The dos and don'ts of buying a vacation home

Fuelled by HNIs and NRIs, holiday properties make great leisure destinations and can also offer good returns. Just steer clear of certain investment pitfalls

A few years ago, an upper middle-class working couple I know, were looking to invest in a second house in northern and north-eastern Mumbai. But they weren't too sure about the return their investment would fetch them, given that property prices were peaking, were largely unaffordable and offered limited scope for appreciation.  

There were, of course, options in the mofussil areas of the city, such as localities beyond Mira Road. But while they suited the pocket, they weren't exactly prime picks in a market nobody knows where it's headed. So the couple decided to explore another option -- the home away from home, or quite simply put, the vacation home.

Here is a market that follows different dynamics and is more insulated against the general slowdown in the real estate sector. Driven by the demand from high net worth individuals (HNIs) and non-resident Indians (NRIs) looking for a second home for leisure and relaxation, spending quality time with family, and pursuing hobbies such as farming and fishing, this market is showing signs of steady growth.

Vacation homes make up 5-7 per cent of the property market. Holiday locations in Goa, Himachal Pradesh, Kerala, Uttarakhand, Ooty, Coorg  and areas around Mumbai like Lavasa, Alibag, Lonavala, Igatpuri, Murbad and Khandala are preferred for the serenity, weather, infrastructure and potential for rental income that they offer.

Potential pitfalls

However, there are certain factors one must consider before buying a vacation home.

Tax implications: A second home will be regarded as non-occupied by the owner and deemed to be let out even if  vacant and the notional rent 'earned' will suffer tax. But if you choose your property location carefully, so that it is in close proximity to the railway station, medical facilities, entertainment areas and other social media, you might actually earn some rent that will neutralise the tax hit.

Farm versus NA: Second home project developers buy large tracts of farm land that is later converted to non-agricultural use. Many sell projects as farm houses on which there are curbs on built-up area that buyers aren't usually aware of. In other cases, developers have been known to violate the original plans and expand construction when they see the project turning into a cash cow, severely compromising the peace and serenity customers thought they were buying into.

Utilities: Unless the second home is well endowed with facilities such as water, electricity, sewage and road accessibility, it will likely be a bad deal. You might want to do a little fine combing  of the location, and the applicable permissions before you commit.

Advantages

Financial edge:Vacation homes are typically much cheaper than their urban counterparts and you could get a decent one-BHK in Igatpuri for about Rs 20 lakh. Chances are you won't need a loan to service its purchase. Markets like Igatpuri, Murbad, Karjat, Dahanu, Neral  and Chiplun have yet to discover their potential, which means they can offer a great upside on appreciation in the medium to long term. And there is more money in the pocket if you can manage to let it out.

Investment buffer: If you have some urgent financial needs at a later stage, such as an education loan for your kids or a wedding ceremony, or even foreign travel, don't knock off your second home. Most properties make good loan collateral.

Tax saving: Any rent the second house fetches gets a 30 per cent write-off  for repairs and maintenance, and can also be set off against the interest paid you pay on a loan you took to acquire it. If the rent is less than the interest paid, the resultant loss from house property can be set off against your regular income.

Leverage: A second house is the only investment class on which you can take a loan and avail tax benefits. All other classes, including stocks, mutual funds, bullion and debt instruments must be made out of your savings. What's more, you need put in just 20 per cent of the property cost and get the rest on loan.

Disadvantages

Liquidation: It is much more difficult to sell off real estate than shares, MF units  or even bullion when  you need the money urgently. A distress sale could get you a really bad deal. But the upside, as mentioned before, is that vacation homes make decent loan collateral.

Maintenance: There are huge maintenance costs involved in sustaining a second home. This is exacerbated in the case of bungalow/farm house properties where additional costs have to be borne on the non-constructed area of the plot, especially gardens. Standalone plots also carry the risk of encroachment, and  a vacant asset would entail the additional cost of a caretaker given its lack of proximity to your place of residence.

Lower rent: Don't expect the kind of rental your house in Mumbai or Delhi fetches you. But do try and ensure what you get covers your EMI and monthly maintenance. If you're really lucky you'll get 6-7 per cent of your property value as compensation for letting out. Else, as little two per cent is usually the norm

Changing times: The couple I know are now having to deal with kids who've become bored of going to the same place again and again, and want something different. In any case, the husband and wife themselves aren’t able to take off every week or fortnight due to tight work schedules and the sheer fatigue driving a good 100-120 km back and forth involves. It is also likely that if either of them are transferred to another city then the visit to the holiday home could come become remote.

Choosing a property  

Accessibility: Buy a house that is a max 4-7 hour drive from your residence, has a naturally ambient environment and is close to a railway station or expressway. The demand for such assets will be greater than those in the interiors and it will be worth your while to dip a little deeper into your pockets and buy such a house instead for something remote. It also won't be as much of a headache getting there every weekend or fortnight.

Infrastructure: Proximity to services and amenities such as commercial centres, medical facilities, restaurants and such like adds substantial value to the second home if you've bought it as an investment. If your house is in a township, a clubhouse will add much value.

Security: Go for gated properties with adequate security staff and CCTV, if possible, as vacation homes that aren't under regular occupation are prone to the risk of encroachment and theft, given their lack of proximity and the fact that their limited use by the owner is easily noticeable by outsiders.

Weigh all the above options well before you put your money on the table. Assess why you are buying a house -- is it just an investment  or is it a second home in the true sense? That is one of the key factors that will determine the kind of property you end up buying. If you're investing, monitor your asset regularly in order to help you take a call on whether you want to stay invested or make an exit.

The author is a partner at Shardul Amarchand Mangaldas & Co. Views expressed are personal. ashoo.gupta@amsshardul.com