Analyzing Short Sale Investments
I hesitate to use the word "investment" to describe a vacation home purchase. I doubt many vacation homes, when the costs are accurately tallied, make their owners money. Nevertheless, you can and should financially analyze the vacation home purchase decision using a simple formula: the equivalent nightly room rate formula.
To use the equivalent nightly room rate formula, you total up the annual costs of owning a vacation home, adjusting for any income tax savings stemming from the mortgage interest and property tax deductions.
After you have the total annual costs value, you divide that value by the number of nights you'll use the property. The formula result shows you the per night cost of the vacation home and, conveniently, can be compared to what you'd pay for a hotel room or suite.
Suppose, for example, that you're looking at a buying a golf course bungalow in Palm Springs for $200,000 using a 4% interest-only mortgage. Table 1 shows and explains the annual costs of ownership and adjusts for the tax savings. In this example, the total annual costs of vacation home ownership equal $20,000.
|Description of cost||Amount|
|Mortgage payment (interest-only mortgage)||$8,000|
|Annual property taxes||$4,000|
|Homeowners association dues||$6,000|
|Utilities, homeowners insurance, repairs||$5,000|
|Less: Tax deduction savings (assumes 25% marginal tax rate)||-3,000|
|Total annual costs of owning golf bungalow||$20,000|
Table 1: An example worksheet that calculates annual vacation home costs.
With the total annual costs of vacation home ownership, you can easily calculate the effective "nightly hotel room charge" you're paying for your bungalow. If you can use the bungalow 40 nights a year, you're paying $500 a night for your lodging: $20,000 divided by 40 equals $500.
So is a $500-a-night vacation home a good financial decision? Well, that's up to you. But with the second home's cost expressed as equivalent nightly room rate, you can easily compare its cost to a room or suite at a hotel or resort complex. What you want to do is make sure the equivalent nightly room rate is at least close to or, ideally, less than what you'd otherwise pay for a room.
And a couple of other comments in closing, too.
First, the nightly room rate is very sensitive to the denominator, which is the number of nights you use the property. If you use your $20,000-a-year golf bungalow for only ten nights a year, you're paying $2,000 a night. Ouch. For sure, owning your own place doesn't make sure in this situation.
On the other hand, if you're staying someplace 200 nights a year, well, that's $100 a night and probably $100 a night is a pretty good deal.
Second, if the vacation home property goes down in value that obviously means there's an additional cost of vacation home ownership: the money you lose at resale. However, with the large short sale discounts now available, it seems very likely that you will not lose money. And if you do make money, that profit will in effect drop your effective "nightly room rate."
A $200,000 golf bungalow might really be worth $250,000 in a traditional sale, for example. If you own such a property for ten years and the short sale discount goes away over that time, you might make back $50,000 over ten years. That's $5,000 a year. And that obviously drops your annual ownership costs by $5,000.
I personally would not count the discount as a reduction in the annual cost. But I do think you can use the discount as a "nudging factor" or "tiebreaker."
If everything else about the finances of buying a vacation home work for you and you're at the point of trying to determine whether or not it makes sense to buy a short sale property, you can look at the discount as a mild, extra financial benefit that will probably make the deal a little better than the formula results show.
Next Sectiion: Analyzing Rental Property Investments
Additional Information for Shortsale Investors
If you want additional information about how tax laws work for a short sale investment or for an individual running a business based on short sale investing, you may also be interested in one of my downloadable e-books shown below:
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