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Can a holiday home be a good investment? Here’s everything you need to consider before you buy one.
It’s summer season, and it’s likely that you heard your colleagues, family, or friends talking about renting out a holiday home over the Christmas and New year break. Chances are, you may have rented out one yourself.
It’s not surprising then that during this time of the year, some real estate investors are more likely to be enticed by the idea of buying a holiday home for investment purposes. For some, the prospect sounds like the classic case of having your cake and eating it, too — you can generate rental income and also have your own little holiday retreat.
But oftentimes, this scenario is just a pipe dream. While it sounds like a good deal all around, investing in a holiday home can often be risky due to the fall-off in demand during off-peak seasons, which can see a property become untenanted for six months a year.
In worst-case scenarios, people often have to sell the property for less than the original purchasing price due to the poor cash flow.
Like all ventures in real estate, property investors should carefully consider if buying a holiday home is a good fit for their property portfolio and investment strategy. It’s important to do thorough research and treat it as an asset like any other. If you can do that, a beach pad or country retreat may make a profitable investment in your portfolio.
To help you reach a decision on whether you should take the leap, we take you through the key questions if you want to invest in a holiday home.
1. Where should you buy your holiday home?
When you think of a holiday home, you are bound to have a personal set of criteria that the property must have, such as having a pool or a breath-taking view. However, the location of your property is also very important.
In fact, location is everything when it comes to buying a holiday home. Remember that demand for holiday homes is often seasonal, and peak season varies between locations. So your holiday home could be vacant for long periods during off-seasons. While almost all holiday houses will generate a good return on investment during peak times (such as during school holidays in Australia), properties in locations that are less desirable year-round may hurt your pockets during the off-season.
When selecting a holiday investment property, make sure to choose a prime location that offers all the “must-haves” such as restaurants, cafes, shopping centres, and tourist hotspots.
It’s also advised to buy in a town or city that has major infrastructure nearby; otherwise, you run the risk of fluctuating occupancy rates between peak seasons.
You should also look into the capital growth potential of the area as well as the vacancy rates in peak and off-peak seasons. It’s also advised to buy in an area with industries other than tourism, which can help to keep it tenanted.
2. When should you purchase a holiday home?
While the timing of a holiday home purchase will depend on your individual financial circumstances, it’s advised to hold off until the peak season is over to buy.
This is because supply and demand tend to dictate the price trends for the property market that you are looking to buy into, so waiting until the off-season can be a smart and money-saving decision as demand will be lower, which in turn will effectively lower the property prices. It’s also ideal that there is a high supply in the area.
For example, buying a property during the spring season will usually mean that there are more properties on the market that can check all the boxes for a good holiday home, but you might be able to snag a better deal during the quieter, cooler months. Remember that property market trends also vary between areas, so it’s vital to do your due diligence and research on your desired location.
Make sure to check out Smart Property Investment’s Suburb Search Tool to get a profile of every suburb across Australian states and territories. Simply enter the suburb name or postcode in the field above and press the suburb to get an insight on vital market information, including growth rates, vacancy rates, median house prices, time on market and key demographic data.
3. What are the costs associated with a holiday home?
It’s a common misconception that holiday homes are properties that need to be looked after only during peak seasons. However, you need to remember that your holiday home will have costs all year round that will eat into your rental income.
Some costs you need to account for include maintenance, advertising, insurance and management fees. If you are able to comfortably manage these costs, even during periods of low demand and long vacancies, your holiday home could be a worthwhile investment.
To minimise costs, experts advise buying a low-maintenance property. It’s also important not to overcapitalise and consider the fittings required to generate the level of rental yield that you are looking for.
If you are purchasing a holiday home as a couple, another thing to consider is the name in which the property is purchased, taking into account the partner who would pay the lowest amount of tax on any earnings on the property. You may also consider using a trust to purchase the property.
It’s also important to remember that to make a profit on a holiday home; you may need to hold it for a long time to recover the buying expenses, including stamp duty, set-up, legal and selling costs.
4. How should you rent your holiday home out?
With more people turning online for almost everything, there are now more options available to holiday home landlords when it comes to leasing their properties.
Platforms such as Airbnb have exploded in popularity in recent years and can often be the go-to place for holiday-makers needing a short-term rental. If you’re thinking of opening your holiday house to guests as a host, here’s what you should know before hosting on Airbnb.
Meanwhile, if you are looking for alternate sites like Airbnb, here are some other similar platforms:
Of course, you could opt for a more traditional form of listing by going with the property management agency that oversees your property. An upside of this approach is that these real estate agents will have comprehensive knowledge of the local housing market and how to maximise the time that your home is tenanted.
5. What are the tax implications of owning a holiday home?
If you do purchase a holiday home for investment purposes, it’s important to understand your tax obligations to avoid getting in trouble with the Australian Taxation Office (ATO).
You must declare any rental income on your tax return. On the upside, you can claim a deduction for expenses that are incurred for the purpose of earning this rental income.
Expenses that can be claimed include the interest you pay on the home loan taken out to fund the property, maintenance costs, property management fees and council rates. Therefore, if you’re claiming deductions for these sorts of expenses, you’ll lower the taxable income from your holiday rental, which will lower how much tax you pay.
For more information, here is our comprehensive guide to tax deductions you can claim on your investment property.
It’s also important to note that you can only claim tax deductions for the period that the home was rented out or genuinely available for rent. Specifically, ATO states you can only claim for expenses for certain periods when your property is either:
For example, if you advertise your holiday home but always occupy the property during the holidays and don’t rent it out at other times of the year due to weak demand, then this means that you didn’t really have the intention to rent the property out, and it is considered to be for private use.
But, if you were to rent the house out for four weeks in the off-season, you could claim deductions for expenses incurred in this period only.
Below are other tax implications buyers need to be aware of:
Capital gains tax
Assuming you make a capital gain on the property when you decide to sell it, you will also be required to pay capital gains tax. However, you qualify for the capital gains tax discount if you’ve held the property for longer than 12 months, meaning you’ll only have to pay tax on half of the capital gain.
Even if you haven’t claimed deductions for expenses related to earning rental income, you’ll still need to keep records of any expenses you incurred through your own private use of the property. This is because these expenses are factored in when working out the capital gain or loss that comes from selling the house.
Additionally, if the property is sold for less than the original buying price, the tax loss may be carried forward to offset gains from other investments.
If you’re planning to crunch the numbers, use our handy Capital Gains Calculator to help you get the ballpark figures.
Land tax and stamp duty
Another tax to consider when deciding on whether to invest in a holiday home is the land tax. Land tax is an annual tax levied on all properties that are valued above a certain amount or threshold.
The amount is based on the value of the land only and not the property value. It does not include the value of the buildings or properties on the land lot.
This means that even if you’re not earning income from your holiday home, you’ll still have to pay this tax. The amount you pay differs depending on which state or territory the property is located in.
Are you looking to minimise your land tax? Here are smart strategies you could use to legally minimise how much you pay.
Another thing to consider is the stamp duty, which will be payable on the transfer of the property, and each Australian state and territory has a different calculation rate. To have a good estimate of what you need to pay, use our Stamp Duty Calculator.
You also may qualify for tax breaks with negative gearing, which is when costs associated with an asset (in this case, your holiday home) are greater than the produced cash flow from the investment.
When a property is negatively geared, you can deduct your loss against other income, such as your salary. While negative gearing involves making a loss, it can be advantageous for investors who anticipate that the capital gain from selling a property will offset any losses.
So, while the tax benefits from owning a holiday home can boost its value as an investment, this shouldn’t be the only reason you choose to invest.
The promise of the combination of rental income and easy future holidays is an attractive prospect, but it’s important to carefully consider if buying a holiday home is a smart investment for you.
Are you on a mission to kick start your property investment journey this year? If you’re a first-time buyer looking to enter the real estate market, check out Smart Property Investment’s brand-new white paper, Why 2022 is the right year to invest for beginners.
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