Can I Afford a Vacation Rental Property?

Owning a vacation rental is a big decision. Yes, you would have a new source of income, you’d be building equity as a homeowner, and you would have a great house to escape to when you need a little bit of rest and relaxation. But a vacation rental property is also a big expense, which forces you to ask yourself the question – can I actually afford a vacation rental home?

“Many people buy vacation homes thinking their monthly expense will be the mortgage and taxes, and HOA fees if it’s in a condominium community,” says Flavia Berys, a real estate broker and attorney. “But buyers need to also factor in utilities like water, electricity, and internet service, television services, repairs, maintenance, and insurance. These can add up quick on a monthly and annual basis.”

How much does a rental property cost up front?

A vacation rental property’s cost can vary depending on what type of property you’re buying and where you’re buying it. A 2-bedroom condo in Nashville will most likely cost less than a 5-bedroom, beachfront house in Miami. When you’re choosing where to purchase, think about where you will see a lot of occupancies, but also consider the fact that you might be using this property every once in a while too. Choose a property and a city that you will enjoy and want to escape to. You can also talk to a local realtor to learn more about the market. Ask them if the area sees a lot of people traveling for business or work. Make sure you also check any HOA rules and regulations for any property you’re seriously considering. Some HOAs might have restrictions about how long you’re allowed to rent the property.

When you buy a property, your upfront costs are your down payment, initial repairs, and closing costs. Remember that for investment properties, you might need a larger down payment. For a primary residence, you can typically get away with a 3-5% down payment, but if you’re buying a home to use as a rental property, you’ll need about 20-30%. Credit score requirements can also be higher for a vacation home than a primary residence.

Sit down and determine the most amount of money you’re willing to spend up front. This number will help your realtor and mortgage broker figure out what the total cost of your home should be so you aren’t looking for properties that are way out of your price range.

How much will my vacation rental expenses be?

A vacation property is a luxury, and it should not be prioritized over your overall financial well-being,” says Eric Vallee, a financial planner. Having a 20% down payment plus closing costs up front is important when purchasing a property, but you also need to consider the recurring expenses of actually owning a new home. Vallee recommends thinking about your other monthly expenses before purchase. Do you contribute to retirement or pay your student loans each month? You’ll need to think about how owning a vacation rental property will affect those other financial goals and responsibilities you have.

Ideally, your property should be cash flow positive year-round. However, there may be some months of the year where occupancy may be low. When this happens, you’ll still need to be able to cover the mortgage and other monthly costs of the home. To figure out if the home and it’s associated monthly costs will be affordable for you, first start by calculating what those costs are (mortgage, HOA, insurance, utilities). Remember to count any miscellaneous items you might need to restock from month to month, like spices, towels, and soap. Also factor in any rental income you would be making and the tax you would owe on that (more about that later!).

“If it will cost you $2,000 per month, start setting aside $2,000 per month in a separate savings account,” Vallee says. “It will tell you whether or not you can consistently cover the carrying costs.” Once you’ve done that for several months, you can then use that money you’ve been saving to help fund your downpayment and closing costs.

Do I need to have an emergency fund for my vacation rental?

Yes. Things break. It’s a fact of life for homeowners. In your vacation home, appliances may stop working, the roof might leak, or a pipe could burst. If this happens, you’ll be expected to fix it. “Depending on the cost of the property, budgeting an additional 1-5% of the property cost per year to put toward capital costs may be a good rule of thumb,” says Vallee.

Another cost that people often forget about is furniture. You’ll need to invest in furniture for every room in order to make your property shine in listing photos. Start saving furniture you like on Pinterest or in a Bookmarks folder and keep a tally of how much it’s all going to cost.

Does insurance cost more for vacation rentals?

When it comes to risks, you also need to think about the cost of insurance. Insurance for rental properties can be higher than for personal residences. Some homeowners insurance policies may have a business exclusion built into the policy, so if you’re running your home as a business, they can deny your claims. Look into a commercial insurance policy instead. These are designed for properties that operate as businesses and provide more protection. You might also need to add-on supplemental insurance (like flood insurance) depending on where your property is located.

To find the right policy for you, meet with a few insurance agents in your area who specialize in vacation rental insurance. Ask them what’s covered with different policies and what insurance might cost for your potential property so you can budget accordingly.

Many cities also require permits for vacation rental properties. Some places might also have you to register your home as a business before you start renting it out. Both permits and registrations typically have upfront costs, so we recommend researching your town’s specific laws before purchasing a home.

What is your time worth?

“The other item I would encourage people to consider is whether or not they can afford the time,” says Vallee. “Since this is a second property, there is double the upkeep that you now have to budget your time for.”

If you’re managing the property yourself, you’ll need to factor in travel costs. Your property might be in another state, so flying to and from that home multiple times a year to maintain it can get costly. It can also be time-consuming and it might limit the number of times you can rent it throughout the year depending on how often you go visit.

If you decide to hire a property management company to help maintain your rental, the cost of that company needs to be included in your budget for the property. However, a property management company can help you manage your rental remotely, so you would cut down on costs from flying or driving back and forth. Property managers can help marketing and listing your rental, as well as with the day-to-day logistics of managing your home. They’ll manage vendors, perform inspections, keep up with local laws and regulations, communicate with guests, and more. Learn more about how we can help you manage your rental property here.

Don’t forget about taxes.

If you’re earning extra income from your vacation rental property, you’ll need to pay taxes on it. The only exception is if you’re renting out your property for less than 14 days throughout the year. When you do that, you don’t have to pay tax on any income you earned.

If you own a vacation rental property, almost everything you spend to maintain the property can be deducted from your taxes. We recommend keeping thorough records for everything and using one credit card for all business expenses to easily keep track of them.

You’ll also need to pay property taxes and any local sales or lodging taxes for your rental property. Chat with other rental property owners in the area or local accountants to learn more about the tax implications of buying a vacation rental property in that city.

Are you ready to buy?

If you’ve calculated all of the costs above and determined that you can afford a vacation rental without taking away from any other your financial goals and responsibilities, then start house hunting!

If you’re not in that financial place yet, that doesn’t mean you’ll never be able to own a vacation rental property. Use these numbers to figure out how much money you need to save and put a plan in place to make your rental property dreams come true.

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