How to decide if a holiday home is a good investment

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Owning a holiday home is a goal for many. However, in the past it was a luxury limited to the lucky few.

Back in 2014, 560,000 Australians owned a holiday home, and Melbournians were the biggest enthusiasts, with one in 20 owning a getaway.

That was before interest rates hit rock-bottom and online platforms like Airbnb and Stayz made it easy to rent out holiday homes, potentially turning them into money spinners.

Sun chairs on balcony overlooking the beach at a holiday home.

While COVID-19 lockdowns put a temporary dent in the short-term rental market, vacation home owners in popular destinations have been compensated by exceptional price growth.

CoreLogic's quarterly regional market update shows that in the 12 months to January 2022, house values in Kiama, a popular tourist destination on the NSW south coast, have soared 43.9%. It's taken the median value to $1,633,086. To put this in perspective, in the 1990s it was possible to buy a home in the Kiama area for less than $140,000.

Other favourite vacation destinations that have performed well over the past year include Byron Bay,  where house values are up 30.2%, the Gold Coast (up 36.3%) and the Sunshine Coast (35.4%).

These skyrocketing values haven't just been driven by demand from holidaymakers. Data from the Commonwealth Bank reveals quarterly migration from capital cities to regional areas over the past two years is averaging 15% higher than in the two years before Covid.

It raises the question, is a holiday home still a good investment? And if you own a vacation place, is now the time to cash in?

Rentals look healthy

While last year's lockdowns in NSW and Victoria dealt a heavy blow to short-term holiday rentals, the pandemic overall has delivered gains to vacation home owners. When Australia closed its borders to overseas tourists in March 2020, Aussies were left with little choice but to holiday domestically. Demand for vacation bolt holes flourished.

Analytics firm AirDNA reviewed 76 Australian cities, towns and destination markets in 2021, noting that each saw rental and revenue growth year on year. It notes, too, that short-term rentals can earn up to three times more than traditional long-term rentals.

As Australia reopens its international borders, demand for short-term rentals is likely to climb. What's less certain is the pace of future capital gains.

While net migration to the regions remains strong, CommBank figures show the number of people relocating to the regions in the December 2021 quarter was down 10% compared with the previous quarter.

"Despite the recent exuberance, I would expect price growth rates in regional Australia to start slowing early this year," says CoreLogic's head of research, Eliza Owen.

However, Angus Raine, chairman of the Raine & Horne property Group, says there is no shortage of buyers lining up for holiday properties. "Demand for holiday homes is off the Richter scale because of Covid," says Raine. "State and international borders have meant people are being forced to holiday at home. Low interest rates are also helping."

He says areas that are especially popular include the NSW south coast, Margaret River in Western Australia and many parts of Queensland.

In the far north Queensland tourist town of Port Douglas, holiday home purchases represent about 50% of local Raine & Horne sales over the past year, up from a historical average of 40%. Meanwhile, on the NSW south coast about 30% of homes sold in the past 12 months are being used as holiday homes.

What to look for in a holiday home

According to Raine, it makes sense to buy holiday homes within a three-hour drive of a capital city. And improved infrastructure is making this easier.

Completion of the NorthConnex tunnel and upgrades to the Pacific Motorway in NSW, for example, have trimmed the drive-time from Sydney to north coast locations like Seal Rocks down to just over three hours - a trip that once took the better part of a day.

Cars driving over the Sydney Harbour Bridge as they head to holiday rentals.

Along with an appealing and accessible location, certain features are worth looking for if you plan to let a property to holidaymakers.

"The property needs to be as easy to maintain as possible," notes Raine. "Hard floors are much easier to maintain than carpet, for instance. It would also be useful if the property provided opportunities for dual income. You can stay there and still earn an income."

Stayz data from last year confirm that paying customers expect more than a few well-loved bunk beds from short-term rentals. Among the essential inclusions, Stayz respondents nominated barbecues, air-conditioning, a pool and even a home gym as desirable features - inclusions that can significantly bump up the outlay for a rent-worthy property.

If you need finance for a holiday home, don't expect to pay standard home loan rates. Jack Talbot, principal of broking firm Leverage Capital, says that when a property is not your permanent place of residence, as is the case with a holiday home, lenders will treat the mortgage as an investment loan.

"Interest rates on investment loans are generally 0.3% higher than for owner-occupied loans provided your repayments are set to principal and interest," he says.

While you may be able to use home equity in lieu of a cash deposit, borrowers may still need sufficient personal income to get the green light from lenders. "A lender will take Airbnb income into account provided it is existing income and the property has been listed on Airbnb for over 12 months and the rental income can be verified with accountant-prepared financials," says Talbot.

"For a property not yet purchased, the lender will only accept projected income that would be generated by the property if it was in a traditional long-term lease agreement."

Holiday rental rules get tougher

The popularity of short-term rentals across Australia hasn't pleased everyone. Unruly parties, late-night disturbances and a squeeze for on-street parking have been ongoing headaches for permanent residents living alongside some short-term rentals.

Several councils have taken matters into their own hands. In Victoria's Mornington Peninsula - the third highest short-stay rental destination in Australia - the local council introduced laws to regulate the sector as far back as 2018. Property owners there are now responsible for the behaviour of occupants. Time limits are in place for the use of pools or spas, and off-street parking must be provided for all holidaymakers' cars.

In NSW, where short-term rentals are a $30 billion a year industry, strict new laws kicked in from December 2020. A mandatory code of conduct sets clear guidelines for minimum standards of guest behaviour, and property owners must be contactable by concerned neighbours between 8am and 5pm each day.

Further rules were added in NSW from November 2021 that limit the number of days a short-term rental can be let where the host is not present. The cap is 180 days annually across Greater Sydney as well as a number of regional areas, including Ballina, Bega Valley, Dubbo and Newcastle.

The Hotels Association of Australia has voiced its concerns about the short-term rental industry. In Western Australia, the state government is investigating the possibility of stricter regulations, including a possible 60-day annual limit for holiday homes that aren't formally registered with local authorities.

Along with meeting new regulations, holiday home owners need to consider the impact of tax.

The Tax Office makes it clear that owners can only claim deductions for the costs of a vacation home when it is rented out or genuinely available for rent. Setting unreasonable conditions on prospective renters, asking rent above market rates or failing to widely advertise a holiday home are all red flags that may suggest owners aren't serious about renting out a place.

Where a property is rented or genuinely available for short-term rent, expenses like loan interest, maintenance, insurance and repairs may be claimed on tax. But you can't claim these costs if you stay there yourself. Expenses need to be apportioned between your time on holiday versus when the place is earning its keep with paying tourists.

If a holiday place is rented out to family or friends at mate's rates, you can only claim deductions for expenses up to the amount of income received.

Even if you never rent out a holiday home, chances are you'll pay capital gains tax on any profit on sale. In this sense, the term holiday "home" can be misleading. As the Tax Office sees it, we can only have one tax-free "principal place of residence" at a time. So, a vacation property doesn't enjoy the same tax-free status as your regular home.

That said, the Tax Office says that if you make a profit on sale, property expenses (such as insurance, loan interest, repair and maintenance costs, and council rates) are taken into account in working out the taxable gain. This makes it important to hold onto any receipts relating to a holiday property and consult a registered tax agent to determine how much tax you could be up for if you sell.

Weighing it all up

Buying a holiday home should never be a spur-of-the-moment decision based on a few magic days on vacation. Yes, short-term lettings can earn much higher rents than a long-term tenancy. The catch is that this income is not year round while ongoing expenses are.

In addition, the short-term rental market is highly competitive. A recent industry report entitled Growing up Fast found there could be as many as 436,000 properties available for short-term rent Australia wide. Homes typically need to have an appealing location and be furnished and maintained to a high standard to attract paying holidaymakers.

The final aspect to consider is the trade-off between making a buck on a holiday home and enjoying it yourself. A vacation property is likely to command peak rental rates during those periods when you probably want to stay there yourself - like school holidays, Christmas and the January summer break.

Anne Graham, senior financial planner and CEO of Story Wealth management, sums up her views on holiday homes: "They are great for bringing families together and making memories. As far as investment options go, though, they can be a minefield."

Graham notes a location may be brilliant for peace and quiet and family fun, but not necessarily for capital growth over time - "unless of course you bought on the east coast 10 years ago!"

As for rental income, Graham cautions that it might not be enough to cover the holding costs, especially if debt is involved and you're only renting out the property a few times a year.

"Before buying that little shack on the coast or in the bush, it's important to be realistic about the likely rental income, the ongoing cost of maintenance and potential repairs and renovations.

"Another issue that often isn't seriously considered is how often you'll use your holiday home. Will you be able to escape to it on a regular basis? Or will the excitement pale as other commitments encroach on  your time and it becomes too hard to get away?"

The upshot, according to Graham, is to take off the rose-coloured glasses and think practically about what you're getting yourself into. If you aren't going to use a holiday home as often as you think, or if you're unsure, consider putting aside funds to rent a place for six to 12 months and try before you buy.

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A former Chartered Accountant, Nicola Field has been a regular contributor to Money for 20 years, and writes on personal finance issues for some of Australia's largest financial institutions. She is the author of Investing in Your Child's Future and Baby or Bust, and has collaborated with Paul Clitheroe on a variety of projects including radio scripts, newspaper columns, and several books.

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