Last year, my friend bought a cottage for $180K. His down payment was 25%, or $45K. This year he boasted to me that he had made $18K in a year off the cottage. It was recently appraised at $195K (+$15K equity) and he rented it out a few times this summer to earn $3K in additional cashflow. Not a bad return right? $18K total. If only it was true…

Here’s the reality…

His one-time costs

• down payment $45K (recoverable when/if he sells)
• land-transfer tax $3K
• legal fees $2K
• utility transfer costs $1K
• initial repairs & furnishing $5K

His ongoing costs each year

• mortgage $830 x 12 = $10K
• property tax $250 x 12 = $3K
• utilities $210 x 12 = $2.5K
• insurance $150 x 12 = $1.8K
• association fees $80 x 12 = $1K

Ignoring the one-time costs that are recoverable when he sells, his actual out of pocket expenses are as follows:

• 1st year: $29.3K
• 2nd, 3rd, 4th, 5th, etc. year: $18.3K

This paints an entirely different picture. His first year ROI is negative. Subsequently, assuming future years, his cottage is likely to appreciate closer to the historical average of 3%, the ROI will continue to be negative.

• 1st year: -$11.8K ($18K appreciation and revenue minus $29.3K expenses)
• 2nd, 3rd, 4th, 5th, etc. year: -$12.3K ($6K assumed appreciation minus $18.3K expenses)

Over the duration of five years, his ROI will be a whopping negative $61K. Not just that, he’s tied up the $45K down payment, unable to earn any ROI from it (other than the appreciation on the real estate that would happen nonetheless).

What if he took those monies and invested them in the stock market instead, earning an average ROI of 7.8% (the stock market average ROI over the last 50 years)? It would paint a dramtically different picture:

• Year 0 (invest monies saved $45K down + $11K transfer, legal, utility fees): $56K
• Year 1 (earn ROI of 7.8%; invest Y1 monies $18.3K saved): $78.7K
• Year 2 (earn ROI of 7.8%; invest Y2 monies $18.3K saved): $103.1K
• Year 3 (earn ROI of 7.8%; invest Y3 monies $18.3K saved): $129.4K
• Year 4 (earn ROI of 7.8%; invest Y4 monies $18.3K saved): $157.8K
• Year 5 (earn ROI of 7.8%; invest Y5 monies $18.3K saved): $188.4K

You are reading that correctly. He would have $188.4K in his investment accounts after only five years. I’m not arguing that a cottage is not enjoyable or worthwhile, but it is important to consider the cost. My family and I rent them a several times each year and while we invest a few thousand into these happy adventures, we aren’t tying up huge sums of monies and increasing our regular expenses to do so.

After having shown this reality to my friend, we are working on a plan to increase his investments instead of his expenses. It’s amazing how easy it is for us to create our own truths and believe them. Before sitting down with him and explaining this, he thought he had made a great investment. Now that he understands the reality, we are working on a plan to put him back on the right track. He may or may not keep the cottage, but he definitely will focus on a more sound investment strategy.

You, and only you, are responsible for your financial well-being. Make yourself a priority, take some time and learn what an investment really is. Your future self will thank you for it.