Is owning a second house really a good investment?

 

The picture above shows my parent’s beautiful summerhouse with a 10 minute walk to the ocean – a great investment?

What you are about to read now is kind of a contradiction to what I have written before about investing in property. I would like to challenge your mind and the common “universal truth” that investing in property is a good thing…

My family has had a summer house in a popular summer vacation resort for many years: Last year my mom told me what a great investment it has been. She mentioned that she and dad bought it for 12 000 USD in 1975 when I was one year old and my sister was three years old. And now the house is worth about 540 000 USD. It sounds like a great investment, doesn’t it? At least at a first glance…

Let’s look at this a bit more. When mom and dad bought the house they had to give it a thorough “facelift” as the house was in bad condition, and they also built on to the house. So they actually invested around 43 000 USD initially, including both the initial house purchase and renovation. But it still sounds like a great investment, right?

And in year 2003 they built on to the house a second time, this time to a cost of 77 000 USD. So they have actually invested 120 000 USD - and now the value is 540 000 USD. So, do you have any idea how much the value increase of the house has been per year since they bought the house? About 6%! Not too bad, but I must say that I got a bit disappointed when I calculated this figure as I thought it would turn out to be even higher ROI considering that 540 000 USD is so much money! L

Figure above: calculation of the ROI of the house investment

However, this is not the whole truth. During the years there has also been running costs such as maintenance and repairs, as well as electricity, insurance, water, etc. If we would take this into account (with the assumption that the running costs year 2014 are estimated to 1% of the yearly house price) we would have paid in total about 71 000 USD during the 39 years we have had the house, bringing down the ROI per year to around 5,5%.

Figure above: calculation of ROI also considering running costs. The housing costs of 70 669 USD decreased our calculated annual rate of return further to 5,45% (sorry about the small figures in the table :-) )

Does this house still sound like a good investment? Well, not really to me. But it of course depends on how you would have used your money otherwise and what returns you are looking for. I am looking for higher returns than 5,5% per year. But the house has been a safe investment, so for being a low risk investment 5,5% is quite good. Also, we shouldn’t forget how much fun we have had in the summer house. So from that perspective it actually has been a great investment!

As a conclusion, in order to get a really good return on your summer house/ 2nd house you should try to rent it out to increase the house payoff. I was in Hawaii (Big Island) earlier this year and got interested in buying an apartment there for rental purposes and for own usage. Hawaii is an excellent location for a rental property with good weather all year long, making the rental period long. And it has beautiful beaches and exciting landscapes and a strong, consistent rental demand from mainly the US and Japan. There are a lot of vacation rentals in Hawaii and I found one that seemed great at the first sight; a smaller condo (1 bedroom) in good shape right by the beach and quite central - and according to the prospect it had a track record for being a successful rental property. And indeed, it would give me a gross rental income of roughly 11%. Not bad. But there was a lot of overhead cost related to this, such as property management, repairs, electricity, which took down the ROI to around 5%. Not that good compared to the first calculated ROI of 11%. But on the other hand, I also would gain from the capital appreciation of the apartment.

Again, here is a good learning that reinforces what I mentioned earlier –things you don’t think really about (i.e. electricity, maintenance, etc.) actually add up quite a bit and actually cost a lot of money, bringing your potential net ROI down! Have this in mind when you look into vacation rental properties!

 

/Chris