Passive income is the holy grail of money-making. Described as making money in your sleep, financial experts continuously advise on the importance of creating passive income streams, especially in retirement. What is the biggest trend in passive income for retirees right now? Rental properties.
Twenty years ago, owning rental properties meant renting the side mother-in-law house to a college student or buying a house near a good elementary school then renting it to a family. These days, with the skyrocketing rise in short-term vacation rentals like Airbnb and HomeAway, the biggest return for your retirement dollars is a vacation rental.
The growing popularity of vacation rentals has changed the way buyers are investing their real estate dollars. In 2004, only 7 percent of vacation home buyers said the primary reason for their investment was to rent to travelers, according to HomeAway. Today, 23 percent of those buyers say the number one reason they purchased a second home was to start a vacation rental business. What is the reason for the sudden shift towards renting one’s vacation rental? Because the supply of vacation homes is having a hard time keeping up with the demand.
More and more travelers are choosing a privately owned home, apartment or condominium as an alternative to a hotel to save money, while at the same time getting a more authentic experience with their travel destination. Since 2010, the vacation rental market has tripled and 82% of vacation rental guests plan to stay in a vacation rental again. Experts predict vacation rentals will topple the hotel industry in the next ten years.
Demand for vacation rentals surpass supply across the board, but even more so in popular vacation destinations like Florida, Las Vegas, and New York.
Retirees are meeting this increase in demand and creating an income in retirement by renting out their vacation home. In general, real estate is smart revenue generator during retirement, but with a $193 billion industry and growing, vacations rentals are as close to a bulletproof retirement investment as it gets.
About 16 percent of vacation home buyers bought “for future retirement plans,” according to NAR.
A vacation rental can be the perfect retirement investment, a little slice of paradise that can serve as both a getaway spot and a source of income in your golden years. But every vacation property and financial situation is different, so it’s crucial to do your due diligence before you sign on the dotted line.
Little time and energy are required to create this retirement income. The average vacation homeowner puts in 10 hours a week working towards the booking of their property. From that effort, they gross $28,000 in annual income for their rental or $54 per hour. Not bad for a retiree. With the advances in technology, managing vacation properties remotely while visiting grandchildren or enjoying an extended road trip is as simple as having a laptop and a good internet connection.
However, managing a vacation rental is not something everyone wants to take on in their golden years, says Mark Painter, founder of investment advisory firm Everguide Financial Group, who owns vacation rental investment properties.
“A vacation rental property can be a little tricky,” Painter says, noting that vacation rentals have frequent turnover of tenants compared with residential rentals, where you might have the same tenants for a year or more, and with commercial rentals, which might have a five- or 10-year lease.
For retirees who do not want to put the extra time into their homes and guests, property managers are a great go-to resource.
Renting one’s vacation homes during retirement also comes with tax advantages. Claiming depreciation of the rental property, but not the land, decreases the tax burden each year. That depreciation is recaptured if the vacation home is sold. If the property is never sold, however, the depreciation goes away upon the owner’s death.
Renting out a vacation home does not mean retirees cannot enjoy their investment. The average vacation rental is booked 18 weeks per year, leaving a large amount of time for owners to personally enjoy the property and their retirement.
Vacation rental retirement investment tips
If you’re considering purchasing a vacation rental as a retirement investment, here are five tips to help you make a wise decision:
- 1. Pick the right property. The vacation rental you choose must make sense from a financial perspective in order to be a good retirement investment, Painter says. Location is key, so do your research on which areas make the best bets for vacation home investments. Want ideas? Consider Sarasota, Florida, Asheville, North Carolina and San Luis Obispo, California. Look at median home prices and median rent in each area. And remember that if you plan to manage the property yourself, it should be fairly close to where you live, Painter says. If the best market is farther away from your home consider using a reputable property manager.
- 2. Crunch the revenue numbers. Before you buy, you need to do the math. If you have historical rental and revenue data, that will give you the best picture of how the property will likely perform, Painter says. If you don’t, look at rental rates for similar properties nearby, and use a conservative estimate of occupancy, he recommends. When Painter was considering buying a beach home in New Jersey, he found he could bring in double the total yearly mortgage just by renting out the property for the summer. Then he could stay there in the cooler months when it was still nice and less crowded. “For me, it was a no-brainer,” he says.
- 3. Decide on management. In Painter’s practice, he’s seen clients enthusiastically purchase a vacation rental that they plan to manage. However, trying to DIY when you’re retired can add up quickly. “It can get cumbersome to keep up with constantly renting the place.” In addition to saving you time, a property manager can expertly market your property, dynamically price your rental, and convert guests at a higher rate which increases your revenue despite commission.
- 4. Compare to other investments. It’s also important to factor in the cost to maintain the property, including buying items for the home and replacing things that break. When you have all the numbers in front of you, look at the expected rate of return on your investment. Compare it across assets, Painter says. “If it’s 10 percent, it’s pretty attractive compared to stocks, bonds, other things you could invest money in, Painter says.
- 5. Get expert help. When 57-year-old PR agency owner Frank Groff decided to purchase a beachfront condo as a retirement investment in Kauai, Hawaii, he wanted to use funds in his self-directed IRA. He hired a financial adviser who helped him navigate the many rules. For example, he isn’t allowed to stay in the condo, ever, because he purchased it with the IRA. He must pay all expenses out of the IRA, and all of his profits have to go right back into his IRA. A fiduciary handles the paperwork, he says.
“The right property in the right location with the right managers is always a good consideration, especially if it diversifies your income stream,” Painter says. If you’re considering purchasing a vacation rental, getting help from a knowledgeable property manager can give you a leg up.