads to financial security. The secret is to treat the home’s finances as you would any other business – in the long run, you’ll be grateful you did.