Second Homes: Buy or Rent?

Many assume a second home means purchasing a house, condominium, or mobile/manufactured home. However, some have long-term rentals that they call their second homes.

Can a Rental Be a Second Home?

Can you realistically consider a rental to be a second home? The answer is "yes!" Just as primary residence renters (e.g., houses or apartments) consider their abodes home, you can also rent your second home.

When does a rental become a second home versus a vacation or other temporary arrangement? Here are some suggested parameters:

1. What is the rental duration?

The longer the rental duration, the more likely you are to consider the property a second home. For most people, a longer-term rental of 3 to 12 months could qualify as a second home.

1. Do you consistently return to the same property?

If you return to the same long-term rental year after year, it's much easier to confer second-home status on the property.

Take the hypothetical example of a Michigan couple renting the same Florida apartment every year from the first week of November through the second week of May. They drive each way, bringing clothes and personal belongings for the stay. They also rent a small storage unit in Florida near the condo to store items they prefer not to haul back and forth, such as bicycles and beach chairs. They no longer pay Michigan state income tax because they only live in Florida for just over half of each year.

Given this scenario, it's easy to see how this couple considers their Florida apartment a second home.

Buying Vs. Renting

The decision to buy or rent a second home involves most of the same factors as the decision to buy or rent a primary home. At a high level, the decision depends on the current housing market, along with your unique financial situation and personal preferences.

Buying Advantages

• Ownership Means Equity: Buying means you own an asset that can go up or down in value. In the past few decades, U.S. real estate values have risen on average in most markets. As a result, buyers can have some degree of confidence their second home value will appreciate over time.
• Earning Rental Income: With full ownership, an owner has the option of generating revenue from renting the property, which may also be an option for some forms of partial ownership.
• Tax Advantage: The federal income mortgage interest tax exemption applies to the sum of primary and second home interest payments. However, interest on other homes is not eligible.
• Freedom: Owners have the freedom to live on the property whenever they want, store their belongings at the home, and decorate the structure's indoor and outdoor spaces to their liking. If applicable, however, Homeowner Association rules may restrict certain practices.

Buying Disadvantages

• Value Appreciation is Not Guaranteed: Risk always accompanies the purchase of an asset. One risk is that the property may not appreciate as much as planned. It may even lose value in certain situations. Homeowners in coastal Florida may be faced with such a prospect.
• Landlord Headaches: Renting a property can be a lot of work and expense.  
• Costs of Ownership: Owning a second home means a long list of expenses.
• Always the Same Place: Owners may be reluctant to travel elsewhere since they've invested so much time and money into the second home.

Renting Advantages

• Avoid Ownership Risks and Costs: A renter offloads ownership risk to the landlord. Responsibility for property maintenance, structural insurance, and other costs belongs to the rental property owner. Also, renters avoid purchasing and selling costs. Finally, renters pay only for the time spent staying at the property, whereas owners pay expenses year-round even when the home is empty.
• Flexibility: Renters don't have to worry about selling an asset when they no longer want to stay at the property. Also, renters can rent different properties in different locations each year, which can be a great way to scout future retirement locations.

Renting Disadvantages

• No Asset – No Equity: Renters forgo the possible investment gains on a second home.
• No Income Opportunity: Renters pay rent. They don't earn it.
• No Tax Advantage: Tax breaks for owners are unavailable to renters.
• At the Landlord's Mercy: While the landlord is responsible for many things, renters often experience delays in getting problems fixed in the property.

Rental Costs

While rent is the major cost, renters face many other possible expenses. Here are a few:

• Security Deposit: This cost ties up cash until you move. Some landlords may keep all or part of the deposit for very picky reasons.
• Pet Deposit/Fees: If allowed, having a pet may incur additional fees.
• Renter's Insurance: Your stuff is not covered by the landlord's insurance, so it makes sense to get separate insurance.
• Utilities: Rental agreements differ in terms of what utilities are included. You may have to pay some separately.

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How to Decide?

Both personal and economic factors inform the decision to buy or rent.

The personal factors include answers to questions, including:

• Do I want the freedom to stay at the property anytime I choose?
• Do I want the freedom to change the property to meet my desires?
• Do I want to restrict myself to one location for a getaway destination?
• Do I want to be at the mercy of a landlord?
• Do I want to be responsible for the maintenance of the property?
• Do I want to take on landlord responsibilities if rental income is of interest?

 Economic factors include answers to questions including:

• Do I want to have an asset that will hopefully increase in value?
• Do I have the financial resources to acquire and maintain the property?
• Does buying or renting make more financial sense?

To get a clearer picture of this last question, set up an economic comparison between buying and renting. For the prospective purchase, find the following data:

• Purchase price
• Down payment
• Mortgage amount and interest rate
• Mortgage Payment (P&I)
• Property Taxes
• Insurance
• Maintenance, Repairs, etc.

 For the rental part of the scenario, find this data:

• Monthly rental amount
• Non-refundable front-end fees
• Other monthly fees

 Also, assume that the amount you would have otherwise devoted to a down payment (your equity going into a purchase) is invested at an interest rate of your choosing.

The analysis, using hypothetical numbers, plays out as follows:

Purchase

    * 15-year mortgage

Rental

In this case, the net cost of buying is less than renting. Note, however, that changing any of the input assumptions could alter the outcome of the analysis. Also, since each person is different, the $1,856 difference in this example may not matter to some. They may rent anyway because their personal factors outweigh the difference in dollars.

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