Monday, February 16, 2009

Second homes - a bad idea?

With the current economic conditions there have been several stories about people being forced to sell (or attempt to sell) their second homes. While a second home has its attractions from a lifestyle perspective, and may provide a sense of well being etc, from a financial standpoint they are a poor way of allocating capital.

I ran a spreadsheet comparing the cost of owning and maintaining a second home against the equivalent amount of money invested in long term bonds and renting serviced apartments when needed. The result is at least partly dependant on what property you are looking at and how frequently it will be used, but based on the particular example I considered, the bond portfolio was a clear winner.

With the ownership option, there is the purchase price, the costs of acquisition and the cost of furnishing the property. I assumed that I would not have to redecorate or do any repairs. On an on-going basis I would have to pay rates (property taxes), body corporate fees and routine maintenance and would have to pay someone to visit periodically to air it out etc. Longer terms, it would need repainting and more substantial maintenance which was ignored for the purpose of my comparison.

With the the serviced apartment option, there is no immediate cost - I would buy a portfolio of bonds (or bond funds) and collect the interest payments. I would pay for the use of the serviced apartment as and when I use it. I assumed three months a year of usage (which is the longest time I can spend in the country without triggering a possible tax residency). Shorter periods of usage would make this option even more favourable.

If I could assume that the numbers would remain static for as long as I wished the arrangement to continue, the serviced apartment option would be a clear winner. In fact the cost of renting the serviced apartment would only be about 20% higher than the annual short term expenses of owing the second home. Put differently, I would have to allocate 3.6 times as much capital to owing a second home than I would need to invest in bonds to pay for the serviced apartment.

Unfortunately, the numbers will never be static. Inflation will play a role. It will increase the costs of renting the serviced apartment, increase the costs of owning the second home and increase the value of the second home. There is also roll over and reinvestment risk on the bonds. However, if I use the property for three months a year, I would have to experience long term inflation of more than 3.6% pa before owning a second home becomes the better choice. Even then, this ignores longer term maintenance issues and the likelihood of using the property for less than the full three months each year.

For completeness, I did not consider renting out the second home for short term periods when I am not using it. If it is my home, I would not want other people living there. However, if I did rent it out for part of the year, this would obviously reduce the cost of owning a second home. I also ignored factors such as the greater flexibility and possible non-availability of the serviced apartment option and the ability to take out a mortgage against the second home or simply convert it into a rental property.

In conclusion, a second home only makes sense from a financial perspective in a high inflation environment. In a low inflation environment, investing in bonds and renting serviced apartments as and when needed is the better choice.

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