Last updated on August 23rd, 2024 at 06:52 pm
Forget what you hear, the economy has all of the earmarks of a recession. High inflation and higher interest rates. In some areas, higher prices for houses. With all of this bad news, believe it or not, it’s time to build your real estate portfolio. The best way to start is to buy that second home that you have wanted for a long time.
There is no “Real Estate Market”. There are hundreds and perhaps thousands of real estate markets in the United States.
This economic downturn is an excellent time to take advantage of others’ bad decisions. Home values have been falling almost everywhere, there are some exceptions. The real estate market is in a state of flux now with some properties selling fast and others taking many weeks to sell at lower prices.
Home prices are dropping and rental properties are seeing much higher rent rates. It’s time to look at investment property if you have been sitting on the fence. The second home markets are now in recession and that can be a good thing for investors and those who just want a great place to relax.
I want to go over this topic in some detail so the best way for me to explain this topic is to break it down into components. Starting with vacation homes. A real vacation home is one where the buyer will use the vacation property for their use. They will furnish the property to suit their needs and enjoy it periodically along with their family.
Single-family houses not condos
I am talking about residential real estate and for now, I want to keep the discussion on single-family houses instead of condos I will cover them later. Assuming that you as a prospective buyer already have a primary residence, this additional house will be a second home which we will call a vacation home.
To afford a second home considering higher lending standards home buyers must have sufficient cash to make this happen. Usually, you can finance 90% of the cost of a second house or vacation home even in a recession. Assuming that you have a qualifying credit score of at least 700 (possibly lower), the hardest thing to deal with is the debt-to-income ratio. Lots of people have the 10% down payment plus about 7% closing costs and good credit. Fewer have a debt-to-income ratio that works.
Add all of your debts including the future monthly payment for your vacation home. Will you have more or less than 42% debt to your total gross income before taxes? A word about gross income. This would include any dividends, interest, or similar income generated from ownership of equities. You can use about 75% of the gross profit from rental property or similar investments. The total of this income can be added to your w2 income. Click on the button above to use a great calculator to determine your debt-to-income ratio.
Keep your debts to 42% of gross income
Divide your debts into your gross income. If the total is less than 42% you may qualify to buy $X of property. In addition to the ratios and credit, it’s very important that you have about six months of reserves to cover all costs of the property in the event of job loss or other loss of income. If you can swing all of this, then you are ready to find that jewel that is waiting for you. Someone who is not as well prepared is forced to sell their property because they can not make the mortgage payments.
A couple of years ago prices increased rapidly in vacation hot spots around the country. People were coming off COVID and bought houses as vacation homes that they had hoped to perhaps rent when they were not there. Unfortunately for many, they were not financially prepared to make mortgage and other payments along with their primary mortgage. A cash flow crunch is now forcing people to sell their vacation rentals.
Overbuying and fewer people taking vacations during the last quarter of 2022 through 2023 have caused some areas to see high rental vacancy rates. This means that some investors can not earn sufficient income to support their rental property. In addition, some people who bought second homes can no longer support that additional cost.
More second homes and vacation rentals will hit the market in 2024 permitting investors and second-home buyers with fatter bank accounts to buy.
This is the best time to jump in
This is the best time to jump in. It seems that we are very far from hitting a housing bubble there are things to pay close attention to. Recently it became clear for example that condo owners in Florida are not required to pay into funds to support long-term maintenance. Word on the street is that association fees will double.
This has caused property prices in Florida to drop as people who can no longer afford their mortgages and insurance contact real estate agents and put their property on the market. I mentioned above that I would get into a discussion about condos.
Ok, this is my personal opinion but I would avoid condos now. Partly for the reason that I just explained about Florida and as importantly, many condo developments were overbought as vacation rental properties. Completion is now fierce in some developments with many owners who were not previously offering their property for rent. The recession has hit Florida condos, particularly second-home units.
As bad times have come, owners of condos must earn income to meet their mortgage and other obligations. This is going to cause a lower rate to be charged for nightly rentals. The fallout in the condo world is still in process so hold off there for now.
Look for vacation properties where there are short-term rentals
Single-family homes in areas zoned for short-term rentals are good places to look for your vacation property. I am not suggesting that you rent your vacation property but if you must, it’s a good idea to be prepared. As we start to see an economic recovery you can decide to rent after many of your competitors have sold their properties to people who will live in them full-time. The bull market will eventually return and along with that, lower mortgage rates and rising prices for housing.
Economic conditions are good now for real estate investing. Why? because anyone with sufficient cash to make the 10% down payment for a vacation home or 20% down payment for an investment property can pick and choose from real estate prices that reflect a significant decline. Market conditions indicate that the housing downturn has flipped the market from a seller’s market to a buyer’s market. This is a great time to buy higher quality houses in good condition. This recession has become an opportunity to buy a second home at another’s expense.
Cash is King (and good credit too)
Without question now anyone sitting on cash is in an excellent position to leverage anothers desperation. Think of yourself as helping the seller out of a difficult situation.
We just came out of a market where property values hit all-time highs. Real estate investors could only find B, C, and even D properties to buy because they were forced out of high-priced class-A properties. This is a good time to buy those higher-quality properties that are distressed.
Buy a fully furnished short-term (vacation) rental In this economy when a seller offers a short-term rental for sale fully furnished, they get virtually zero dollars for the value of the furnishings. Appraisers will give them nothing for their $20,000+ investments in furniture and furnishings.
I mentioned that rental income is high and climbing in many areas making it possible to break even or turn a profit from renting on a long-term basis. You can buy a distressed short-term rental at a discount and rent it on a long-term basis which will pay the bills and possibly generate additional income. Even new homes are being offered with interest-rate buy-downs and deals that we have not seen in 14 years.
A good reason to buy a vacation home now is that you can buy right. What I mean about buying right is that buying a second home in a recession requires resources, timing, and some skill. If a property is offered for example at $300,000 buying right may require you to pay not more than $250,000 with concessions thrown in. Some properties are priced fairly but often sellers must sell quickly because they can not afford to keep their second home due to the recession.
Recession is forcing people to sell their second home
The recession is causing many to sell their second home at a bargain price just to get out from under the mortgage payment. As I have mentioned sometimes these properties are fully furnished and you can steal the furnishings for almost nothing in a well-negotiated deal.
Yes, higher mortgage rates are with us for now but based on history, there is reason to believe they will come down. You can refinance your property at a later date when rates are down and values are up. See, there is a silver lining out there.
The property will always go up even when it comes down for short periods. Housing prices are likely to decline a bit but there is still a shortage of properties on the market so the time when this trend reverses can be just around the corner.
Furnished vacation homes are the way to go
On the Mississippi Gulf Coast where I live, the number of vacation homes purchased during the COVID rush are coming on the market in larger numbers. These properties are usually in great condition and most are furnished. A few sellers are stating that they will include furniture for full price offers or you can buy the furnishings for $X.
Don’t be fooled, many of these people are desperate. You are more likely to get everything thrown in and a discount from the asking price. Many of the sellers do not live on the Mississippi Gulf Coast or other vacation destinations. The last thing they want is to pack and haul all of those extra things to their home.
My average cost to paint and furnish a house is about $18,000. If you want to buy your own vacation home that you can afford to keep without earning a dollar in rental income, buy a vacation home that is for sale.
You must have cash, good credit, and good debt-to-income ratio
Financial institutions are requiring that buyers of second homes be strong financially as discussed above. Lots of potential investors with weak financials must wait for the market out. Their time will come again when there are more homes on the market than there are buyers. Even then, it’s going to be difficult with higher interest rates for them to turn a profit as they have been able to for the past 10 years. Prospective buyers who have been hoarding cash are in the best position to take advantage of the market.
The real estate industry is going through a series of changes now. For the past ten or so years with very low inflation and low interest rates, buyers and investors could find bargains and afford to finance them. Along with inflation has come the higher cost of repairs making it difficult for home flippers to make a profit. The hot housing market of the past will be back after a while so it’s time to get in the market for your vacation or short-term rental when there are higher-quality homes on the market for lower prices.
I have weaved into this article both as second homes for your enjoyment and the use of those homes as potential vacation rentals. Let me be clear about how the two stand now. A vacation home is great to own at any time. It’s an investment in the sense that you will earn from the increased value over time and save money over hotels. It’s a great feeling knowing there is a place to decompress when you need it.
Rental income should be extra in this economy
If you decide to rent it for additional income, do so knowing that you do not need the income. As I mentioned, the short-term rental market I am writing this is soft now. Too many properties and too few vacationers.
If you purchased your vacation home a few years ago or purchased it for all cash, you may be in a position to earn income from renting your property on a short-term basis. Unless you purchase your property today at an exceptional price in a good vacation rental market it’s not likely you can offer it as a full-time rental and earn a profit. Buying a second home in a recession requires attention to detail and help from a local real estate agent.
I have purchased properties at bargain prices and financed at what was at the time higher interest rates between 4-6%. Those properties are profitable due to what are now low fixed-rate mortgages and low mortgage payments.
I have encouraged people to buy vacation rental properties to earn income but that ship has sailed for many potential buyers and investors. If you are in a good financial position and can take advantage of a good deal, you can potentially offer your property on the short-term rental market at a profit. Or, you can purchase a property and rent it on a long-term basis which is what I am suggesting to many investors in this market. This is of course not the vacation home this article is about.
A client bought at a bargain price
A client of mine purchased a three-bedroom, two-bathroom house for $160,000 within walking distance of the beach. It was on the market for $245,000. The real value was about $260,000. My client put about $40,000 into the property to rehab and furnish it. His total investment is $200,000 and his property is worth at least $250,000-$275,000. Not only has he added at least $50,000 in value to his investment, but with a reasonable interest rate and low mortgage balance, he can afford to make less money temporarily until the short-term market returns.
The example above is what I mean about buying right. There are few properties like the one above and you have to move fast to buy them. If you want to use your second home as the start of your investment portfolio, you need to have resources available to move quickly. This means understanding how to evaluate a property, having good credit, cash in the bank, and a good debt-to-income ratio.
I often comment on popular internet forums such as Quora (over one million people have viewed my answers) about buying an investment property. So many things have changed during the past year, and it’s difficult to keep up. I was strongly promoting vacation rentals for a few years as a great way to supplement your income with a property that you would buy anyway for a vacation away from home.
The good old days
Interest rates were at historic lows and real estate investments were making money for property owners. Prices were more reasonable than the two-year run-up in price due to the shortage of properties that started to change investor dynamics. People were able to take a second mortgage and invest the funds into a new property at low interest. Some were cashing out of mutual funds taking their great gains and using them for investment in residential real estate.
In the space of less than one year interest rates doubled, the stock market dropped by 35% or more, and property values in many areas of the country increased to a rate that became unaffordable. To top that off, inflation is hovering at 8%. Do you want the good news now?
It may seem to be the worst possible time to invest in real estate but it is not. Interest rates are half of the historic highs and seem to be settling in at around 8% for investors. 8% is more of a long-term average rate taking out the lower interest rates (aberrations) of the past 10 years. Home prices have dipped in many areas. The markets that will be the hardest hit will be those with the fastest run-up during the past two to three years.
Local real estate markets are going through a transition now
My area the Mississippi Gulf Coast saw a substantial double-digit increase in property values in 2021-22 which is now adjusting downward a bit. Inflation seems to have hit its peak. I have read on forums that the market in many areas is similar.
What does all of this mean for you attempting to invest in a vacation house? It means that you have to stop and wait for that deal, the one that makes your skin tingle as you immediately contact your real estate agent to make that home purchase. Buying a second home in a recession takes some skill. Ask your real agent to set you up on their website to notify you when properties with your specifications pop up on the market. Buying your vacation home at a lower-than-market rate permits a good growth rate for equity down the road.
Did you know that using Zillow and Realtor.com without working with a local real estate agent only gives you part of the information you need? Multiple listing services have public information and agent information. Agent information is often critical in decision-making. This agent information is not available on public websites. Your real estate agent can set you up on their website where you can browse the listings and the agent can tell you about the ones you have selected.
The best places for a second home
If this article did not scare you off, time to talk about where to buy your vacation home. I usually tell my clients to leave emotion out of any business decision. This time I will say that there is a portion of your decision that includes emotion and that’s ok. Buying your second home in a recession requires that you love the area. This is the emotion. Next comes the financial non-emotional part.
Buy where you think you want to be on vacation only if the area has the potential for price appreciation and down the road short-term rental income. Leave your options open. You may like that hill in Georgia overlooking a valley but it’s difficult to get to and who will be looking after it when you are gone? On the other hand, that beautiful beach on the Mississippi Gulf Coast with lots of amenities is something you can fall in love with. It’s close to amenities but not crowded.
Of the two locations, which will appreciate better? Which will be easier to have someone manage for you? Of the two, which has the best opportunity for extra income if you need it? Make a decision that makes emotional and financial sense for you.
Please read some of our other blog articles such as Why Florida? Consider the best alternative now before moving and Why you need to retire on the Mississippi Gulf Coast!
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