Housing arbitrage, or the $1.4 million muse

Has anyone heard of the following trick, which might be called housing arbitrage?

Buy one house at the beach and a second house near a ski resort. You live in the beach house in the winter and the ski resort in the summer. You rent out the beach house in the summer and the ski resort in the winter.* Can your earnings (rental revenue minus mortgage costs) be enough to live on?

Why it could work: the cost of each house will be roughly proportional to the average annual rental income in that location. If you didn’t live in the properties at all, you should roughly break even (income = mortgage payments). But you are living in each location during the time when rent is essentially free (not contributing to the average) so you have no housing costs. If you find good enough deals (or put money down, or have some small income like freelance writing, etc.) your income may exceed your mortgage enough to live on.

What’s the minimum you could get started with on this strategy? Probably a minimum income to live comfortably as a starting point would be $70K before taxes: see justification below. Assume you can make about 5% of a home’s value in rental income: this seems feasible. Then you need $1.4 million invested in real estate (say two $700K houses) with no mortgage (completely paid). Suppose you can also borrow at 5%. Then if you put 50% down on two $1.4 million properties ($2.8 million total), your effective mortgage rate is 2.5% and your “spread” is 2.5%, so you again earn $70K, but now you have two twice as nice houses (but more risk, need to qualify for loan, etc.). Now here is some magic. Suppose you find an incredible deal (say, in a down real estate market) and you can earn 10% in rental income. You can borrow at 5% and only want to put 20% down, still a respectable portion that the bank may be willing to go for. You buy two $600K homes ($1.2 million total) needing only $240K in cash. Now your rental revenue is $120K and your mortgage payments are $48K, so your net income is, viola, $72K!

Didn’t I forget about taxes and insurance? No, I’m just assuming these can be covered by your $70K income. I did forget about health insurance, though: that could threaten the strategy, at least in the United States. You can can hope that the new health care law helps, or keep an enjoyable day job, or purchase insurance out of the $70K.

You might say $70K pretax is not enough to live the lifestyle you want. But remember, you effectively have no housing costs, and this is just meant as a starting point. This is your “muse” as Tim Ferriss calls it: a steady reliable income that is your buffer. You still should pursue freelance ideas or business ideas that you are passionate about, and one of those just might hit it big. This just gives you freedom to pursue other ideas on your own. Hopefully even at $70K you can save some money to purchase additional properties and increase your income. Note that once your mortgage is paid off, your income will go up.

One nice thing about this strategy, and real estate investments in general, is that they are naturally inflation adjusted: rental rates should go up if inflation goes up.

This really only seems practical for people without kids in school. Although I suppose if your kids went to school in the beach location it might work. You’d only spend 2.5 months in the ski resort.

Certainly there are downsides: constantly moving, living in off-season tourist towns, living in properties that are rented half the year, dealing with renters, risk of loss or default, and managing the business headaches.

If housing arbitrage could really work, why aren’t more people doing it? Maybe it requires too much capital and maybe my math is wildly optimistic. Probably it’s no more than a fun mental exercise. I’m sure it’s been thought of. I can’t find it on a cursory web search but it seems hard to articulate to a search engine. If enough people started doing it, by definition house prices would go up to eliminate the arbitrage.

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* Maybe take a week or two in the summer at the beach and the winter at the ski house.

10 thoughts on “Housing arbitrage, or the $1.4 million muse”

  1. A potential issue is that the high/low seasons for the rental location coincide for the most part.

  2. Seems similar to but more complicated than buying an apartment building for $1.4M, living in one of the apartments, renting the rest, and then managing the building, no? That certainly is common.

    I think the main questions to think about with your analysis are: (1) whether it is realistic to expect people to pay a rate as high as $500/night on a $600k vacation home ($120k/365/70% occupancy) and (2) whether you can manage and repair a short-term rental place from afar at low enough costs that it doesn’t eat up most of that $70k of income.

  3. I don’t think a 600k beach house will generate 60k in annual rental income. I also think this is fairly sensitive to the macroeconomic conditions.

  4. This was treated by Hollywood long ago with New York City millionaire who spent Winters in Palm Beach and unknowinly had a bum who openly lived in each of his two mansions in the off-season.

    You would have to differentiate between seasonal rentals and short-term rentals such as for a week-end. Managerial costs and above all the turnaround time of inspection, cleaning and repair can eat into rental time. Local managing agents often make glowing promises but condo investors find that actual rentals and actual rental rates are always far less than promised. Prime vacation properties get rented but anything sub-prime can suffer greatly.
    Just about any asset can be arbitraged. Ships are often built and leased out on a long-term twenty year charter, but once the 20 years ends the ship can be chartered in the more volatile spot charter market.
    Its the same way with housing. Time and Asset Arbitrage involving growth, depreciation, risk, consumer trends, etc. Golf Course developments used to be the darling of the specialty real estate developers but are no longer the hot spots they once were. Nor are Residential Air Parks which used to be the hightest profit item in specialty real estate development.
    Most housing arbitrage is now in commercial buildings in downtown areas. This is a process that involves owning and operating a commercial building and then converting to residences.

  5. I also think that the assumption that you will have no vacancy periods is very unlikely since you are looking for short term tenants here, not long term ones.
    Also Greg makes a good point about repairs, which not only will be expensive when you do it remotely, but might require you either live in the rental while being repaired, or leave it vacant during these repairs.
    So your math is a little tight ;)

    I will add that it highly depends on the market, here in Canada for example, it is not easy to get a second vacation property without putting a significant down payment.

  6. I like this idea. This really only seems practical for people without kids in school. Although I suppose if your kids went to school in the beach location it might work. You’d only spend 2.5 months in the ski resort.
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  7. The arbitrage in this situation is that you live for free. The numbers you have are fairly irrelevant to the arbitrage itself. The annual benefit is whatever you would normally pay annually for rent/mortgage wherever you currently live, minus the costs of seasonal moving.

    To make it work, you should start as a rental property investor and look to buy rental properties in both beach and ski towns. At this stage, you should consider most of the objections: repairs, housing market, macroeconomics, vacancies, agents, business headaches, etc.. If the properties are good investments on their own – that you could make money on them provided you lived somewhere else – then you can buy them.

    Now what you have is several rental properties, at least one of which is vacant at any point in the year. There is little cost for you to live there yourself and so you might as well live there instead of paying for another place as your primary residence.

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