Is buying a vacation home a good investment?

The pros of buying a vacation property

Grow your wealth

Celebrated writer Mark Twain once said: “Buy land. They’re not making it anymore.” If you’ve got a hefty sum stashed in the bank, investing in a vacation property can be a great way to grow your wealth.

According to Royal LePage Canada, the aggregate price of single-family recreational homes increased by 11.5% (to $453,046) in the first nine months of 2020, and the aggregate price of a waterfront property increased by 13.5 percent (to $498,111). Case in point: I purchased the land for $189,000 in July 2020. By November 2020, the adjacent lot was now selling for $269,000.

That being said, this boom is a blip and I don’t expect such a steep hike in the future. Like everything else this year, it’s not typical, and RE/MAX Canada predicts Canada’s recreational property market is predicted to increase by 8% in 2021.

An extra source of income

If you own a cottage, you could be sitting on a cash cow. With travel plans disrupted and so many Canadians grounded, the demand for cottage rentals has surged across the country.

So, theoretically speaking, you could rent out your cottage and use the funds to subsidize the mortgage. However, keep in mind that getting a mortgage for a rental property often comes with higher rates. What you can charge as rent largely depends on the size of the property, the level of luxury, and the location. But the payout can be pretty big: the weekly revenue ranges between $1,000 (for a rustic retreat) to $25,000 per week (for a glam getaway at a Muskoka mansion).

Let’s break it down: according to my calculations, the mortgage payment for our 3-bedroom cottage will total $38,000 per year. If it’s rented at $350 per night for approximately 120 days (4 months), that could bring in $42,000. This would offset the mortgage payments and pay for other expenses (more on that later).

Possible tax deductions

Here’s the good news: if your cottage is a rental, you can deduct any relevant rental expenses from your earnings. Everything from the cost of social media ads to paying a teenager to mow the lawn counts as a deduction! Just keep meticulous records of any eligible expenses and file them away.

But it can get complicated at tax time, so use an accountant or online tax preparation software that covers investment and rental properties.

A place to chillax

I’ve put this as the last item on the list, but really, it should be your first reason to buy a cottage: pure enjoyment. If, like me, you dream of owning a little piece of paradise and you can afford to do it, why not take the plunge? Some of my best childhood summers were spent at a friend’s cottage, canoeing and clustering around the campfire. The memories made were truly priceless.

The cons of buying a vacation property

It’s expensive

My mortgage payment is an estimated $38,000 per year, and that doesn’t include additional expenses associated with cottage ownership, such as property taxes, insurance, utilities, and ongoing maintenance. Tallying up all the costs, I expect that our annual total expenditure will be closer to $50,000 annually. It’s a lot of money, which could be used to pay down debt or invest into a TFSA or RRSP.

Soaring prices and bidding wars

With the real estate market in cottage country going gangbusters, scoring a recreational property can be a challenge. Expect to encounter bidding wars, bully offers, and sky-high prices. Hot properties are selling within days of listing, and sometimes at 50%-70% above the asking price.

Tax implications

Subsidizing your mortgage with cottage rentals may seem like a sweet deal – until you realize that extra cash is taxable. Yup, it’s true: any income that you earn from short-term rentals must be declared on your tax return and could possibly push you into the next tax bracket (meaning a bigger tax bill pour vous). Plus, if you earn more than $30,000, you’ll have to charge GST/HST.

“You will need to determine the percentage used personally and the percentage used as a rental property,” says Kelly Rust, CEO of SheDo Tax Company and a former employee of Canada Revenue Agency. “Make sure to keep all receipts and documentation for tax time. For the times that you rent the cottage, you will need to either claim as rental income on a T776 Statement of Real Estate Rentals form within your personal T1 income tax return.  Ensure that you are claiming all the rent you received on your tax return.”

Another consideration: if this is a secondary property and you decide to sell it down the road, you’ll incur a hefty capital gains tax. In Canada, 50% of the value of any capital gains are taxable.

“With most people that buy cottages, it becomes their second home,” says Rust. “Down the road, if you decide to sell, capital gains will likely need to be calculated.”

A second job

If renting out your recreational property is a financial necessity, expect some headaches to inevitably come with the job. Yes, I say job, because that’s exactly what it is. Expect to spend your precious time managing bookings, solving problems (like a rodent infestation or a neighbour’s complaint about noise), hiring (and firing) help, property maintenance, organizing records and accounting, doing site inspections, and more. If your municipality starts putting restrictions on short-term cottage rentals, bank on attending town halls or lobbying city councillors.

Even if you’re not playing host, a significant chunk of your time will be spent on property maintenance. Whether it’s hauling garbage to the dump or repairing the dock or evicting critters, you’re signing up for a side hustle.

Mediocre return on investment

If you expect to get instantly loaded from a cottage purchase – think again. You’d likely get a better long-term return on investment by sinking your savings into stocks.

Historically, stocks tend to increase in value more quickly than real estate, as well as produce higher than average annual returns. For example, the S&P 500 index fund has historically produced total returns in the 9% to 10% range. Likewise, the Canadian stock market provided an average annual return of approximately 10% from 1970 through 2015. Meanwhile, Canadian real estate prices have only increased by about 5.35% per year over 10 years (ending December 31, 2019). Looking at the numbers (that don’t lie), investing in stocks is the more lucrative option.

Cottage ownership, however, isn’t necessarily about financial gain. So if you go for it, try to hold onto the property for at least 10 years to reap the reward of the investment.

Costs

A mortgage is likely the biggest cost of cottage ownership, but don’t forget all the other expenses that add up. Here are other costs to consider in your budget:

Taxes

There are several times when the taxman may come knocking at your door.

• Land transfer tax: it’s a one-time tax paid upon purchase of the property. The amount is calculated as a percentage of the cost of your home and varies by province and municipality. In some provinces and cities, first-time homebuyers are eligible for a tax rebate. To give you a rough idea of what it might cost, we paid $1,575 for our vacant waterfront land lot.
• Municipal property taxes: An annual tax paid to the municipality that pays for services like garbage removal, police/fire, and so forth. Your tax rate is set by the municipality and varies depending on the type of property that you own. To give you a rough estimate, we pay $1,283 annually.

Heat and other utilities

Make a line in your budget for electricity, heating and cooling, and other utility costs. It’s difficult to ballpark a figure, as the amount you’ll pay varies by region and energy source (propane, natural gas, electricity, solar, wood, etc.).

“A conventional air-tight wood stove is the most efficient from a pure cost perspective,” says Jeremy White, owner/project manager of Beacon Construction in Bancroft, Ontario – a construction company that specializes in cottage builds. “However, personal time and energy go into preparing the wood for burning. Electric heat is 100% efficient but can be costly to operate. Propane is efficient (and probably the most popular) due to its ease of use and accessibility. Each of these heat sources can be used in different ways — there is forced air, hydronic or, a combination of the two.”

The location also matters, as does whether it’s a three or four-season cottage. Here’s an example: some Ontario cottagers report paying as much as $600 to $1000 per month for electric baseboard heating in the wintertime when the temperature can dip to -25 below. That being said, if your abode is on balmy Vancouver Island, your bill may be next to nil.

Given that my three-season cottage will only be open from June until October, I’ve allocated $1,500 annually to cover utility bills.

Home insurance

Insurance tends to be higher because cottages usually sit empty for long periods and may be damaged by weather-related events. But how much you pay and what’s covered will be determined by the insurer and the policy you choose. Do you want coverage for the garage, boathouse, and recreational vehicles? Is the property located on an island or remote community? Is it a rental? All these factors can impact your monthly premiums. Not to worry though, there are a number of ways to save money on home insurance, such as bundling your policies, improving the security of your home, and more.

The bottom line? Do your homework and shop around for a policy that covers your needs and offers the best home insurance rate possible. For a detailed look at this matter, read more about what you should know about home insurance in Canada.

Rental expenses

Renting your cottage can bring in extra dough, but it can also add extra costs to your monthly budget. Price out the costs of a cleaner ($100+ per visit), property management fees (some agencies charge up to 50% of rental cost), online home-sharing service fees (Airbnb typically charges 3%), snow clearing, firewood delivery, an insurance policy that covers rentals, and more. It’s also a good idea to set up a reserve fund in a high-interest savings account to cover general wear-and-tear, as well as an emergency fund to cover damage caused by guests (which does happen, unfortunately).

Ongoing maintenance, repair and miscellaneous expenses

Although White says that cottages “are very similar to houses in terms of regular maintenance,” he also says to consider the following “less commonly known” costs:

• Snow removal
• Seasonal opening/closing costs
• Garbage disposal
• Potable water systems
• Septic maintenance: “Tanks are pumped every 3-4 years and currently cost about $400.”
• Cottage (private) road maintenance fees
• Cottage association fees
• Additional vehicle fuel and repair
• Dock maintenance: “Some – if not all – dock systems need some kind of attention in the fall. Some types are removed entirely from the lake, others are left in the water but are moved to a more suitable location to weather the winter.”
• Water sports equipment maintenance/storage

Generally speaking, homeowners should budget 1% to 3% of a home’s value each year for ongoing maintenance and improvement. For example, if you own a $300,000 cottage, set aside between $3,000 to $9,000 each year into a high-interest savings account with a better-than-average interest rate. That way, you’ll have the cash on hand if you need to update or repair something.

Tips for buying a vacation home

A few tips for buying a recreational property:

• Get pre-approved with an online mortgage broker. Using your computer, tablet, or phone, you can compare quotes from multiple lenders across Canada in a single search and it won’t cost you a dime!
• Get a home inspection: “Look past the interior and exterior décor and focus on the main structure or ‘bones’,” says White. “Walk around the property with your contractor or home inspector. Inspect the foundation and the core structure of the building for signs of water damage, cracking and movement. Closely inspect the electrical panel, mechanical, and plumbing systems to ensure they all appear to be in good working order. A great view can be distracting, so compile a list of specific items to look at while viewing the property and check them off one by one. This will make you more attentive to potential problems.”
• Double-check the important legal stuff: “Get confirmation from the local municipality as to who owns the shoreline or if there is a road allowance at the lakefront,” says White. “Make sure that you have deeded access to the property, as an assumed right-of-way over a road allowance or a neighbour’s property may not be legally defined.”
• Request past utility bills. To avoid the shock of your first utility bill, ask the seller or real estate agent to produce copies of past utility bills.
• Inspect the septic system. Everyone knows the value of a home inspection, but prospective cottage buyers should insist on a septic system inspection. No, flushing the toilet isn’t enough! Ask the seller to provide copies of the inspection and/or approval reports and even consider arranging for your own independent inspection as well. The seller should also pump the tank before the closing date. A new septic system is expensive ($8,000+), so you’ll want to ensure that the existing one has been properly maintained and actually works before you take possession.
• Test the water (literally). Find out everything you can about the water source. If there’s a well, test the water regularly. The water isn’t guaranteed to be potable in rural areas, and you may even need to bring in your own drinking water. It’s not a dealbreaker, but it’s a “need to know” item.
• Do your rental research. If you’ve got grand plans to rent the joint, a vacation rental data and insights company like AirDNA can help you understand the market and set competitive pricing. It’s also worthwhile to talk to cottagers in the area who rent out their vacation properties and get their two cents. Also, call the municipality to confirm that short-term rentals are permitted under the current rules.
• If you’re renovating or building from scratch: “Source out a reputable contractor and seek references from their past projects,” says White. “Visit the contractors’ past sites to inspect the finished quality. Install high-efficiency appliances and fixtures and do not shy away from applying extra insulation. Construct a dwelling that will have the lowest monthly operating expenses and require the least amount of maintenance, so you can enjoy the reason you wanted to cottage in the first place.”

Final say

If you’ve read this far, I hope you’re feeling more prepared (and excited!) about cottage ownership. Or maybe you’ve decided that investing is more your thing, and that’s okay! Owning a vacation home is a joy, but also a responsibility – one that you need to feel ready to take on.

Happy cottage-hunting!