Why Your Summer House Could Be a Shaky Investment

May 29, 2018, 1:00 AM UTC

For decades, it’s been part of the American dream: owning a vacation home, a lakeside or mountain getaway somewhere for the family to escape to on weekends or for a week or two in summer. And with the country enjoying strong economic growth, a healthy stock market, and relatively low mortgage rates, you might think beach houses and country cabins would be especially hot commodities today.

But all is not well in Holiday Village. “Vacation-home sales have been relatively weak for the last four or five years,” says Aaron Terrazas, senior economist for housing analysis firm Zillow. Demand is being stalled by a traffic jam of different trends—ranging from climate change to demographics to, of all things, the Trump tax reforms. Year-over-year price changes in many second-home markets have dipped into negative territory, and some experts think that trend could go national over the next couple of years—making many buyers think twice about a real estate investment that people used to count on for both fun and profit.

From one angle, the vista looks rosy: The median price of U.S. vacation homes rose 4.2% in 2016, to $200,000, their highest level since 2006, according to the National Association of Realtors. But there were only 721,000 vacation-home sales transactions that year, a 36% drop from 2014.

More recent sales data is harder to track down—the realtor association recently announced that it would no longer publish a vacation-home survey, citing the costs and challenges of figuring out which homes are primary residences and which are part-time. But other analysts say the slowdown has continued—and that it’s likely to get worse before it gets better. And the numbers back them up. To help Fortune analyze vacation-home price trends, real estate site Trulia looked at zip codes in which at least 25% of residential properties were identifiable as vacation homes. While prices in those zones rose a respectable 14.8% in the three years through March, they badly lagged prices in non-vacation areas, which increased 25.2%—a difference of more than 10 percentage points.

Experts attribute the relatively sluggish market to a perfect storm of factors—including, well, storms. Eastern Seaboard beach homes have lost a lot of cachet, Terrazas explains: “Climate change has come to the forefront, and people are evaluating those coastal risks more than they have in the past.” Indeed, Trulia’s data shows price softness and even declines in seaside areas ranging from Ocean City, N.J., to Virginia Beach, to Florida communities like Miami and Key West. But the damage isn’t confined to the beach: Year-round mountain vacation communities like Coeur d’Alene, Idaho, and Bennington, Vt., are being affected too. So what other worries are on buyers’ minds?

The sleeping giant of interest rates may be the most obvious concern. The Federal Reserve raised the federal funds rate by 25 basis points in March, to 1.75%, while signaling two more rate hikes on the way for the year—and perhaps a third, to help cool a hot economy and bring rates closer to historical norms. Such increases, of course, filter down into the entire mortgage market. And while vacation homes are more likely than primary residences to be bought with cash—only 72% of purchases involve mortgages—the rising cost of borrowing is likely to further dampen buyers’ appetites for a getaway spot, says Felipe Chacón, a housing economist at Trulia.

Vacation-home investors are also being stung by an enemy they share with hotel chains: home-rental services. “The availability of great rentals through Airbnb and VRBO is hurting for-sale demand,” notes Pete Reeb, principal at John Burns Real Estate Consulting. Those platforms have made it easy to take a house in the mountains for a relatively long stretch—without any down payment, mortgage, or upkeep costs.

Part of the slowdown is also generational. While boomers, who grew up amid post–World War II prosperity, were captivated by the idea of a getaway nook for the family, younger Americans are not as entranced. “Seems like an antiquated status symbol to me in some ways,” says Erin Lowry, a millennial and financial blogger from New York City. “Personally, I don’t have interest in purchasing a vacation home, because I’d prefer to keep exploring new cities and countries, instead of feeling obligated to return to the same spot.”

Millennials also aren’t in the greatest financial shape, compared with earlier generations at the same age—and by definition you can’t buy a second home if you haven’t purchased a first. Homeownership among adults ages 25 to 34 actually fell slightly in this year’s first quarter, to 35.3% of that cohort, according to the U.S. Census. That is around half the national average, and near multidecade lows: In 1982, for example, homeownership in that same age group was around 67%. (As for poor Generation X, they were the ones “hit very hard by the housing bust, and took the brunt of foreclosures,” says Terrazas; they’re too financially shell-shocked for ski chalets.)

The bottom line: “Rich people already have [vacation] homes, and ordinary folks aren’t feeling very prosperous,” says Ingo Winzer, founder of real estate consultancy Local Market Monitor.

Of course, plenty of people are feeling prosperous today, especially with last year’s Tax Cuts and Jobs Act having put more cash in their pockets. But ironically enough, that same legislation is creating ripples in some housing markets that could prove particularly deleterious to second-home owners.

The problem: To help pay for corporate and personal income tax cuts, Congress capped some lucrative real estate deductions. Previously taxpayers (single or married) could deduct interest on mortgages of up to $1 million; now that cap has been lowered to $750,000. That figure spans all homes owned—and while the ceiling is high enough to exclude most homes in the nation, a swath of higher-end and second-home owners are finding they won’t be able to deduct as much as they used to. The new tax law also capped federal deductions on state or local taxes—or SALT—including property taxes, at $10,000. While these changes aren’t make-or-break purchase factors for millionaires, they’re enough to make many potential buyers think twice about a second home.

Research firm Moody’s predicts that the new tax laws will amount to a 4% headwind for the overall housing market in 2019—in other words, resulting in 4% less appreciation, or 4% more depreciation, than if there were no new tax laws. Zillow’s Terrazas and other analysts expect an even bigger tax drag for
vacation homes in higher-tax states (think New Jersey or Massachusetts). And that, combined with other factors, could make the difference for owners between realizing price gains or winding up underwater.

Clearly, anyone looking for a good reason not to buy a second home right now has all the ammunition they need. But if you’re already a vacation-home owner, what are the best ways to keep your investment from becoming a financial drag?

Play landlord: While Airbnb and its ilk may be dampening for-sale demand, they’ve also made it easier to find short-term tenants. Put your unit up for rent some of the time you are not using it, and use that extra cash to cover the monthly nut (or the property taxes).

Refinance: If you have a mortgage on the property, and your rate is more than 100 basis points above current rates, think about refinancing, advises Terrazas. With rates trending upward, this might be your last chance for a while to ease those monthly payments.

Sit tight: If you are a long-term owner, gyrating prices should mean almost nothing to you—just as day-to-day stock price changes mean nothing to a buy-and-hold equity investor. After all, many vacation-home buyers see the property not as an asset to be leveraged or traded, but a generational gift, to be enjoyed with and then passed down to the family. Return on investment: immeasurable.