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There is a lot to consider before buying a second home, well beyond the costs of the mortgage and interest rate. Partner F. Michael Zovistoski explains how he helps clients decide if it's a good financial decision and prepare for the long-term investment.
Q: Many high net worth clients are “snowbirds,” maintaining seasonal homes. Others maintain second or third dwellings to rent out via AirBnB or otherwise. When and for what type of client is owning multiple homes a good or bad idea?
Zovistoski: Owning a second home is not something that should be taken lightly, as it is a sizable commitment. Real estate is not a highly liquid asset, meaning it will take time to convert into cash, should the need arise. Having real estate in multiple states may also complicate estate planning, as each state is looking to exact their fair share of estate tax from their high-net-worth client.
Maintaining a second home from a distance can also be complicated. Clients need to build a network of trusted laborers to take care of routine and emergency repairs (landscaper, plumber, electrician, general contractor, etc.). Additionally, these tradesmen need to gain access to the property when nobody is home. Consequently, the services of a property manager or property concierge may also be needed.
Maintaining a second home is expensive, so clients looking to own a second home need to have disposable income and sufficient liquidity in their portfolio to maintain the property as needs occur.
Q: When is it better for clients to take a long-term lease on a second home instead of buying?
Zovistoski: Many individuals go on vacation and fall in love with a particular location or community. At this point, they can imagine spending a significant amount of time enjoying the area and may be impulsive enough to consider buying a house. On the other hand, an individual may have found the perfect location but is hesitant to pull the trigger. In both cases, taking a long-term lease may be the solution. A long-term lease provides the time for the individuals to objectively evaluate the location, experience the seasonality of the area, meet, and explore the community to gain confidence in the area before making the big purchase.
Q: What should clients keep in mind about a second home when they are not occupying it? What are the pros and cons of renting it out?
Zovistoski: Security is a major issue when not occupying a property for an extended period of time. To prevent squatters or theft, a good security/fire alarm system adds peace of mind to a homeowner. Once the property is secure, the client will need to be able to monitor the property remotely to prevent damage. This would include smart thermostats to monitor the heat and humidity, and water leak detectors to automatically shut off water from a remote location, should a pipe leak or burst. Now that the interior of the house is secure and monitored, outside security cameras and friendly neighbors are critical tools in monitoring the grounds.
Renting a property can provide additional cash flow, but also brings in a whole host of concerns. First, we recommend placing the property in an LLC to protect the high-net-worth clients’ other assets. Should someone get injured on the property more than insurance may be needed, an LLC can help insulate the balance of the owners’ assets. Second, you cannot count on the rental income, as houses tend to need renovations and may be off the market for an extended period. The client needs to have adequate resources to afford the second home without the need for rental income. Third, guests or tenants will probably not treat your property in the same manner as you would, therefore expect higher wear and tear on the property, which could result in additional maintenance costs. If a tenant does not find the house to their liking, they may request a discount or refund. Operating expenses, such as utility and insurance costs can also increase. Four, all personal items such as clothing, toiletries, and food items (as guest may have allergies) need to be stored and locked away. Bottom line: renting a second home sounds easy but takes a lot of patience and planning.
Renting a property can also sustain income tax implications. We recommend setting up a separate bank account and using separate credit cards to account for rental income and operating expenses. The IRS publication 527 provides direction as to what are allowable deductions that can offset rental income (including the rental of a vacation home). These deductions, including depreciation, are prorated between business use and personal use. The business use portion is allowed to offset rental income. Unless the taxpayer is a real estate professional, any losses on the rental property are suspended and carried forward to future years.
Q: How much does the location of the second home matter? After all, different states have different property & taxation laws and insurance issues, right? Also, as clients age, is it unwise for them to reside even part-time in a remote location far from family and medical care?
Zovistoski: As the famous quote goes: “The top three keys to success in real estate are location, location, location.” Location matters if you are selling or renting the property. Location matters if you want friends and family to visit the property. (I have a client with a vacation home/rental property in Uruguay. It’s a beautiful place but takes a while to get there.) Many clients look for second homes near their children and/or grandchildren. Access to medical care is important, but if the second home is near a quality medical facility, today’s medical records can typically be accessed electronically, allowing clients to coordinate care between doctor groups in various locations. Finding the right location is more important than finding the perfect second home.
As clients age, many look to move to a single-floor home. When buying a second home, consideration should be given to accessibility and single-floor second homes or homes with an elevator may be necessary.
Q: Other considerations before clients take the plunge?
Zovistoski: Other considerations include the cost of insurance, if the second home is in a flood zone or beachfront. Some states tax personal property, so care must be given to notify various government agencies of the change in ownership. As noted above, real estate in multiple states can complicate estate planning and filing.
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