Economics

Here’s Why You Should Be Wary Of “Recreational Real Estate”

A few years ago, I was having lunch with a group of friends during a ski trip to the French Alps.

One of the guys leaned across the table and showed me some photos on his iPhone of a stunning piece of property. It was a gorgeous chalet set amongst the trees and snow of a mountain resort in western Canada. A very seductive piece of real estate.

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I commented that he and his wife must rattle around in there like peas in a pod given how big the property was.

“Yep, we do, now that the kids have grown and are off doing their own thing.”

“Expensive to maintain?” I asked.

“Very,” came back the quick reply, accompanied with a sigh.

I wasn’t surprised.

He continued, “In fact, I could take two months holiday each year in some of the best resorts in the world with the cash that I pay just to manage this place.”

And there would be no hassle. Walk in, walk out. Maintenance and all those other costs are someone else’s problems.

I asked if he had any plans for the property.

“Absolutely. We’re trying to sell the place.”

He’s now retired. He wants to put the capital locked in that asset to better use to generate income. His pretty property wasn’t doing that.

So how is the sale process going?

“It’s been on the market for nearly a year. No serious buyers yet.”

He’ll have to drop the price quite a bit to move it.

That hurts, but given he built it almost twenty years ago, he’ll still probably come out ahead.

That is, if he can sell it…

Not an unusual story

I hear this story repeated frequently by friends and acquaintances all over the world.

This story happened to be in Canada, but it could just as easily as have been Tuscany, Provence, Phuket, Niseko, or the Algarve.

The ingredients are always the same.

They fell in love with a piece of “recreational real estate.” It’s a vacation property off in some beautiful, often far-flung place.

But the family doesn’t really use it much these days. The kids have flown the nest and have their own agendas.

Maintenance and management costs are very high. It’s not a simple lock-up-and-leave apartment.

Worst of all, the property doesn’t produce a decent reliable rental income stream.

And this all comes just as retirement is hitting home and that regular paycheck is fading…

Similar story, next day

The following day I heard a similar story.

This time it was a property in France, but with a slight twist.

In this case it was a delightful country property that could produce some income as a bed and breakfast. But the French tax regime makes running a small business virtually impossible.

The French bureaucracy is stifling for most small business. Take my ski instructor, for example. His little ski instruction business requires the services, and costs, of at least two tax advisors to navigate the rules and regulations.

It’s no surprise that tens of thousands of French people have moved to Hong Kong in the past decade. France doesn’t support entrepreneurial-minded people who want the freedom to create personal wealth.

So selling the property is their only escape. They’ll move the cash to England, where a real estate rental business can be viable and the tax system is codified and transparent.

So what’s the problem? Well, the real estate market in rural France is dead.

The owners know they are going to take a big hit if they are to get their cash out in any kind of reasonable time frame.

I know other owners of recreational real estate in France, Italy, Spain, Croatia, New Zealand, Australia, Canada and the U.S. who are trapped with their recreational properties.

Yet, in major cities in these countries, real estate markets are often doing well. Prices have recovered in many and now stand at levels well above pre-global economic crisis highs.

Even if they are not at such levels, recovery is in the air at least.

But more importantly, there is liquidity. By that I mean deals are getting done.

That is not always the case for those wonderful beach, river, mountain and lakeside locations.

Recreational or investment? No doubt here

Regular readers will know that I am a big believer in owning real estate for long-term capital preservation, growth and income.

A small property or two in your investment portfolio can provide a big boost to your income stream later in life.

As we know, the vast majority of people retire with an income stream that’s a fraction of what they were making immediately prior to retirement.

Many people retire without any private income stream at all. Reliance on state handouts is their lot. The western world is facing a retirement crisis. It’s a fact.

Regular readers will also know my views on recreational real estate investment. In my opinion, it is often not an investment at all. It is an expensive consumption item.

It’s easy to get seduced by a wonderful country cottage, the beach house, the chalet in the mountains. I have almost succumbed to this temptation a number of times myself.

I remember sitting in the enormous garden of a friend’s house in the south of France one sunny summer afternoon a few years ago, drinking rosé and thinking “I could make this work.” I even got in touch with a few agents… But fortunately, I came to my senses.

Rationality tends to fly out the window when we look at these beautiful examples of the builder’s art. There is no doubt that you and the family may love to spend a couple of weeks, or even a month a year if you’re lucky.

Rational thought says this…

But think about some of the realities.

Owning a recreational home somewhere means that you will probably feel obliged to go there every holiday you take. It narrows your options. Perhaps you might want to go to other places, experience other countries, locations, activities. Owning that cottage by the lake means that you may not get to enjoy other experiences as much, if at all.

And what about taking care of the cottage, chalet, house when you are not there – or when you do go there. I know people who spend the first week of their holiday doing maintenance and fixing up their recreational real estate. If that’s the sort of thing you like, then fine. But I view my holiday time differently.

And who is going to manage the property for the many months that you are not there? To check that pipes have not broken, that the windows and roof are not leaking. To ensure the place isn’t overrun with insects, mice, cockroaches… and worse.

And then there is the cost of that management service. Employing a professional management company can be expensive. You can pay anywhere from 10-40 percent of your rental income to your management and listing agency.

On top of that, there are local fees, duties, taxes and charges that might be levied on you as an owner – which may differ if you are a foreigner.

And if you’re a foreigner, there are plenty of countries in Asia, and elsewhere, that offer only very weak property rights.

For example, in Thailand, you’re not allowed to have outright ownership of landed property (i.e., a house, not a condo/apartment).

You can have 49 percent ownership. Then you need to get a (trusted) lawyer to create a structure that allows you to circumvent that. In addition, the land is only leasehold – and often just a 30-year lease.

My email inbox is loaded with files of wonderful, seductive, gorgeous recreational real estate sent by agents from all over the place.

I browse to get a sense of how markets are behaving. But I’m not tempted.

I have enough expensive vices in life as it is. (Being a boat owner is one of them!)

Don’t get me wrong. I don’t believe you should never indulge your real estate fantasies. But recognise them for what they are. Just that. A wonderful fantasy, to be enjoyed and paid for.

The two examples I gave earlier are just a couple of many that I’ve seen over the years. I’ve seen so many friends and acquaintances put their hard-earned money into holiday real estate – without even owning proper investment real estate!

It’s madness!

To those of you in your thirties who’ve maybe have some cash in the bank… please ignore recreational real estate. Forget about it.

In my opinion, it only makes sense if you already have a property or two under your belt, maybe a home and an investment property.

I know if you live in London or Hong Kong you won’t necessarily be able to afford a family home. But please, if you are looking at real estate make sure at least it’s a solid investment property.

And by that I mean, a nice one- or two-bedroom apartment. It should be a location where people where a suit and tie to go to work. Somewhere you and a better half would be happy to live yourselves.

That’s exactly how I’ve built my investment property portfolio. My properties all have 1-3 bedrooms. They’re located in areas favoured by professionals and are therefore rarely vacant. They are in major global cities with solid property rights and a transparent legal system. And they require minimal maintenance.

By the time you’re in your late 50’s, the mortgage is paid off, you will likely be sitting on good capital gains. On top of that you’ll have an asset that’s spinning off extra cash flow month after month.

I can’t tell you how many folks in my generation wish they had a few assets like that right now…

An exception?

More recently, a good friend emailed me saying he was considering buying a lake house. What did I think?

Usually when I get an email like that, the alarm bells start ringing. My default response is to fire back an email that includes something along the lines of what I wrote above.

But this time I said, “Go for it!”

Why?

Well, my buddy has worked hard and enjoyed success in his profession. He’s invested wisely and – critically – he owns a few investment properties already (one of which he asked my advice on a few years ago).

He’s not one of the “younger readers” I refer to above who should be focused on building a core asset base rather than splurging on this kind of vacation home.

Nor is he particularly old. But he’s just a guy who made a good decision and bought investment real estate when he was younger. Because of that now he has the luxury of being able to even consider a decision like this, with the kind of financial independence that we all aspire to.

My friend is the perfect example of what happens when you make those tougher decisions earlier on in life. Because recreational real estate is always tempting, no matter your age!

And maybe when you’re in your thirties or early forties, and if you have a little money in your pocket, the idea of that lake house or chalet in the mountains is tantalisingly seductive. But that’s when the tough decision counts.

Do some people make money on recreational real estate? Of course. But in my many, many years in real estate I’ve found that to be the exception, not the rule.

Don’t confuse recreational real estate with an investment. It’s a consumption item, a dream to indulge in for you and your family.

And don’t assume this is something you can easily sell if the need arises.

Good investing,

Peter Churchouse

Article by Stansberry Churchouse

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