Timeshares, a second home in the U.S., and small-town real estate investment trusts (REITs) can be are some of the worst investments you’ll make in real estate

If you visit a vacation resort this winter, you may get invited to a complimentary dinner, cocktail party or other event. In return for the free drinks, food or entertainment, all you’ll have to do is sit through a pitch for an “investment” in a timeshare. It may be worthwhile to attend, depending on what else you have to do. But in our experience, timeshare purchases rarely provide you with any real advantage.

Below are a number of examples of the worst investments in real estate, including more on timeshares.

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Worst investments in real estate: Why timeshares are rarely worth it

You might look on timeshares as the vacationers’ version of the new stock issue. Some of them seem to work out well for some people, at least for a while. But on the whole, it’s a good idea to stay out of new issues, and an even better idea to stay out of timeshares.

Before buying any timeshare, check the Internet for resales of comparable timeshares. You’ll often find they sell way below the initial sales price.

Even if you find what looks like a great deal on a timeshare resale, we see no point in committing yourself to any one resort operator, much less one resort. You won’t be there often enough to develop any rapport with your neighbours or the staff. Management can get sloppy at existing resorts, especially after the timeshares are sold out. For that matter, your interests or tastes may change, or you may be unable to travel for health or other reasons. To top things off, new resorts open up all the time.

You can always resell your timeshare—many buyers do. But transaction costs are high and resale prices are likely to be below your cost.

Timeshares are marketed as something of a cross between a real estate investment and a hedge against inflation. But, generally speaking, only the land portion of any real estate investment provides a hedge against inflation. The buildings and equipment are going to depreciate, just like your car, though maybe not as quickly. This depreciation poses a greater risk if you overpay for the asset to begin with.

Worst investments with real estate: A second home in the U.S. may be a good personal lifestyle choice. But it’s a risky investment

Costs may be higher than you think. Beyond the purchase price, you’ll also have to pay real estate taxes and condo fees, if that’s your choice of a dwelling.

On top of that, there’s insurance and maintenance. In addition, due to the heat and humidity, you have to run the air conditioning year-round to avoid mould. By the time the housing market stabilizes, new condos will come up for sale and compete against decades-old units. Let’s say when you sell, you pay a 5% real estate commission. You will need the real estate market to go up by 5% or more every year, just to break even.

If you make any money on the sale, you’ll be liable for capital gains taxes, unlike the tax-free capital gains you can earn on your Canadian home.

You can still find attractive investment opportunities in Florida and other U.S. Sunbelt real estate markets, but not in the kind of properties that most Canadian buyers are seeking. If you’re investing in real estate primarily for profit, you should look at multiple-unit rental housing or commercial properties, especially those with big parking lots or extra land. Investments like these can give you current income, plus long-term development possibilities. That’s a potent combination for patient investors.

Buying a second home in the U.S. Sunbelt may be a good personal lifestyle choice. But it’s a risky investment, and a bad place for any significant portion of your retirement savings.

Worst investments in real estate: Small town REITs

Small towns often depend on at most a handful of employers. If one of the town’s main employers reduces its operations or shuts down, tenants leave town. As populations shrink, the town’s rental accommodation vacancy rate can go up and stay high indefinitely.

This problem is even more pronounced in a small town’s commercial real estate. Offices, storefronts and industrial space are more specialized than residential real estate, due to factors such as zoning, ceiling heights, pedestrian traffic, parking and so on. If apartments stay vacant for months, commercial space can stay vacant for years.

Even at the best of times, small-town real estate is harder and more expensive to finance than city properties. Because of the higher risk of cut-offs in rental income, lenders demand bigger down payments and higher mortgage rates. This makes small-town property harder and more expensive to sell.

It is even worse when the REIT is private because private firms don’t face the same scrutiny as publicly traded companies. This means the REIT calculates the value on its units (just once a year in this case), and needn’t reveal all the information that’s available to the public from publicly traded financial investments. It portrays this feature as a benefit — since it avoids the volatility and speculation of public markets!

The combination of these two “benefits”—a small-town focus plus a once-a-year valuation by the REIT’s insiders—are enough to prompt us to advise against investing.

What real estate investments to you think are the worst? How about the best?

What mistakes have you made with real estate investments?