Key Take-Aways

• The vast majority of wealthy families own a vacation home or other additional residences
• The choice to acquire additional residences for personal use (not income) should be considered through a personal, not investment lens, i.e. on a pure investment basis, second homes are not that attractive
• If the family does not have the liquidity to continue ownership of the property, they can suffer significant losses if forced to sell in times of market stress

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For those of you who have experienced it, September in New York City can be magical.  When the summer heat breaks and the humidity falls, the City feels even more alive with the air slightly cleaner than usual, the skyline punctuated by the clear blue sky.

A quick Google search did not surface the weather on September 25, 1885, but one can imagine what it might have been like.  The day was an auspicious one, as it marked the reading of the last will and testament of William H. Vanderbilt, the son of the Commodore.   At the Commodore’s passing, he was the richest man in the world, and his son, William, inherited that title as the majority of the family fortune fell to him. 

8 short years later, William passed, leaving behind a fortune of $200MM.  Yet unlike his father who did not divide the family fortune equally amongst his children, William gave sizable gifts to 6 of his children.  With 2 sons inheriting the vast majority of the fortune, ~$75MM apiece.

Today, $75MM places you in the richest 0.10% of US citizens – a still sizable amount of wealth.  But if we adjust for inflation, a similarly sized inheritance today would equate to ~$2.1bn give or take.  

One of the inheritor sons, William K. (Willie) Vanderbilt was married to Alva Vanderbilt.  One can speculate as to her reasons, but Alva must have felt the money burning a hole in her proverbial pocket, for shortly after the inheritance arrived, she persuades her husband to allow her to build a summer retreat in Newport, Rhode Island.  

It was not that Alva and Willie were under-invested in real estate at the time.  An 800 acre country estate in Long Island known as Idlehour, complemented their ‘townhouse’ on 660 Fifth Avenue inside the City.  Yet, a third house is what Alva wanted, and she tended to get just that. When the Newport place was complete, The Marble House, was a residence without compare.

The total cost of the property was $11MM in 1892 dollars, $9MM spent on interior furnishings alone.  In 2021 figures, the house cost $328 million.  On a $2bn inheritance, nearly 20% was spent on a single residence.  Even in today’s landscape of mega-residences, The Marble House was breath-takingly expensive.  

For a period of time, the house was used with some regularity. Though it was ultimately more or less shuttered towards the end of Alva’s life.

Alva finally sold the house in 1932.  The final sales price?  $100,000 – a pittance of the original figure.

So what is it about real estate?  

For today’s post, I want to explore the ownership of real estate more deeply.  Importantly, I do not want to consider investment real estate, which has seen plenty of ink spilled in describing its characteristics and return potential.  Instead I want to consider the good and the bad of real estate ownership for personal use only.  We will discuss the economic implications of ownership, as well as the psychological benefits. 

For wealthy individuals and families, private property is likely to be a meaningful use of funds, as well as occupy a significant amount of time and mental energy.  A 2015 survey conducted by Wealth-X and Sotheby’s found that 80% of the Ultra-high net worth ($30MM and up) own at least 2 homes, with 53% owning 3 or more.  In total, the UHNW as a cohort average ownership of 2.7 properties.

No doubt there is something uniquely appealing about physical space.  While sounds and smells make indelibly prints on our memory, there is a deep sense of resonance in memories tied to a physical location.  Whether it is Christmas memories in a cherished childhood home, a beach or ski-home where the family played together, or quiet retreat allowing meditative contemplation and restoration, we walk away from experiences impacted by the role the built environment played in allowing those memories to be formed.

And at the same time, real estate can also serve a deeper psycho/social purpose through its social signaling.  As Arthur Vanderbilt noted in his Fortune’s Children about Alva (referenced above as well), “Alva wasn’t interested in another home.  She wanted a weapon: a house she could use as a battering ram to crash through the gates of society.”  

Homes can serve as powerful social markers to broader society.  Their cost and geographic location can establish or enhance social standing.  Architecture and furnishings convey deeply personal messages about the family’s financial wherewithal, as well as aesthetic sensibilities.

This signaling can serve multiple purposes.  Some may see it as validation of a lifetime’s labor.  For others it may serve as a strong message about their relative financial standing vs. peers.  For others, social standing may be of little import, but geographic proximity may provide access to better opportunities of all sorts.

Personal Property Is Not an Investment, Per Se

These psychological considerations are buttressed by the favorable economic characteristics of real estate.  The ability to borrow cheaply for long periods of time, the general trend of home price increases, as well as the tax deductibility of mortgage interest, create a climate where real estate investment is viewed favorably.

Here I would draw a needed distinction.  Investment properties or even second homes that are also made available for rent on platforms like VRBO have a distinctly different economic characteristic from the second home only enjoyed by a single family – not surprisingly, the absence of cash in-flows.

In conjunction with writing this article, I developed a comprehensive model of an additional home ownership to further analyze the return potential of buying an additional piece of real estate.  

In building this model, I attempted to surface a core set of assumptions.  First, a house not used for income purposes represents a step-up in the standard of living of the family.  While sounding self-obvious, this is an important characteristic to consider.  If the family decides to shift other spending on vacations and only spend time at the vacation property, then it may offer a relative savings vs. other lodging choices, but for many families the choice to own a second home represents an increase in cash needs over the course of a year.

Second, it is important to consider all the relevant costs in accurately accounting for the return potential of the property.  This includes the obvious things like taxes, insurance, and HOA fees.   Yet far too often, people under-estimate the maintenance cost of a property given that maintenance occurs in a lumpy fashion for major home components such as HVAC, appliances, etc.  As well let us not forget that homes are also subject to the whims of fashion – whether paint choices or interior design trends.  To realize an at-market multiple when it comes time to sell the property, the owner will need to keep up with market trends or expect a discount at time of sale. 

Here are some example assumptions to consider:

Assumptions:
Inflation	3.0%
RE Appreciation	3.0%
Stock Market Appreciation	7%
Maintenance (% of value)	1.0%

So what does our analysis tell us?  

For this, we looked at 2 live examples – a $1MM mountain home near Asheville, NC and a $4MM beach house on Alys Beach on 30A in Florida.  We considered ownership of the houses for a 20 year period, with the purchase being financed. Both houses showed remarkably similar economic characteristics.  

When one looks at a vacation home from a purely financial return perspective, we calculate an Internal Rate of Return of between 0 and 1%.  Certainly, one benefits from the appreciation in the value of the home, though this is tempered by all the other costs associated with homeownership.  

Our analysis also assumes that you buy a home at ‘market-price’ and are not able to source a great deal.  As the old adage goes, you make your money in real estate on the buy, not the sell.

What this means then is that while an additional personal residence may not ‘cost’ you money in the long-run, it is not going to be a home-run investment either. During the period of ownership, the owner experiences very real annual cash outflows to support the home. These outflows are largely offset by the return of the equity in the home when it comes time to sell the property.

If a family is considering growing its portfolio of personal real estate, they should recognize then that the driving dynamics supporting such a choice is going to primarily a reflection of personal choices and values, not economic returns.

Cash, as always, is king.

An additional key dynamic to consider during the period of ownership is that the owner experiences real cash outflows to cover mortgage payments, etc.  These payments are offset by the increase in the value of the home, but that return is only realized when the home is sold.  The purchaser of additional private property should carefully consider their cash flow needs and their ability to continue to service the property, even in times of market stress.

As we saw with Alva Vanderbilt, timing is everything on the exit.  If you were to be in a position as a forced seller, you could experience real, permanent, and substantial capital losses. 

That being said, on a net cost basis (cash burn per year less than appreciation in the home’s equity), the annual ‘paper’ cost of the home could represent a substantial value on a per night vs. staying a hotel or resort.  And of course, the more the property is used, the greater this relative difference is. But make no mistake, cash will be going out the door, not the other way around.

As well, there is the relative return trade-off present if you had chosen to invest similar amounts of cash in higher returning assets vs. an extra home. Cash invested in a low returning, illiquid asset is not available to support portfolio growth. If there are specific investment targets for legacy or philanthropic goals, careful analysis should be done to consider the impact of removing cash from the portfolio and more or less parking it on the sidelines during the period of ownership.

Bottom-line – the choice to expand a personal real estate portfolio should be done for personal, not investment return reasons.  While you might likely make a modest return, most likely the investment is a wash (to a slight loss after considering inflation).  

That being said, there may be other relevant ‘return’ metrics to consider.  The creation of a place for family to enjoy, to entertain friends and loved ones, etc. etc. confer psychic returns that while not quantifiable on a return basis, may contribute meaningfully to the growth of the human and legacy capitals of the family.

Disclaimer: Does not constitute investment advice.

Other miscellaneous thoughts about real estate:

• Alva and other turn of the century families were caught in a sizable shift in the economic model of real estate. Newly wealthy American families looked to their English forbearers as examples of consumption. English country estate were a centuries old tradition, but importantly only made sense in an agrarian based society, where the activities of the estate likely were a source, not use of cash. Mechanization, urbanization, and changes in tax policy significantly impacted the economic characteristics of the ‘manor’ home. The relative increase in the cost of labor combined with the sizable maintenance costs of such large homes made them a financial albatross for many families.
• I wonder if we are not in a similar transition in current times. Trophy real estate remains massively expensive in today’s dollars, but the homes are largely smaller than the Biltmore, Breakers, etc of the 1880s – 1920s period. The risk now is that technology through VRBO and Airbnb has significantly increased access to vacation properties. While on the one hand this grows the pool of potential customers, it does likely lower the need to actually own. For families with exceptional real estate assets, careful consideration is warranted about who the potential buyer of the home might be. The number of buyers might be far smaller than originally estimated, or the tenor of the buyer may have changed to someone looking to acquire for rental purposes only. Some families may choose to place loved assets into trusts or other structures to ensure longevity of the families ownership. Those structures would do well to carefully plan the costs to maintain and improve the home.