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Using a Vacation Rental Property to Build your Portfolio at a Discount

Amanda's Note: This was provided by an online contact. 

You can use real estate to diversify your investment portfolio. And you can use a vacation rental to generate rental income as well as potentially put to other uses, instead of simply investing in real estate investment trusts and apartment buildings in order to make money from real estate. Here are tips on using a vacation rental property to build your investment portfolio.

Plan on Cash Flow the Right Way

Vacation rentals are overwhelmingly used to generate cash flow, and that cash flow is seasonal. Plan the purchase of the property based on the cash flow it can generate, and ignore potential capital appreciation since vacation properties are almost entirely priced based on seasonal demand. The only potential exception to this is when an area is shifting from a vacation hot spot to a residential area; this is rare.

Run the numbers on the potential purchase based on the costs you’ll have to pay (mortgage if you don’t pay cash, insurance, property taxes, repairs, utilities) relative to the income you’ll earn. Remember to find out what you’d realistically get for the property during the busy season for a home of the type you’re buying, not the best-case scenario because you’ll lose money if you fail to see that dream become a reality. This is a business decision; plan based on the worst case and most likely case, not what you wish was true, or the rental property will become a financial nightmare.

Shop for Value, Not Price

Cash flow for a rental property is relative to demand, not property value. This means you should look for properties that meet the checklist renters are looking for, not the cheapest property far from attractions or lacking key features visitors one. This means you could find a vacation rental property close to the amenities tourists want and rent it out for a fortune – and high return on investment – without spending a lot. Conversely, if you buy a mid-market property that would work well as a rental home for long term local occupants but not seasonal visitors, you’ll lose money no matter how cheap it was.

Understand the Rules and Restrictions

If you’re renting out a vacation property, you’re still obligated to maintain the property or pay a property manager to do so. Have a plan on how to meet these needs so you aren’t sued for failing to meet your obligations as a landlord. For example, when buying a vacation rental on the Outer Banks, consider finding a property manager there so you don’t have to worry about making it out there to repair a problem even though weather or traffic makes that nearly impossible.

Read the rules and restrictions for home owners’ associations and condo associations. They may not allow you to buy a unit and rent it out without jumping through various hoops. If you find that you cannot find seasonal visitors and try to rent it out on online lodging marketplaces, you may run into other restrictions, including the requirement by some jurisdictions to get a business license. Know the maximum headcount you’d be permitted to allow to stay in the property before you rent to a group that size.

Don’t buy a home as an owner-occupant and then rent it out unless you actually live there for a while. Violating this rule can get you in trouble with your mortgage company if they loaned you money at a lower rate or accepted your loan with a smaller down payment on the expectation you’d live there.

The proper way to use vacation rental real estate to diversify your portfolio is to make a realistic assessment of your potential profit and revenue, choose properties based on value and understanding the rules you’d have to meet as a landlord and find out the restrictions on a property.

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Amanda L. Grossman is a Certified Financial Education Instructor, Plutus Foundation Grant Recipient, and founder of Frugal Confessions. Over the last 10 years, her money work helping people with how to save money and how to manage money has been featured in Kiplinger, Washington Post, U.S. News & World Report, Business Insider, LifeHacker, Woman's World, Woman's Day, ABC 13 Houston, Keybank, and more. Read more here.