October 12, 2021
Taking a step away from prognosticating on markets; let’s consider vacation homes. It’s arguably a more fun and enjoyable topic for most people.
As with most decisions, I want to consider the motivation that drives someone to purchase a second home. Personally, we have been to many nice parts of the world, and we have often considered buying a second home. There are no correct answers on whether to make such a purchase, but I think there are considerations to be made that many of us often ignore.
First if you are retired, or plan on retiring to a community where you will spend three to six months per year, and/or the purchase price of second home won’t have a material impact on your wealth, you can stop reading now. It probably makes sense to buy a second home if that’s what you desire.
However, if you are buying a second home for the following reasons:
1) I always wanted to own a second home.
2) I will rent it out for income, and it will pay for itself eventually.
3) My kids will use it, and we will all get together there in the future. We love it there!
4) I think it will be a great investment.
5) I will be happy because that is my happy place.
Maybe it’s worth considering whether a different and more simplified strategy makes more sense.
Let’s address the five reasons:
1) What do you like about a second home? We all love a nice relaxing vacation, and we all love a good fantasy about owning a piece of paradise, but:
a. You own all the maintenance and management costs.
b. You pay the taxes, association fees, and realtor fees if you are renting it out.
c. You will spend time dealing with any issues pertaining to the property.
2) If the property is costing you money, what’s good about that?
a. Under certain circumstances, you cannot claim a mortgage interest deduction.
b. High demand for your rental property often coincides with times you want to use it.
c. You have to pay for insurance and cleaning services too.
3) Your kids might come, but they may not.
a. Life changes, tastes and interests change.
b. You may not want to be tied to this location; you may want to experience a new place.
4) It may or may not work out financially.
a. Unless the house earns positive cash flow (positive annual return), your house is essentially an expense. If it’s an expense, you should make sure that your spending discretionary income on things you like most.
b. Houses are illiquid assets, vacation homes usually more so. Therefore, your returns should be higher than a diversified liquid portfolio of equities, fixed income, REITs, etc.
5) It may suck your energy away from what makes us happy about a family holiday in the first place. Which (I believe) are:
a. We want to spend quality time with our loved ones.
b. We don’t want to be overly encumbered with life’s distractions and detractions.
The bottom line is that it is difficult to overcome the issues mentioned above. I would also add that it is a lot simpler to rent a really nice home (feel like it is your own for a while), and hand back the keys at the end of the stay without a care in the world. You focus only on the enjoyable aspects of spending time together with family and friends without the hassles of owning a home.
From personal experience, our family has done this many times, and it feels great. I am extraordinarily grateful for every holiday we have had with our children and friends. We spent many years going to Big Sky Montana, but as our tastes changed and our kids became older, Aspen, Colorado became like a second home for us. We have great friends there, and we were lucky enough during COVID to enjoy 6 weeks last winter in a beautiful home. This was secured by a good friend and excellent real estate agent in Aspen (if you want to know Aspen, PJ is the man to know). The home is very expensive to own, and it wasn’t cheap to rent. However, the rent we paid out is not nearly as expensive as it would have been if we had to pay the tax, maintenance, insurance, management, and realty fees on it for the year. Additionally, because our son is back in school physically, we cannot spend more than a week in Aspen this year. No stress: I told the owner we couldn’t rent the house this year!
We love Aspen/Snowmass, and you could argue that by renting, we didn’t get the price appreciation of an Aspen house, and now we are priced out of the market. The market there is extremely hot; supply is limited, and this is a uniquely popular town with people from many parts of the world. According to Christie’s International, the median price for single family homes is $9.5M up 27% Q1 2021 vs. Q1 2022, and the average price per square foot is $1,940. There are very few people on planet earth that can afford these prices; so, price is possibly less relevant to many of them (it’s not an economic decision for many).
Many people might say: I should have bought! Now I cannot; how silly of me!
I would argue, that’s not necessarily true; even with the benefit of hindsight (and I know how accurate we are in making decisions with the benefit of hindsight).
Why? You still haven’t overcome most of the problems in the five points above. You might argue that surely you have overcome point 4; it has worked out financially. But, that assumes you are going to be able to exit the second home market at current prices. Vacation homes are illiquid, and in Aspen it is likely to be even less liquid due to the small number of potential global buyers.
However, let’s say you did manage to exit the market and pocket 27% or maybe even much higher. I’m still not convinced it makes sense for most people.
Why? If you bought an index fund of the S+P 500 on March 31 of 2020, on March 31 of 2021, the price appreciation was over 53.77%. Much more liquid, much more diversified, and much more aligned with the growth of the US economy than buying a second home in Aspen or anywhere else for that matter. Of course, this is cherry picking time frames, but the point is:
It seems to me, far more sensible (for most people) to buy a liquid portfolio on public markets, grow your wealth over time as the economy grows, and use some of your excess wealth to enjoy luxury holidays that are stress free!
To see why, here is an over-simplified illustration:
Mr. Jones is a 50-year-old head of household, with a wife and 3 children, and they have $1.25m in cash savings.
He won’t be able to buy a decent place in Aspen at $1.25m, but there are other locations to buy at that purchase price. Let’s say the price of the home appreciates by 5%/year over the next 25 years, and let’s assume insurance, rental agency costs, and maintenance of approximately 4%/year, your expense will be roughly $50,000/year. So, it costs Mr. Jones $1,250,000 over the 25 years to own the home. At the end of 25 years, he has a home worth $1.875m at age 75 ($1.25m growth of 5%/year for 25 years).
What if instead, Mr. Jones decides to invest his $1.25m into an S+P index fund over the 25 years, and the fund returns only a 5%/year (much less than the 8% average annual return from 1957-2018 according to Investopedia). He decides to take luxury holidays (even Aspen, CO if they desire) with his family which cost $50,000/year; this ends up costing him $1.25m over the period. His S+P investment would be worth approximately the same $1.875m.
IF the results are the same, what is the point of this illustration? What does Mr. Jones gain?
He gains:
· More time to spend with family and friends without the hassles of managing a home in
another location.
· Flexibility to go wherever the family wants to go on holiday (including Aspen).
· More liquid investments allow Mr. Jones to pivot if his life or economic circumstances
change.
· Less risky investment because it’s more liquid and more diversified.
· In a deep recession, you can make a portfolio change if warranted, but you are unlikely to
be able to sell your vacation home.
I am not trying to talk anyone out of a vacation home, but I often see people make major financial decisions without completely thinking through the benefits of keeping things simple! Food for thought.
Gratitude:
I just want to say how grateful I am to have so many incredibly mutually beneficial relationships. As I seek to further August Wealth’s mission to alleviate stress for families pertaining to money and investing, there are high expectations of myself and others. I need to let all of you involved in this mission know how appreciative I am.
Thank you to my many former colleagues and market professionals around the world. Hopefully, I am providing some insight; you are surely helping August Wealth and our clients navigate these challenging market conditions.
Thank you to our team at August Wealth; without whom, we could not provide wealth and market advice that serve our client needs now and in the future. I have never been a part of a better team, and I am incredibly proud to be on this journey with them.
Thank you to Stratos and all our external partners that are providing outstanding support that helps us fulfill our mission to clients. They provide the IT security, compliance, and middle office administration with expert care.
Lastly, and most importantly, thank you to all the families we serve. Our mutually beneficial relationships make our lives richer, and that has nothing to do with money. My hope is that it creates a positive cycle of helping one another. It is a pleasure and a privilege to be a part of your lives. If there are ways we can serve you better, please let us know.
Philosophical:
A final thought on the importance of reciprocal relationships based on love and care for one another:
A friend and I grabbed coffee the other day. He has turned out to be one of the most important new friendships in my life these past few years. He is one of the nicest, most generous, and levelheaded people I know. Normally easy going, on this day he was distraught over a situation with a new neighbor, and it was clear how much distress this was causing him.
I felt his pain, and I thought how unnecessary and pointless it seemed to me that his neighbor chose a path that would suit them at the total expense of my friend. Instead of compromise and some self-sacrifice, the neighbor went around his back without discussion to further his own agenda.
My friend will move beyond the pain because he will simply give of himself to others who are willing to accept his generosity. However, the neighbor may end up with a life of suffering until they realize what they cannot see. Instead of one of the most beneficial relationships anyone could ask for, they discarded it over a silly material desire.
We have all been hurt by others taking advantage of us because they have the upper hand, more money, more privilege, more control. It never feels good; so perhaps it’s wiser to develop long term mutually beneficial relationships by being generous?
If you think you have gained something at the expense of someone else, stop and reflect; you haven’t.
If you think you have lost something (or think yourself foolish) because you have given too much to someone in order to ease their pain, stop and reflect; you haven’t! You have gained something infinite.
“Attachment is the source of all suffering.”
Buddha
Thank you
Joe
Joseph Cardello, Principal
August Wealth Advisors, LLC
The Loft, 101 Franklin Street, Suite A
Westport, CT 06880
Direct (916) 461-9451 toll free (800) 985-9477
jcardello@augustwealthadvisors.com
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