Is a vacation home a good investment?

Sometimes, emotions are the motivation for buying a vacation property. I like to evaluate a property purchase from a financial point of view as well—and here’s how. 

The costs of buying a vacation property

Say, a property’s purchase price is $500,000. Whether you use cash, a mortgage/home equity line of credit, or a combination of the two, there are other costs to consider.

If you purchase with cash that you could otherwise invest for a 4.5% return (to use a conservative assumption), there is an opportunity cost of not investing that money or leaving it invested. If you borrow money, there may be an interest cost of 4.5%. So, to keep it simple, we will assume an opportunity cost or financing cost of 4.5%. 

Property taxes, utilities, insurance, condo fees, and maintenance could easily add another 2% to 4% per year in costs. Those costs could be even higher for an older cottage or for a property with amenities and high fees, but we will assume 3% per year for discussion purposes.

So far, our costs are up to 7.5% per year on a $500,000 property, which works out to $37,500 per year for our notional vacation property. 

Expected returns on vacation properties

What about the financial return from owning the property? Canadian real estate prices have risen by about 6.3% per year for the 10 years, ending Dec. 31, 2023. Over the past 30 years, the increase is about 5.1%. Some cities have seen much higher growth rates, and others much lower. Prices have also cooled off significantly in the past couple of years. (Check out MoneySense’s guide on where to buy real estate in Canada.)

Over the long run, in the U.S., real estate prices have risen just slightly more than inflation. In fact, since 1890, U.S. real estate has increased by less than 0.6% per year above the rate of inflation. Given the Bank of Canada’s 2% inflation target, despite a recent spike in the cost of living, I would argue a more reasonable long-term growth rate for real estate is 2% to 3%.

So, we will assume the value of our notional $500,000 property grows at 3% per year; in the first year, that would be $15,000. That means the net cost in year one of owning the property is 7.5% (or $37,500) minus 3% (or $15,000), totalling 4.5% (or $22,500).

Buying versus renting a vacation home 

If you are contemplating a $500,000 vacation property purchase, and you think my assumptions are reasonable, you need to ask yourself: Are you going to get $22,500 worth of use out of the property? Could you rent a comparable property for less than $22,500 per year, for the time you plan to use it? If you could, a vacation property purchase may not be the best financial choice.

Still, that does not mean you shouldn’t buy a vacation property. There are non-financial reasons to own a vacation property, and not every choice you make should be about money.

Tax implications of renting your vacation home

If you plan to rent out the property to generate some income, that could reduce the net cost and make the purchase more fiscally responsible. There are, however, tax implications if you do this.

Rental income is taxable. On the other hand, renting out a vacation property you own will also provide some tax deductions. The deductions are based on the proportion of the year the property is available for rent. So, if you use it six months per year and rent or make it available for rent for the other six months, half your eligible expenses may be tax deductible. 

Eligible expenses include: 

• Mortgage interest
• Property tax
• Condo fees
• Repairs
• Maintenance
• Utilities
• Insurance
• Property management fees
• Other miscellaneous costs

In addition, if a property owner’s short-term rentals—that is, daily and weekly rentals—exceed $30,000 over four consecutive quarters, they may be required to register for and collect sales tax (GST/HST). If the property is used for short-term rentals more than half the time, the owner may have to pay sales tax if they sell the property or even if they someday convert it back to primarily personal use (less than 50% rental use). This is one reason to be especially careful about using a personal use property as a short-term rental for a short period of time. The sales tax implications could far outweigh the potential rental income.

Financing the purchase of a second property

When financing a second property with a mortgage, you may be able to put down as little as 5% of the property value if the home is fully winterized with plumbing, electricity and heating, and it has a permanent foundation. A seasonal cottage may require a higher 10% minimum down payment, and a property that you intend to rent out may need a 20% down payment.  Of course, based on your income and other factors, you may have other borrowing limitations requiring an even higher down payment.

Properties purchased in the U.S. or other countries may require larger down payments to qualify for a mortgage from a local lender. Renting or selling the property will also generally result in tax implications in that country as well as Canada. Canadian residents are taxable on their worldwide income, including rental income and capital gains when selling foreign real estate. Foreign tax paid can generally be claimed on your Canadian tax return as a foreign tax credit to avoid double taxation. 

A vacation property can be considered your principal residence, even when it is in another country. The principal residence exemption is claimed when a property is sold. However, you can only have one principal residence in a given year, so any time you and your spouse or common-law partner own multiple properties, at least one of them will be subject to capital gains taxation in the future. 

So, should you buy a vacation property? 

I would start with the math that I shared initially. Try to figure out the net cost of buying the property using your own numbers, and then consider whether you could rent something comparable for less. 

Even if you can, that does not mean you should rule out buying a vacation property. If you can afford it without compromising other financial goals, it’s something to consider. But remember the annual tax implications of renting out the property, as well as the future tax implications upon sale or death.

Check out the current mortgage rates.

powered by

Read more about buying a second home:

• How much of a down payment do you need on a second home?
• Should you buy real estate through a corporation?
• Mortgage rules when buying a second property in Canada
• How to know if a secondary suite or basement apartment is legal—and a worthwhile investment
• Mortgage renewal calculator

About Jason Heath, CFP

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.

Linkedin Twitter Facebook Website