WallStreet Your Real Estate-Post #3
The Rulebreaker-Lifestyle Properties:
Buy Soon, Buy Smart, And Enjoy Forever
Before we continue with the rules for investing, we need to talk about a type of property that require a looser application of the investment rules. These are properties where buyers need to consider loosening the rules or they’ll miss out on special times in life. Real estate is incredible if you make money on it and you can also have fun with it. If you’re so focused on squeezing every penny out of your real estate, you could miss out on the wonderful things it can do for you. If you plan and save well, there is a time and place in your life for hard working investment properties and another time and place for special lifestyle properties. When you’re analyzing your purchases, make sure you understand if you want to buy a lifestyle property or an investment property. People often confuse the two and assume that lifestyle properties can do double duty as investment properties. Sometimes they can, but often what looks desirable as a lifestyle property won’t cash flow the way, say, a triplex in the city will. A lifestyle property requires a different analysis: one balancing income potential with enjoyment potential.
Lifestyle properties are the properties that enhance your life by allowing you or your friends and family to relax and enjoy them. This type of property includes everything from your home to your second home to land with a barn where you might ride ATV’s, snowmobile, or keep your horses. These properties function to enhance your life by allowing you to gather with others for hobbies, activities, enjoy serenity and meals. If you treat your lifestyle property strictly as an investment, it takes the joy out of them. Very few families will find sanctuary in a primary home that is blandly designed with the perfect neutrals for resale. If you look at your ski house as an investment, you’ll keep it rented as much as possible and feel guilty using and enjoying it during prime winter weeks. If you focus strictly on running “the numbers” they might not justify the purchase and you’ll miss out on so much in life. Interestingly, lifestyle properties may not cash flow but in certain regions they build equity robustly over time.
My parents bought a second home when I was five. They didn’t have much money saved but they really wanted us to have a place to call home because we were moving every two years. They bought an inexpensive patch of sand in the middle of two roads on an island you could only drive onto when the tide was low. There they built a 900 square foot pre-fab home made by Acorn that was modern and looked like something Ikea would have designed. Ours was the first home on the island to have electricity and no one had cell phones or a land line. There was a phone booth about 2 miles down the dirt road and if you were walking by and the phone rang, you wrote down a message. As kids, we loved that home and as adults our fondest memories come from that home. We think our childhood was shaped more by our summers there than almost anything else. We ran to friends’ houses on dirt roads with our dog Misty beside us. We learned to catch quahogs and dug for razor clams by the water. We had no tv or internet so on rainy days we spent hours playing War or Monopoly, which usually ended in accusations of cheating, throwing the board, and storming out. We also learned how to varnish, stain, paint, winterize, and maintain the house. If my parents had focused their time and energy on buying a more sensible triplex in the city where the numbers ran perfectly we could have missed out on so much. It turns out they were able to sell it at a good profit and eventually buy a more sensible duplex when the time came but we’re so glad we had that special home when we were kids.
Your first purchase will likely be your home, which is the ultimate lifestyle property. You want to make sure you can afford it, but also that you love it and feel ‘at home’ in it. Your home is the springboard for your life’s dreams. If you treat it strictly like an asset, you could stunt your growth. I’m not suggesting that you overpay or buy something you can’t afford. I am saying it’s critical to connect with your house on a deeper level and consider both what you love and what makes sense on paper. If you have to choose between a home you love and one that’s cheaper, pick the one you love if you can afford it. If you’re living in an asset, it’s hard to relax and enjoy it because you’re always worried about preserving the asset for the next buyer. That doesn’t sound like home.
Your second purchase could either be an investment property or a lifestyle property and possibly both, if you buy smart. If you’re young and don’t have children or a lot of vacation time, you may want to lean toward a cash flowing investment property. This will give you the ability to buy something sensible you can later trade for a lifestyle property or more investments. Right now, the tax laws allow you to save on capital gains taxes by doing a 1031 exchange of an investment property into another rental property, which could be a lifestyle property. 1031 laws are beyond the scope of this post, but we’ll discuss them more in future posts. This investment purchase will help build your portfolio without the stress of potentially losing money each month on house expenses. You’re at the point in life where you have future years to create memories for friends and family so it’s sensible to wait a bit longer for a lifestyle property. Similarly, if you’re older or in a place in your life where you need consistent cash flow more than a place to visit, it may be wise to opt for the investment property. We’ll discuss what kinds of investment properties make sense for these times in your life in later posts.
If you’re at an age where you have multiple friends and family with whom you want to share your hobbies or even if you’re single and want better access to these hobbies, a lifestyle property may be the way to go. Some hobbies, like skiing, mountainbiking or surfing, are more enjoyable when you’re younger. You don’t want to wait until your knees or shoulders are ready to give out to spend a lot of your time doing them. Other hobbies like fishing, golf or boating may mean that you can wait longer to buy a lifestyle property. If you have a young family or young grandchildren and you want to start creating memories for them, it makes sense to consider the pros and cons of a lifestyle property. If you pay cash, lifestyle properties will often provide you with some cash flow even though they may not provide as much cash flow as an investment property. If you need to get a loan to purchase your lifestyle property you may end up with negative cash flow so make sure you consider all the costs if your budget is tight. There are some tax benefits to owning a lifestyle property so make sure you talk to your accountant to fully understand how your lifestyle property will cash flow. Markets and rentals fluctuate with lifestyle properties, so examine your finances to ensure they can weather these changes.
If you do buy a lifestyle property, even if it doesn’t cash flow the way an investment property will, it could build equity faster if you buy the right one. This means that the cash in your pocket when you sell could be greater than when you sell an investment property, even if the investment property had lower carrying costs. This doesn’t always happen but buying smart will help you make a sound lifestyle property purchase. Making sure you can weather market fluctuations will also mean you’re not forced to sell in a downturn so you can continue to build equity.
When buying a lifestyle property, there are several things that will help you build equity. Scarcity and a prime location help build property values over time. Your primary targets should be properties that can’t be easily duplicated. Look for properties with epic views, easy water, golf, or ski access, unique amenities, walk to town or other desirable features that can’t be copied. Look in areas where it won’t be easy for developers to build properties that compete with your property. If there is vacant land near your property that is developable, that could mean developers will build competitor properties. If you can, try buying in the best location for your purposes. This means buying near the best location for your desired activities – the best beach, ski resort, golf course, etc.. If you buy a uniquely amazing property in a desirable location and you plan to hold it for at least five to ten years, there is a high probability your values will go up.
Things to consider
There are a number of questions you’ll want to consider when looking at a lifestyle property that you rent out versus a primary or second home that you don’t rent out. If you love the property, you can loosen the investment rules and it doesn’t have to cash flow (if you can afford that) since you may build equity in it. There is no guaranty that it builds equity and it could lose value if you’re forced to sell it, so make sure you consider that possibility. Regardless, you’ll want to ask certain questions so you can make an informed purchase.
Here are several questions to consider when buying a lifestyle property you’ll rent out:
- Do you like to return to the same place year after year or do you prefer to explore new places each year?
- How many seasons will your property be rentable? People often focus on the number of days a property can be rented, but annual net rental income (your profit after expenses) is what’s really important.
- How much does the property potentially generate in gross annual revenue?
- Does your rental rate vary per season? Are you likely to want to use it during the ‘high season’? If you plan to use it during the high season, how does that cut into your profits?
- How do you feel about people using your vacation home?
- Are you considering buying in a party town or somewhere quieter? If it’s a lively place, be prepared to take high security deposits.
- Is it furnished ‘turn key’ for rentals with linens, kitchenware, towels?
- Do you like the furnishings and are they in good condition and up to date?
- Can you replace furniture and other items easily long distance?
- How will you handle carpet, appliance or tv replacement long distance?
- How will you handle repairs long distance?
- Do you mind working on certain aspects of the property when you’re on vacation?
- Do you have a reliable property manager?
- What are the services and what is the fee charged by the manager?
- Is the management company reputable?
- Do they have a track record of good management and do you have references?
- Do you want the management company to rent out the property for you? If not, do you have the time, patience, and skill to rent it out yourself?
- Are they able to compete with other management companies and keep your place rented?
- How desirable is your property compared to other properties they manage?
- Does your property have amenities, a view or proximity to desirable destinations that will set it apart from other properties?
- What are the costs of utilities, HOA dues, taxes, management fees and any other expenses vs. the average rental income? Remember, even if you break even or go into the red, you’re saving money on renting another vacation home and if you buy smart, you could be building equity.
- What are the tax implications of owning a lifestyle property that I rent out? Make sure to talk to your accountant to fully understand the numbers.
If you analyze a lifestyle property like an investment you may never buy it and you’ll miss out on summers at the beach or winters in the mountains or a beautiful primary family home. We know a lot of people who have missed out on their dream properties because they thought they could outfox the market and buy when it tanked. They’re still waiting, now five years later, and the best years of their lives are passing them by. Loosen the investment rules a bit when you’re analyzing lifestyle property purchases and look at your time of life. That way you’ll have time to enjoy it when you, your friends and family are young and healthy.
In the next blog post, we’ll learn to make an informed choice and move forward. The rule for investing states, “make an informed decision” and I added “and move forward.” So many people get stuck in the research phase they don’t buy anything and lose out if the market keeps climbing. As in the stock market, there are risks with real estate. Unlike the stock market, those risks are compounded by the amount of money it takes to buy a property and the amount of effort it takes to manage it. It’s critical to have the power of knowledge when you’re making this important decision. I’ll teach you how in the next blog post.