I am a big believer in having balance when it comes to managing money. That is, it makes no sense saving ever dollar and always “going without”. After all, none of us know how much longer was have on this planet so we must make the most of every day. However, by the same token, it’s equally silly to spend all our income without any thought towards saving for tomorrow. We need to do both. It’s about finding a balance between spending some money today and save some for tomorrow.
It can be very rewarding having a holiday house from an emotional and lifestyle perspective. It is a great ‘escape’ from the city and a wonderful opportunity to relax with family and friends.
This blog investigates the “true” cost of buying a holiday home versus renting. I suspect you’ll be surprised by the results – I was!
I compared two options:
Option 1: Purchase a holiday house for approximately $800k and rent it out when you aren’t using it. I have assumed that you use it mostly during school holidays and over the Christmas/summer break. Given that the main reason for purchasing the property is mainly for lifestyle improvement, I have assumed that its only rented out during off-peak times and generates approximately $15k p.a. in income (after direct expenses such as cleaning, advertising and management fees).
Option 2: Instead of buying a holiday house, you can obviously rent them from businesses such as AirBNB and Stayz. I have assumed that you rent a property for 2 weeks over the Christmas period and approximately 4 weeks throughout the year for a total cost of $15k p.a. Doing this frees up your borrowing capacity which allows you to purchase an investment property instead.
Beware of the tax treatment
The ATO is focusing on holiday homes with the rise in popularity of short-term renting via businesses such as AirBNB over the past few years. If you buy a holiday home, use it during the peak periods and rent it out when you are not using it, it is very unlikely that the ATO will allow you to negatively gear it. Instead, the maximum tax deductions are likely to be limited to the gross income received (i.e. you’ll break even only from a taxation perspective, so it will be tax neutral – no tax saving or expenses). Any excess expenses will therefore not be tax-deductible. If you want to enjoy the full tax deductions (negative gearing) you have to make a genuine attempt to tenant it throughout the year including during peak period.
Also, when you sell the property, it is likely that you will have to pay Capital Gains Tax on a proportion of any capital gain (if applicable).
What capital growth can you expect?
Some holiday house locations have generated relatively strong capital growth over the past 20 to 30 years. However, probably the most important thing to recognise is that prices tend to be more elastic. That is, holiday houses are discretionary assets so when things get tough, people will sell these assets first. This means that these locations experience flat growth or even a reduction in value during tougher economic times (e.g. recessions).
Holiday homes in a sort-after locations will not necessarily achieve the same capital growth rates compared to blue-chip suburbs that are closer to the city because of the variability in demand. Therefore, in the financial modelling (comparison) that I have completed, I have assumed capital growth rate of 6% p.a. (which is 1.5% lower than what I would use for investment-grade property).
What do the numbers tell us?
In summary, buying a holiday home is financially inferior compared to renting a holiday house – but not by a massive margin. My analysis suggests that your net worth will be approximately 10% lower in the long run, which probably isn’t enough to materially set back most peoples’ retirement plans. My financial modelling takes into account the cash flow impact, the opportunity cost and the overall impact on wealth of both options.
| Estimated overall net worth in today’s dollars (assuming a home value of $1.5m and a home loan of $600k) |
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| Projection period | Buy a holiday home | Rent a holiday home | Difference |
| In 10 years | $2.85m | $3.15m | $300k (10.5%) |
| In 20 years | $5.71m | $6.30m | $590k (10.3%) |
Obviously, if I assume a lower growth rate (i.e. lower than 6% p.a.) then it would impact these projections significantly – in which case renting would be a lot better option. Therefore, if you are contemplating purchasing in an inferior location from a capital growth perspective then renting will probably be a materially better option. Similarly, if the capital growth rate is 7.5% then both options are virtually even.
Be realistic about your usage
Do you know anyone that has bought a treadmill? It sounds good on paper (i.e. you can run or walk in the comfort of your own home) but virtually everyone that I know that owns a treadmill never uses it. The same can be true with holiday homes. If you buy a house you might find yourself feel obligated to use it. Or you might find that kids, work and family obligations prevent you from maximising your usage. Whereas with renting, it is completely discretionary. The less likely you are to use a holiday home the more advantageous it is to rent rather than buy.
How can you minimise the negative financial impact?
Of course, there are steps you can take to minimise any potential negative financial impact that buying a holiday home might produce. In fact, if you buy well and achieve a strong capital growth rate, it might even help you build wealth.
There are two considerations to determine your holiday house strategy:
1. Determine your price point.
If you are buying a holiday house in a location that has not produced strong growth (i.e. over say 7% p.a.) over the past 20 to 30 years then the less you spend, the better. However, if you are purchasing in a proven growth location, then sometimes the more you spend the better off you’ll be because you will purchase a higher quality asset. Sometime, people think minimising their budget will help them minimise the cost. But sometimes this is a false economy because it results in purchasing an inferior asset that will probably produce inferior growth. With property, the quality of the asset will determine your growth rate. Therefore, if you are going to do it, do it properly. Buy a quality asset.
2. Apply the laws of supply and demand.
When it comes to selecting an asset, apply the three investment-grade property tests being:
- Land value – more than 50% of the purchase price needs to be represented by land value meaning less than 50% should be building value.
- Scarcity – supply of comparable vacant land should be very limited. Often, water views drive a lot of growth in coastal locations. Housing blocks with an ocean view are limited supply and therefore generate strong growth.
- Proven performance – only buy a property if it and the surrounding properties have demonstrated the ability to generate strong capital growth over the past 20 to 30 years.
To buy well, all three of these characteristics must be present. This blog explains these further.
Do you need help developing a holiday house strategy?
Whether you should purchase a holiday house depends on your current financial position, cash flow, estimated usage, financial goals and so on.
It is possible that investing should be your priority before buying a holiday house, but the answer will be different for everybody.
If you would like help working out whether it’s appropriate for you to buy a holiday home and if so, how to do it well, don’t hesitate to reach out to us.
