Rss Feed Tweeter button Facebook button

Archive

Posts Tagged ‘timeshare’

Timeshares: Do They Make Financial Sense?

March 5th, 2010 No comments

Are timeshares a good financial move? In this post I offer some advice.

I went to a timeshare seminar in Puerto Rico while on vacation. This was not the first time I went to one, about 5 years ago while in Vegas I endured the same sales pitch. Then as now, my instinctual reaction is to question why anyone would want to buy a vacation 3,5 or more years ahead of time. With all the options that exist today to plan and buy vacations this does not seem like a good idea to me. My opinion can be summed up as follows. It’s an allusion to that famous line in the movie, The Godfather II (“keep your friends close, but your enemies closer’):

“Be cautious about paying for a future expense today. Be extra cautious if you also borrow money to do it”.

Borrowing money for expenses is bad practice, and you should have a good reason whenever you do it. While timeshares have some characteristics as “assets”, they are best viewed as a form of prepayment for vacations. Why would anyone want to prepay an expense that is discretionary? Basic common sense says you wouldn’t unless there is value in there somewhere. Let’s do the math.

When timeshares first appeared, they were little more than a prepayment plan for future vacations. The industry has evolved, the timeshare that was offered at the seminar was a deeded property with title. They also provide the ability to use your account (with a point system) to pay for other vacation expenses such as rental cars and airfare. This is not unlike a condominium or townhome, the only difference is ownership is split up into multiple pieces instead of having a single owner for all 52 weeks of the year.

The Sales Pitch

The salesman was no ordinary rep, he was an executive of the company. A good salesman always impresses me because it’s a skill that I have struggled to develop. He talked about all the traveling he did in his life, visiting and living in places all over the world.  I was drawn into his stories not only because of everywhere he has visited, but also his spirit of adventure and how he made his love of travel into a career. I was thinking:

“Forget the timeshare. How much will it cost to rent YOU as my travel guide for the next 20 years?”

Then reality set in. How can I be a free spirited traveler if I have to earn enough money to pay off this timeshare? I bet he didn’t own a timeshare when he did all of his traveling in his younger days. Nope, timeshares are for working people not unemployed folks who buy travel cheap.

The Offer

The first timeshare contract offered was for a one bedroom unit, one week a year. There is a lot of flexibility here, so if you decide to take your vacation during the ‘off season’ you may be able to get a 2 bedroom unit instead. (If you think that you can get Hawaii cheap by going during the ‘off season’ keep in mind that all the great places you would want to go –like Hawaii– don’t have an off season.) The total cost: about $20,000.

Timeshare Cost: $20,000

Loan Interest Rate: 8% (30 years).

Total Value: $50,000.

The sales pitch for the timeshare was about 3 parts dream/motivation and 1 part financial. The main financial argument that was made as to why a timeshare is a good value was a calculation that compared the cost of buying a hotel room for 30 years versus buying the timeshare now. The hotel room cost was as follows:

(7 nights * $100 hotel room * 10 % taxes) added up over 30 years with 5% inflation.

If you run this calculation in a spreadsheet, you will get a figure around $50,000. So, the argument goes, you can buy $50,000 worth of vacation for only $20,000. Sounds good, right?

But, It Is Really Worth It?

The way to evaluate this offer is to consider two key points: how you are going to pay for it as well as how to “adjust” the offer based upon your expectations of actual use. The way we will adjust the value of the timeshare based upon your expected use is by “discounting” the future. The thinking goes like this: the timeshare is more valuable to you if you really think you will use it than if you expect to use it less. From this calculation you can make an informed judgement as to whether or not it’s a good value.

If you borrow the money at the offered interest rate of 8%, you will not come out ahead. The total cost including interest at 8% is more than the total cost of simply buying the hotel room the next 30 years (about 51K versus 53k). It doesn’t make sense in situation to buy the timeshare. So, even if you use the timeshare every year for 30 years (unlikely), you still will pay more.

If you pay cash, the calculation requires some more effort. For this calculation I will borrow a financial concept from business. Take your initial “investment” in the timeshare and compare it to the “discounted” value of the hotel room after applying a “risk” factor that measures your confidence in how much you will use the room.

Understanding the Discount

Discounting is a commonly used business calculation that has application in personal finance. In fact you already use it but may not realize it. Here is a simple example. When you buy a magazine once at a news stand you pay full price. If you buy the same magazine 24 months in a row you are still paying full price. If you chose to buy the same 24 months worth of the magazine through the publisher (paying upfront) they won’t charge full price they will give you a discount, perhaps 50% or more off the retail price.

There is a practical as well as a financial benefit here. The magazine publisher wants you to pay up front because it guarantees revenue as well as strengthening their case with advertisers. As a consumer, you might not be sure that you will want the magazine all 24 months, so why pay full price now for 24 months? The discount helps to mollify your uncertainty. The Discount is based upon the simple idea that money paid today is more valuable than money paid in the future.

Applying the Discount

From a purely financial angle, money you hold onto now can earn interest (or in the case where you borrow the money, you save interest costs). Here’s the calculation to determine the value of the timeshare based upon a “risk” free rate of return plus a risk premium:

Timeshare Value = Discounted 30 year hotel room cost (risk rate + risk premium)

For the “risk” free rate of return I will use the 30 year U.S. Treasury, which is about 3% now.

Here is the total cost of the hotel room discounted back:

$50,000 at 3% discount ==> $30,000

$50,000 at 5% discount ==> $20,000

$50,000 at 8% discount ==> $14,000

In this example, a risk free return means that you will use the timeshare 100% over the next 30 years. So, at a 3% discount you could pay up to $30,000 at which the timeshare saves you money (so, in this case you are $10K ahead!) If there is any possibility that you will not use the room, you add a risk premium. If you add a risk premium of 5% (for a total of 8%), the price you should pay goes down to $14K. This implies that you will not use the timeshare about 50% of the time (16K/30K).

At the offering price of $20K, it is implied that you will not use the timeshare about 30% of the time.

Should You Buy One?

Timeshares don’t work for me, but that doesn’t mean they are not right for you. I know a few very savvy people who are skilled at their own personal finances who own timeshares. If you do want to purchase one, carefully consider the cost versus a realistic assessment of how much you will use it.

This article was featured at the Carnival of Financial Planning at TheSkilledInvestor.