Sometimes emotions are the motivation for getting a vacation property. I also like to judge a property purchase from a financial perspective – and that is how it really works.
The costs of shopping for a vacation property
For example, for instance the acquisition price of a property is $500,000. Whether you employ money, a mortgage/home equity loan, or a mix of each, there are other costs to contemplate.
If you purchase with money that you may otherwise invest at a 4.5% return (to make a conservative assumption), there’s a chance cost of not investing the cash or leaving it invested. If you borrow money, it’s possible you’ll incur an interest cost of 4.5%. So for simplicity, we’ll assume the chance cost or financing cost is 4.5%.
Property taxes, utilities, insurance, condo fees and maintenance could easily add one other 2% to 4% per 12 months to the fee. This cost might be even higher for an older vacation home or a property with amenities and high fees, but we’ll assume 3% per 12 months for discussion purposes.
So far, our costs are as much as 7.5% per 12 months for a $500,000 property, which works out to $37,500 per 12 months for our fictitious vacation property.
Expected returns on holiday properties
What in regards to the financial return from owning the property? Canadian real estate prices have increased by about 6.3% per 12 months over the ten years ending December 31, 2023. Over the past 30 years, the rise is about 5.1%. Some cities have seen much higher growth rates, others much lower. Prices have also dropped significantly lately. (Read MoneyDown’s guide to purchasing property in Canada.)
Over the long run, U.S. housing prices have risen only barely greater than inflation. In fact, U.S. housing prices have risen lower than 0.6% above the speed of inflation annually since 1890. Given the Bank of Canada’s 2% inflation goal, despite the recent increase in the fee of living, I’d argue that a more reasonable long-term growth rate for housing is 2% to three%.
So let’s assume that the worth of our fictitious $500,000 property increases by 3% annually, which can be $15,000 in the primary 12 months. This signifies that the web cost of owning the property in the primary 12 months is 7.5% (or $37,500) minus 3% (or $15,000), for a complete of 4.5% (or $22,500).
Buying or renting a vacation home
If you might be considering purchasing a $500,000 vacation property and imagine my assumptions are reasonable, it’s essential ask yourself: Will you have the ability to make use of the property for $22,500? Could you rent a comparable property for lower than $22,500 per 12 months for the time you intend to make use of it? If so, purchasing a vacation property will not be the perfect financial decision.
