It’s summer and hopefully you’re kicking back somewhere, recharging the batteries with plenty of blue sky and sunshine. It’s at times like these, perhaps strolling along the beach with our partner, nothing urgent to be done and plenty of time to think, that the thought might pop into our head “wouldn’t it be great to spend more time here. I wonder what it costs to buy a holiday house?”
Conveniently, real estate agents will have their windows brightly broadcasting all the various potentials to satisfy your desire. As a Financial Autonomy listener though, you are likely the prudent, perhaps even cautious, member of your little tribe, so perhaps your mind might turn to the factors that ought to be considered when contemplating a holiday home purchase.
Over the years I’ve worked with many clients who purchased holiday houses, so this week I thought I’d share with you a few of my observations.
Before we dive in, a quick shout out to the crew at Ambulance Victoria. I heard through the grape vine that we’ve been getting a bit of a mention in your group chat. Thanks for listening, and thanks for all the hard work that you and your counter parts around the country do, especially at this time of year.
The first logical filter is, can you afford it? A holiday houses is clearly a nice to have, not a must have, so it’s something you would only take on once you had your home comfortably secured. Ideally that would mean fully paid off, but depending on your income levels and overall balance sheet, it may just mean a low level of debt relative to the value of the property.
You are likely to be borrowing to buy this property so start by determining how much a month surplus income you have that you could put towards this new mortgage. With this figure agreed upon, use the mortgage calculator in the MoneySmart website to reverse engineer how much you can afford to borrow, and therefore what you can afford to spend on a holiday house.
Given you will have significant equity in your home, it may be that you could borrow 100% of the value of this property, so a deposit need not be required.
A common approach when considering the affordability of a holiday home is to assume it will be rented out in the early years, until the debt is reduced to a manageable level. The rise of Airbnb has made this type of short-term rental much more viable.
This approach can work very well for properties in the right location. I have a client with a property in Bright that is booked out pretty much year round. However I have other clients whose properties rarely get booked because, whilst they are lovely and peaceful, they’re also quite remote, with little around them to draw people in. Or alternatively I’ve seen owners of holiday homes in areas where the supply is just enormous, such that whilst it may well get rented in the peak summer period, it produces negligible income for the other eleven months of the year.
Be very cautious then in your sums as to how much holiday rental income your property might bring in. If going down this path, you need to allow for significant cleaning and agent costs, plus additional wear and tear on the property and its fittings. Layer on top of this the increase in propensity for state governments to add taxes to short term rental properties, and it’s quite possible your holiday house will become considerably less profitable than it perhaps first appeared.
Another significant factor when it comes to affordability, is the increasing impact of land tax around Australia. From a social equity point of view, land tax does make sense, insofar as if someone has the wealth to own a second home, it’s perhaps reasonable to ask them to contribute a bit more to society. When you’re the owner of the property though, and get a bill for thousands of dollars, this social justice might feel a little tough to swallow.
When assessing your affordability, you will need to consider how owning this holiday house will affect your normal holiday spending. It would be reasonable to assume that your normal holiday costs would reduce, as you would be staying down at your holiday home rather than travelling elsewhere. Presumably though you’re not always going to want to go to the same destination for your holidays, so you just need to weigh up how that might play out over the longer term.
Assuming you can get yourself over the affordability hurdle, you now have exposure to another significant asset, and likely geared exposure at that. Capital growth in this circumstance could have a very meaningful impact on your overall wealth. I’ve certainly seen many examples of people purchasing holiday houses along the coast decades ago, having a fairly basic dwelling on the property, enjoying it with the family for many years, and then discovering somewhere around the point of retirement that the value of the holiday house is now more than their primary home. Such an outcome is far from guaranteed of course, and it usually only happens after extended periods where the value of the property goes absolutely nowhere. But nevertheless in comparison to normal holiday spending, money plowed into paying off a holiday home does have a potentially attractive long term financial outcome.
Given this potential upside, another thing for you to consider is the appropriate ownership of the property. Should it be in joint names, one of your names, or in a structure like a family trust. You should get specific advice on this applicable to your particular circumstances, but the balance to be struck is between the potential for negative gearing if this is a property that you’re going to have available for rent the majority of the time, versus capital gains tax when the property is sold. If the property is likely to work as a negative gearing vehicle, then it would make the most sense to have the ownership in the name of whoever currently pays the highest rate of tax. However if you expect the property to be positively geared, or alternatively sold down the track triggering capital gains tax, then it would be best in the lower income earners name. A trust structure could give you flexibility here, however be wary of the land tax implications of this, and the additional accounting costs required to administer of this structure. Very often the costs outweigh the flexibility benefits.
I’ve seen several instances where the holiday home is used to facilitate a move in retirement. Most frequently I see this play out as the holiday house getting knocked down, and a new long-term home being built. This can be a great outcome. The couple entering retirement have the excitement of designing and building a home that is specific to their and their families needs. They’re familiar with the area, know the neighbours, and understand fully what they’re getting into. They can sell their home in the capital city, capital gains tax free, potentially using the downsizer contribution rules to give their superannuation savings a boost. The block of land is frequently bigger than the suburban property too, which gives room for the grey nomad caravan or any other hobbies they might like to pursue.
Holiday houses can produce wonderful family memories and be a good financial move as well. As with any investment though, pitfalls exist, and in a transaction like this where borrowings are involved, you need to be cognizant and realistic about the risks involved.
