A Second Home
Pleasure? Investment? Think It Through
Boomers considering purchasing a home away from home may want to start the process by asking why they want to buy it, say financial planners.
As it happens, many consumers are asking that question and arriving at a suitable answer.
The number of annual second home purchases rose to 359,000 units in 2001 compared with 264,000 units in 1991, according to a survey released by the National Association of Realtors, Washington. The survey, covering the period between 1999 and 2001, found that approximately 6% of all annual home sales were second homes.
If someone wants a second home, the first step is to ask “why do you want one and what is the purpose?” says Sean Seabold, a certified financial planner with Sebold Capital, Naperville, Ill. As a general proposition, “every asset needs to have a purpose.”
The first order of business, say planners contacted by National Underwriter, is to decide whether the property is a vacation home or an investment property.
Planners should encourage boomer clients to think about how a second home fits into their lifestyle, if indeed, it does, they say.
Making sense of a second home purchase is both a lifestyle and money decision, they add, and the first step is to see if it makes sense given the boomers life and family.
For instance, Seabold says that if a boomer has a high-stress job, then a getaway home may make sense. But, if it takes hours to get to the residence, the person also has to weigh that cost since “time is a very big asset,” Seabold continues. A boomer needs to “own assets but not have assets that own them.”
And, if the client travels a lot, a vacation home may not make as much sense as it would for someone with a more stationary job, he says.
If the property is going to be used as an investment and rented out, Seabold encourages having a professional manage it.
If someone has a friend manage the property, that person runs the risk of having him or her become less of a friend, he adds.
A client who decides to treat a second home as an investment must be dispassionate, Seabold says, and objectivity can be “very, very, hard.” He suggests “not making a decision at the resort or property.”
Another suggestion is “to follow the money,” he adds, which entails making sure a client has sufficient discretionary income after accounting for funding of long-term goals and an emergency fund.
The “oops cost”–an additional 10% over and above what a boomer anticipates on spending for upkeep on the property–needs to be part of the calculation, he says. A client who is cutting finances close may want to reconsider a purchase, he adds.
If there is sufficient discretionary income, then a planner can help a client look at additional factors, Seabold adds. For instance, transaction costs are significant, so it usually is better for the purchase to be a long-term investment, he says.
Depreciation and expenses resulting from improvements to a property can offset income and therefore, taxes, he says, but the caveat is that if depreciation is taken and the market value of the property appreciates, greater capital gains will be realized at the time of sale.
More generally, according to Seabold, an investment property can offer tax benefits but should not be bought strictly for tax reasons.
More long term, an exit strategy needs to be considered for the time when “the kids are gone, and what do you want to do with” the property.
If an out-of-state property is purchased, then placing it in a land trust should be considered in order to avoid having to go through probate for the property as well as probate in the state of domicile, he explains.
Boomers who are buying pleasure homes face expenses including maintenance, taxes and insurance, says Charles Frazier of Frazier Cain LLC, Suwanee, Ga., and a former president of the Georgia chapter of the Financial Planning Association, Atlanta. “If you have a pleasure home, then it is all expense.”
Consequently, he continues, you have to make sure that you have sufficient income and cash reserves. “It is like going to a cafeteria and making sure that your eyes are not bigger than your stomach.”
For instance, he says he has one client who prepared for the purchase of a second home by reducing debt and then saving for that purchase.
When asked if prices are too heated at this point to purchase a second home, Frazier responds, “Too high compared to what? Next year? Five years out?”
Whether a client should trade up on a primary home rather than purchase a secondary home very much depends on that client, he says, adding that larger homes appreciate faster than starter homes.
Reproduced from National Underwriter Life & Health/Financial Services Edition, January 23, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.