Over the last month or so many readers took some time off on holidays.
While having a great time in the sun by the sea, some would have been considered buying a holiday home or apartment.
Many think they can get the dual benefit of a rental income and a free holiday.
I would be cautious about buying a holiday home.
Make sure you are purchasing with your head and not just your heart.
Many investors kid themselves and tell their friends and family that they bought a holiday home for financial reasons, when, in reality, the main reason was lifestyle.
Most people fall in love with the idea of owning a holiday apartment and few pay much attention to the investment fundamentals.
So, just as before you would jump into any investment, ask yourself two simple questions:
1. Why am I buying real estate in the first place?
2. What end result does this particular property need to produce for me?
Make sure you are buying with your head and not just your heart
If you are looking at buying a holiday home, either to let out for part of the year or as a permanent rental, let’s take a look at the pros and cons of investing in holiday properties…
1. Ensure you purchase in a prime location
During the good times, all holiday properties perform well, but in the not so good times, secondary locations may suffer from low occupancy rates.
When selecting holiday investment properties choose a prime location with beach views near all the ‘must haves’ such as restaurants, cafes, shopping centers and tourist hotspots.
Buy in a town or city that has major infrastructure nearby otherwise you run the risk of fluctuating occupancy rates between peak periods.
2. Understand how holiday rentals work
Rental returns can fluctuate widely for holiday homes.
In many coastal spots, the average period of strong demand for holiday rentals is 8 to 10 weeks a year with demand plummeting during winter.
Particularly in Australia’s southern states.
Demand is more consistent for holiday properties in warmer locations but only for prime properties.
Proximity to the beach and a sea view make a big difference when it comes to success with holiday letting.
If you buy a property further back from the beach maybe you should consider a permanent tenant rather than holiday letting.
3. Choose self-contained
Many holiday apartments were built for short term rentals and have small rooms.
While smaller or motel style apartments may yield a higher rental return on purchase price, you should choose a self-contained apartment with larger rooms and a separate kitchen, laundry, bathroom and bedrooms.
In general, this type of property should give you better capital growth and the option to move in yourself if you ever decide it’s time for a change of life style.
4. Look for professional management
With management rights of holiday apartments often being sold to recently retired couples or a superannuation payee seeking a job in retirement, ensure the management of the complex you are considering has a strong track record in apartment complex management as well as a comprehensive understanding of the highly competitive holiday accommodation market.
An experienced and professional management team could make the difference between an empty and occupied apartment.
5. Do your sums
Holiday rentals are usually much higher than those for normal properties and increase even more in peak season.
This may make the initial sums for holiday properties look great and many are touted to return positive cash flows.
But you will need to allow for longer vacancy periods and fluctuating occupancy levels from season to season.
This coupled with higher body corporate and management fees compared to regular developments means holding costs may be higher than you initially estimated.
And remember that every week you stay in your holiday property is a week’s less rental income you will receive.
And the times you would usually like to stay in your apartment will be the times that most other tourists want to stay there too.
Multiple tenancies in peak holiday periods means you are likely to have much higher property maintenance costs in your holiday property.
You need to budget for the replacement costs for appliances such as fridges and washing machines which break down frequently in hot weather and peak periods.
The annual maintenance cost (excluding body corporate fees if they apply) for holiday properties is often about 4% or 5% of rental income.
And the cost of property management is higher for holiday properties often in the order of 15% of your rental income.
Nowadays You also need to provide household items that were once considered “extras” that are now viewed as essential by holiday tenants.
Things like air-conditioning and barbeques as well as DVD players and Foxtel.
6. More volatile property values
The values of properties in holiday locations tend to be volatile.
They boom in the good times and prices crash in the poor time.
During recessions, property slumps or even just generally quieter economic times, holiday homes are high on the list of expendable assets.
They are one of the first things owners will consider selling if they are going through hardships.
Even in boom times, regional properties can take longer to sell than their city properties and even in good times regional and coastal properties generally take longer to sell than their metropolitan counterparts.
Figures from Australian Property Monitors show that the average time on the market for a property in the 6 months to December 2006 was 239 days at Queenscliff on Victoria’s popular Bellarine Peninsula and 206 days at Bowral in the NSW Southern Highlands.
Most investors should be looking for properties with stability, not the volatility offered by holiday homes.
7. Tax implications
When buying a holiday home and rent it out, you must declare the income in your tax return.
If you use your property for your own purposes for part of the year and then operate it as an investment property for the rest of the time, you will need to convince the Tax Office that the property is a genuine investment.
While you should be able to claim deductions (including interest expenses) for any times that you have rented out the holiday home, these must be proportioned according to the time it was rented out and the time used for your own personal use.
Unless the holiday home is your main residence, you will most likely have to pay capital gains tax when you sell it or transfer it into someone else’s name.
And while traveling expenses to inspect and maintain commercially let holiday properties are allowable as income tax deductions, don’t assume you can deduct the cost of your flights to and from the Gold Coast to “inspect” your property.
The cost of travel is not allowable as an income tax deduction if your traveling is associated with your personal use of your property or simply with the general maintenance of it.
The good news is you get high depreciation allowances on holiday houses.
That is because some short stay accommodation qualifies for 4% depreciation for 25 years compared to the standard 2.5% for 40 years.
To be eligible, your apartment must meet certain criteria including being available for overnight stays and your apartment complex needs to provide a common dining facility.
If you’re a first time investor who requires consistent returns and good capital growth, stay away from investing in holiday accommodation.
On the other hand if you are an experienced investor looking for diversification in your portfolio and lifestyle is an important consideration for you, holiday accommodation is worth thinking about.
The problem is that you will find that the price boom of the past decade means that many prime coastal spots are beyond the reach of many investors.
Many properties in these areas have been bought up by Baby Boomers who want to retire or take a sea change.
They want to stay within 3 or 4 hours of major cities and they don’t want to move too far from access to their children and grandchildren.
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