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article imageOp-Ed: Financial Downside of Buying a Foreign Vacation Property

By Monty Spivak     Jul 18, 2010 in Business
Is it financially beneficial to buy a foreign vacation property? Let’s take a balanced look at the rent (or lease) versus buy alternative for international property.
Where have all of the contrarians gone? I can find many articles on how and why to buy a foreign vacation property, and some with a few important caveats, but none about why one should not! Let’s take a balanced look at the rent (or lease) versus buy alternative for international property.
My wife and I regularly watch House Hunters International on HGTV. It is probably our favorite program to watch together. We would love to run away to live in a large house with views on a cliff in an exotic country. Frankly, we often do not understand how many of the house-hunters have such large chunks of cash to blow on a property which would be used occasionally. These people seem to have no financial worries, and readily plunk down $500k USD for villas which they will use a few months of the year. I am not questioning the purchase for a move to a new country for work or retirement; I am just struggling with whether they should buy a foreign vacation property, or simply rent one as required.
I see why one would feel good about owning a foreign vacation property – probably at a substantially lower cost than would be available in a developed country. There is pride of ownership, owning a small piece of a vacation paradise, and we can all imagine the various non-financial benefits, such as family time together, clean air, and a boost to morale.
Some articles propose that there are financial benefits through rental income when you are not using it; mortgage, property tax, and operating cost tax deductions (if you manage it carefully within the boundaries of a personal-use and a financial asset); capital gains when you sell your property; and lower retirement expenses while living abroad. Quite frankly, these assumptions are easily challenged. In these tough economic times, many visitor/retirement communities in developing countries are half-constructed, and substantially unoccupied. Rental income is harder to come by, as people are using cash to retain their principal homes; capital gains on any property are now uncommon (and capital gains taxes in certain countries punish foreigners); and, as people are working longer and retiring later, the benefit of building equity will be delayed. Do not get me wrong, I am not refuting the idea of the feel-good benefits, I am simply proposing that one should take a balanced perspective of foreign property ownership, which should come down to clearly-defined costs and benefits.
Perhaps the most touted financial benefit of foreign vacation property ownership is the potential of long-term property appreciation and capital gains. Until two years ago, this was an indisputable fact. If, for example, you bought a vacation property in a low-cost area, twenty years ago, then your investment would now be worth substantially more. The use of the vacation property would have been a bonus on top of the financial gain. The various global crises have currently reduced, or perhaps eliminated this benefit. For example, with 20% unemployment and high debt-load in Spain, the previously-booming property market has reversed. There may be a recovery in the longer-term, but the economic crystal ball is unclear on this topic. Perhaps this is the right time to jump in at bottom property values for future capital gains? Who knows?
I performed some research, and have concluded that buying a home outside of Canada and the United States will expose you to a number of unique issues which may burst your bubble. The vacation home may be complicated and expensive to buy, have foreign ownership restrictions, may not have clear legal documents and ownership, and may commit you to a lifetime of substantial maintenance fees. There's a lot more tax paperwork involved, and you may need a tax specialist, as well as you may be required to file tax returns in the country of the vacation home. You will be exposed to other idiosyncrasies in the foreign country, such as immigration laws, travel taxes, car ownership taxes, and many various fees. If you do not speak the local language, then I am sure that there is an additional layer of costs for absolutely any goods or services. Let’s face it – when your trades-person earns $5k/year, you look like a big ATM to him. The opportunity to remodel your bathroom just became three times as expensive. To summarize… the financial risks are high.
Now let’s take a look at the cost-benefit. Let’s propose that your $500k property (and all of the legal fees and taxes) is paid for in cash, which has an opportunity cost of only 5%. This is actually a very conservative rate, as foreign and even domestic vacation property mortgages are more difficult to qualify for, and are more expensive. You could easily invest in many blue-chip companies on the NYSE or TSX to yield this return, and we can also assume that the growth of the securities on the NYSE or TSX will approximate the increase in value of your property. This 5% yield equates to $25k/year of income that you will forgo to buy the foreign property. We will also propose that all of your taxes, electricity, maintenance, security, insurance, and other services on your foreign property cost you $1k/month. With the view from your aerie, you probably need a car. I assume that you will also need a few items to make it homey, such as a dishwasher, swimming pool, etc.. Let’s call it another $1k/month for these other handy items, repairs, and other incidentals. Of course, I am ignoring the costs of any potential structural problems, cosmetic maintenance fixes, or problems with the weather, landslides, earthquakes, floods, and other natural disasters. As well, let’s just forget currency transfer and conversion costs, and the fact that you have a fair piece of change stranded in an illiquid asset in a far-away developing country. For budgeting purposes, this brings the total annual cost of the vacation property to about $25k + 2k/month = $49k/year.
If you plan to rent out your overseas vacation home, you will need to pay a local property manager and probably have higher maintenance fees. On HGTV, we just watched a family from Tucson buy a vacation resort in Fiji. If they do not use the services of a property manager, then it may be a little difficult to handle the cleaning, maintenance, and pass along the keys, to a tenant from the other side of the globe. Let’s assume that you can recover 40% of your costs by renting-out the palace for a several months of the year. This leaves your net annual cost at $30k/year. I have ignored food and entertainment for the purpose of this comparison, as one does need to eat…
Perhaps you plan to spend only $250k? Well the math is pretty easy; just cut the $25k/year opportunity cost (or mortgage cost) in half, which brings the annual cost to around $37k. You will still have all of the service and other costs, so the $2k/month remains fairly constant. Of course, the 40% rental recovery would be proportionally reduced, so the overall ratios remain fairly static.
I suggest that there are a number of ways to spend $30k/year on long-term vacations without stranding your assets. There are some great deals in the marketplace. We have recently seen 100-day cruises going for $7k/person. Long-stay European vacations, which includes car rentals, for a few thousand dollars per person. There are month-long trips to China (all inclusive) for $4k/person. Alternatively, you can rent someone else’s mansion for a few thousand per month, and then walk away at the end – no fuss, no muss. In fact, rent a different property for a few months, each year, and try different locations. All of these should work out to less than the $30k net-cost of a foreign vacation property. This would not win-out if you plan to be at your vacation property for a substantial portion of the year. I propose that the break-even is somewhere around six months; at that point, it may be worth buying the second home-away-from-home. The alternative vacation options will not provide you the non-financial benefits, but will also avoid the various non-resident aggravations.
There is one factor which can substantially impact your business case. This is the number of people who will use the vacation property. If you have a family of six, then the alternative vacations will be a lot more expensive than if you are paying for a couple. On a per capita basis, the foreign vacation property can be a lot less expensive than paying for packaged, per-person vacations. That said, as your family matures, your needs will evolve. Perhaps your future teenagers will become a lot less enthusiastic about being stranded in a location without their friends for one month at a time? Perhaps you will not be prepared to leave these same teenagers behind at your primary residence? After all, it can be dangerous letting the inmates run the asylum. The point is that you need to assess your long-term usage and costs prior to making this substantial financial decision.
Only you can decide if the joy of foreign vacation property ownership is compensated by your hard-dollar cost. Emotions can, and perhaps should, trump financial decisions. There seem to be many alternatives to this investment, and you need to decide your financial priorities and flexibility requirements. I like my assets to be liquid, and denominated in Canadian dollars, US dollars, or Euros. Although we are still a number of years away from retirement, my wife and I do not aspire to own a little piece of paradise. I have enough trouble maintaining my current home, and am not looking for either a far-away castle or a fix-me-upper.
This opinion article was written by an independent writer. The opinions and views expressed herein are those of the author and are not necessarily intended to reflect those of DigitalJournal.com
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