And now, yet another housing trend has emerged: purchasing a second home while still renting a primary residence. Vanessa Famulener, president of homes at the real estate technology company HomeLight, says that a poll conducted by the company in the summer of this year found that 64% of real estate agents reported a growing trend of buyers purchasing their second home first. But, trending or not, is this a smart strategy? Below, we look at some of the advantages and disadvantages, as well as other factors you should consider if you’re thinking of using this approach to homeownership.
When does it make sense to purchase your second home first?
Janet Farmer, branch manager and mortgage loan originator at Atlanta-based firm Hyperion Mortgage, points to the rise in remote work as a positive for prospective homebuyers. As more employers adopt work-from-home norms, this gives buyers more flexibility, and more opportunity to potentially purchase a second home while still living primarily in a rental. “Many first-time homebuyers that live in urban areas can enjoy the benefits of homeownership by purchasing a second home while renting their main residence,” Farmer says. However, she notes that this strategy is most effective if you can rent a smaller space in a more expensive urban area and then purchase your home in a less expensive vacation destination. This is especially true if you live in one of the U.S.’s most expensive cities. Agent Steve Gottlieb of New York City brokerage Coldwell Banker Warburg—who routinely sells homes that cost several million dollars—agrees that you may have better luck purchasing a home in a less expensive market. “If someone is happily renting an affordable home in an expensive market, sometimes buying is financially prohibitive,” he says. “An example of this might be if someone is renting an apartment in New York City, and they can’t afford the type of apartment they’d like to live in.” However, he says those renters can take the money they can afford to put down and buy a house nearby in a less expensive area—and that can become the weekend getaway spot or a summer home. “You can continue to rent your affordable apartment, and then own a house somewhere else, enjoying potential investment appreciation on that value,” Gottlieb says. Bill Golden, realtor/associate broker at Keller Williams Realty Intown Atlanta, admits he hasn’t had any clients purchasing their second home first. However, he does have several clients who have purchased a vacation property, intending to retire there eventually—and those clients used the same strategy discussed above. “They have made it work by just renting a small place in the city to use when needed—since renting in the city, though not inexpensive, saves them the cash outlay, which enables them to buy the vacation property," he says. By purchasing a vacation home, Golden explains that it can serve double duty by saving on vacation costs and—if you choose to rent it out, through Airbnb or another service—providing income when you’re not using it. “Plus, it will most likely continue to go up in value, making it a great investment,” he says. The investment angle can be particularly appealing for several reasons. For instance, right now you can lock in potentially low interest rates. “Even though interest rates have risen, they are still lower than they have been at some points in history,” says Sonja Breeding, a certified financial planner and vice president of investment advice at Rebalance, a financial planning services hub. “Assuming you are also contributing to a 401(k), property investment adds diversification to your portfolio,” she explains. The investment home can also provide passive income. “Real estate can be a great long-term investment, often producing eight to 10 percent in annual ROI for owners,’’ says Aaron Dorn, chairman, president, and CEO of Studio Bank in Nashville.
Factors to consider before purchasing a second home first
Mortgage rates
When you’re financing a home that you don’t intend to use as your primary residence, you may have to take on higher costs. “Many mortgage products and rates are exclusive to owner-occupied homes and first-time homebuyers,” warns Dorn. On investment properties, the rates are often adjustable—and when those rates adjust, he says your profit margin can also change.
Taxes
“When investment properties are sold, capital gains taxes are usually higher on investment homes, as they often don’t have the same exemptions and allowances as personal residences,” Dorn adds. Before making any moves on purchasing a second home first, he recommends speaking with a banker, mortgage expert, or tax advisor to ensure you understand the financing and tax implications.
Home maintenance costs
Whether you buy a house or a condo, you can’t just purchase the property and then forget about it. “The second home will require maintenance, décor, and landscaping—and the appliances and fixtures depreciate over time, requiring routine reinvestment into the property,” Dorn explains. And if you purchase a home that needs extensive repairs, factor this expense in the total cost of ownership—and don’t forget you can’t rent the property out until you fix it up.
Rental income, and the lack thereof it
Speaking of renting out your property, it’s not always as easy as it may seem. “Rental properties aren’t always rented, which results in downtime in revenue,” Dorn says. Also, you’ll need to carefully decide what type of renters you want (yes, we know you want good renters that pay on time and won’t trash the place, but that’s not what we mean). Is your goal to have the same individual(s) occupy the home 12 months out of the year? If not, do you plan on having vacation renters who will only be there certain times of the year? Don’t forget that if you plan on vacationing at your second home, your renters will need to move out when it’s your turn to visit the house. And that vacation time will also mark a period of time without rental income.
Internet service
This probably wouldn’t be your first consideration, but it can quickly become relevant. For example, let’s say your dream is to purchase a second home off the grid—deep in the woods or high on the mountains. Farmer advises doing your research to ensure the area in which you want to purchase has the necessary resources. “If internet access and cell phone access are essential to your work, investigate the cost and reliability of the services in that area,” she says. Coastal or mountainous areas may have more frequent service outages—and this may be fine when you’re visiting a quaint location for a couple of days, but not when you plan to stay there several months out of the year. And if you plan on renting the house out, is this a place others would pay to stay at for more than a few days?
More questions to ask yourself
As a general rule, when purchasing a second home first, some of the considerations are the same as purchasing your primary home. Veronica Fuentes, managing director at Northwestern Mutual provided us with a list of questions to ask yourself before making a decision:
Is the home in a good location, school district and accessible to public transportation?Is it in a high foot-trafficked area?If you plan to rent out the property, what type of tenants do you want to attract (i.e. single folks, married couples, families)?Do you have enough money saved to make a solid down payment and pay for potential future repairs?How quickly can you get tenants in the property?In the event of a vacancy, do you have enough savings to cover the mortgage for some time if you had to pay it yourself?
As with every financial decision, it’s important to do what makes sense for you—and not just go along with the trends or follow what others are doing. If you’re considering buying your second home while still living in a rental, make sure to budget for all of the possible costs (providing plenty of cushion of unforeseen expenses) before moving forward with any decision.
