Personal Property
Back to Reality

The vacation-home market certainly has changed since I dove into it not that long ago.

On Aug. 30, 2004, the very day I took my only son to his first day at college, I went trolling through home listings on the Internet, and wound up making an offer on a second home in Naples, Fla. Freud probably would have had a field day with that, but I wasn't just trying to distract myself from the pangs of an empty nest. If I was going to get the vacation home I had been dreaming of, there was no time to waste.

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At the time, real-estate prices were rocketing and supply was scarce, especially in resort towns like Naples, which sits on the Gulf of Mexico in southwest Florida. As was true in other coastal towns, relatively modest places like the one I bought, a three-bedroom condo near the beach, were being snapped up within days or even hours of being put on the market, sight unseen.

It didn't even matter that hurricanes were blasting through the gulf almost weekly. Buyer mania was so strong that I drove from the airport to my first walk-through inspection of the home in the furious rain and whipping winds of Hurricane Jeanne; at one point, I raced my rental car past a palm tree leaning over the road at an alarming angle and watched in my rear-view mirror as it crashed to the ground. I felt pressure to close the sale quickly, since would-be buyers started putting backup offers on the home almost from the moment my full-price offer of $225,000 was accepted. I didn't want the sellers to look for reasons to back out of the deal.

The home grew in value at supersonic speed even while the sale was in escrow. Judging from sales of comparable units, in the five months between my purchase offer and my first mortgage payment, my beach place appreciated by more than $150,000, a gain of more than 66%. It had taken more than five years for my primary home in the Washington, D.C., suburbs to grow two-thirds in value. At the end of 2005, the median price of a single-family home in Naples reached $367,100, a 36% gain over the year before, almost three times the national appreciation rate. I felt like I'd won a palm-fringed lottery.

But there are clear signs that the tide is turning in Naples. Inventory levels now are four times as high as they were a year ago, local real-estate agents say, largely because nervous investors are trying to cash out their gains before rising mortgage interest rates topple the market. "Big price reduction" ads are starting to pop up in the thick weekly real-estate sections of the Naples Daily News. Worse, at the end of 2005 Naples was 96.3% overvalued -- based on historical norms for home prices, household income, population density and other factors -- according to a quarterly analysis of 299 housing markets by Boston-based research company Global Insight Inc. and Cleveland financial holding company National City Corp. That made it the most overvalued housing market in the country.

Hand me my crying towel, please.

Of course, Naples isn't the only second-home mecca that the report calls overvalued. Others include Santa Barbara, Calif. (76.7%), Bend, Ore. (68.4%), and Miami (60.8%). Indeed, coastal areas popular with vacationers and investors are by far the most likely to have had unsustainable price increases, says National City's chief economist, Richard de Kaser, who conducted the study. He notes that 18 of the 20 most overvalued markets in the country are in California and Florida; the most undervalued markets are in the center of the country, including Texas, Minnesota and Michigan.

As recently as the end of 2003, Mr. de Kaser says, only seven towns were considered extremely overvalued -- 30% or more out of line. Now 71 are, representing 42% of all of the housing value in the country. That shouldn't matter to people who are buying in an overvalued spot for the long term, he says, but it should matter if you plan to sell within a few years. "It's absolutely not the time to take risks," he says.

So, vacation-home buyers, take heed: The days when you could flip a beach house or ski place for fun and profit are probably over. That doesn't mean that you should avoid a second home altogether, but it's time to take a serious look at the economic factors that propel vacation markets, and to weigh the financial costs of ownership. Here are some things to consider:

WHO'S BUYING -- AND WHO CAN'T?

It seems every real-estate agent says that now -- whenever that happens to be -- is the best time to buy, but obviously, that's not always the case. So before you invest in any resort town, check on the dynamics of the local real-estate market and on the area's economic health.

First, look at who's buying. Are new households coming into the area, and why or why not? Are homes selling mostly to investors, part-time owners or permanent residents? Too many investors can leave a market vulnerable to substantial price swings. A preponderance of part-timers can drive up prices and drive out locals. Permanent residents lend the market stability. Real-estate agents and local lenders are good sources for this kind of information.

Second-home buyers should look into school quality and the general affordability of homes in the area, even if these issues don't affect them directly, says Ken Libby, a real-estate broker in Stowe, Vt. "They affect the long-term prognosis of the community," he says.

If the schools are terrible or declining, permanent residents may be inclined to move away, leading to vacation-home ghost towns and depressed real-estate values. You can get information on school performance from real-estate agents or from the Web site of the state education department.

Buyers also need to ask about job growth in the area they're considering. If year-round residents can't find work, they won't be able to buy homes. But even if job growth is strong, affordability is important. While part-time residents may not give much thought to where the local teachers, firefighters, police officers and restaurant workers live, they should, many real-estate agents say, because when these workers get priced out of the market, essential services suffer -- and so do home prices. And there's a warning signal here: According to the National Association of Realtors, in the fourth quarter of 2005, housing affordability hit its lowest level since 1991.

HOW EASY IS IT TO SELL?

Housing markets take a long time to change from boom to bust, because homeowners often are loath to accept that things have changed. A home can linger for months on the market before a seller finally realizes that he isn't going to get the same price that his neighbor did during last summer's price peak.

But some statistics are early warning signs that a market is in decline, and you can find these in local newspapers, online or by talking to real-estate agents or local government officials. If inventory levels or foreclosure rates start to rise, or the average number of days that homes in the area sit on the market starts to creep up, the market may be turning.

Have questions about your home's finances? Our selection of calculators and worksheets can help you find answers.

Also, look at what big home builders are doing, especially if the number of permits being issued starts to decline, since they keep a close eye on markets and pull out at the first sign that they're becoming overbuilt. Once builders start giving away freebies like finished basements, watch out -- if they feel the need to give incentives, it could well be because the market is softening.

Housing starts and new-home closed sales and presales are also worth tracking, but bear in mind that these can remain high even in markets that are in the early stages of decline, since before builders can cut back, they must first finish constructing and selling the homes they already have in the pipeline.

DOES RENTING MAKE MORE SENSE THAN BUYING?

Thanks to a number of Web-based calculators, it's now relatively easy to compare the cost of renting versus owning. For instance, using the online "rent versus buy" calculator at TCalc.com, I computed the cost of a home for five years at a purchase price of $425,000 versus renting it at $1,500 a month, with a 1% increase in rent each year. I assumed a 5% down payment of $21,250, a 30-year fixed-rate loan at 6.9% with one point, $4,250 in closing fees, $583 annually in homeowner's insurance, $390 a month in condo association fees, a 1.25% property-tax rate, a 6% annual home-price appreciation rate, and a 28% tax bracket. Under this scenario, buying wins -- largely because of equity buildup and mortgage interest deductions. Over the five-year span, the calculator shows, you'd spend $83,218 to rent the home, compared with $53,759 to buy it -- a saving of $29,459.

But online calculators are imperfect when it comes to vacation homes. First, renters rarely rent vacation homes for an entire year -- they rent seasonally. Seasonal rents are often double what annual renters pay, but they only obligate the renter for a short period of time. So a renter who paid $3,000 a month would be out $9,000 for a three-month season, compared with $12,222 for the owner.

An owner has other costs the renter avoids. Equipping a three-bedroom home with all of the stylish furnishings and electronics upscale buyers demand can cost upwards of $20,000. And when it comes time to sell, unless you want to take on the responsibility of marketing your own home, you'll have to pay a real-estate commission. At 6%, that would come to $25,500 for the purchase price assumed above. So the gains you make from owning rather than renting can easily be wiped out.

You can recoup some of your costs by renting out the home when you're not around, but according to the National Association of Realtors, eight out of 10 vacation-home buyers choose not to do that. Perhaps that's because renting out a home entails a host of other expenses that can run into the thousands of dollars, including repairs, cleaning, advertising and professional property management -- an expense that by itself can eat up as much as 30% of the rental income.

Ultimately, the decision to buy a vacation home rather than renting it will probably come down to more than economics -- just as it did with me in my mad-dash pursuit of a Naples beach house. But whether you're looking for a weekend getaway, an eventual retirement home, or a gathering spot to pass on to the grandchildren, don't let the sunlight dazzle you. In this cooling housing market, you are probably going to be spending your vacations there for a long, long time.

Write to June Fletcher at june.fletcher@wsj.com