June 11, 2021
Vacation homes and rentals can provide enjoyment for you and your family and be an excellent investment when you buy them in a good location. Today we're going to talk about three different categories — a family vacation home you don't rent out, an income-producing investment, and a combination of family vacation home and income-producing rental. Each of these options has a different criterion. Let's see what they are.
1. Private Family Vacation Home
Buying a family vacation home is an exciting endeavor that can make vacationing more convenient and enjoyable. Here are some major things to consider when getting ready to shop:
- If you're still working, do you need it within a short two-to-four-hour drive? If so, start there.
- Do you live in a hot or humid state and long to escape the heat?
- Do you live in a location with frigid winters and want to get out of the snow?
- What type of recreation do you enjoy — hunting, fishing, water sports, skiing, hiking, biking?
- Do you want to be near the mountains, beach, a popular vacation destination, or the big city?
- What's your budget, and how much down payment do you have saved?
- How many square feet and bedrooms do you need?
- Do you want to be near a major airport, or will you be driving to your vacation home?
- What seasons will you be visiting? This is important to decide before you start shopping.
- Is this a home you may want to retire in eventually?
- If you work remotely, will you be going there often? If so, does the area have good internet?
- Is your ideal vacation home luxurious, rustic, remote, or near a big city?
- What type of property would you like — single-family home, townhome, condominium?
Go through this list and answer these questions. By the end, you'll have some good ideas of locations to check out.
2. Family Vacation Homes You Also Rent Out
When you're looking at also renting out your vacation home, that's where you need to consider your return on investment. For rentals, one way to gauge that is to look at the capitalization rate.
What is the capitalization rate?
It's a formula for commercial real estate that shows the rate of return on investment. It's calculated by dividing the net operating income by the property's current market value. When you're shopping, ask your real estate agent what the cap rate is of the location you're considering.
Here are five examples of popular vacation areas with high cap rates:
- Big Sky, Montana: Cap rate 9.2%
- Cape Hatteras, North Carolina: Cap rate 8.6%
- Poconos, Pennsylvania: Cap rate 8.2%
- Gatlinburg, Tennessee: Cap rate 7.8%
- Dauphin Island, Alabama: Cap rate 7.8%
One thing to keep in mind when calculating the cap rate is — the higher, the better. That's because there can be market fluctuations month-to-month, season-to-season, and year-to-year. You'll have to consider you won't be renting the property 100% of the time.
Some experts say a reasonable cap rate is 8% to 12%. But since you're also going to be using it as your own vacation home, you might just be considering the extra rent as a bonus to help cover the mortgage.
3. Investment Vacation Rental
If you want to buy a vacation rental strictly for business and you won't be staying there at all, you'll need to have your financing lined up. Down below, we talk about conventional guidelines for vacation homes.
No matter what type of vacation home you buy, it's essential to work with a knowledgeable real estate agent. That's especially true if you're buying in a popular vacation spot like Orlando, Grand Canyon, Lake Tahoe, or Yosemite. The agent will tell you more about investing in that market and connect you with property managers if needed.
When considering a property, make sure you know the rental rules for the city and county. That's vital if you're considering daily or weekly rentals or a full-time Airbnb. That's because how you're planning on renting out your property can impact what type of financing you can get.
For example, it can be challenging to find a lender who will finance a daily rental property. And, if you're thinking about buying a condo in a popular beach community — make sure to read the condo's rental guidelines. That's because your lender will.
If the condo has a main check-in desk with other one-day rentals, you could have a hard time finding a lender. This property type is often called a condotel because it's operated as a hotel with a main registration desk, and each condo unit is individually owned.
Second Home Guidelines for Conventional Loans
For Second Homes, adhere to Fannie Mae's requirements (B2-1-01, Occupancy Types):
- The borrower must occupy the property for some portion of the year.
- Only one-unit dwellings are allowed.
- Property must be suitable for year-round occupancy.
- The borrower must have exclusive control over the property.
- The property cannot be subject to any agreements that give a management firm control over the property's occupancy.
- Property must not be a rental property or a timeshare arrangement. If there is rental income from the property, the loan is eligible as a second home as long as the income is not used for qualifying purposes and all other requirements for second homes are met.
Which Type of Vacation Home is Right for You?
When you first start considering purchasing a vacation home, you might not be quite sure what you want. That's OK. Many buyers feel that way. Go through the questions above, find a knowledgeable real estate agent, and start looking.
It is essential to know that conventional guidelines are stricter when purchasing a second home or vacation home. You'll need to have excellent credit, stable income, more reserves, and a larger down payment. Plus, you may or may not be able to consider the rent income to qualify. Good luck in your search to find the ideal vacation home.
To learn more about PenFed loans or what loan is right for you: