Timeshare economics explained. By an economist.

An expert economist's feedback following a timeshare presentation in South Carolina gives priceless insight into whether timeshare makes financial sense for the buyer.

Leading economist

Arnold Kling earned a PHD in economics from Massachusetts Institute of technology before working in research for the Congressional Budget Office and the Federal Reserve Board. He then worked for many years in the prestigious position of Chief Economist for the aforementioned Federal Reserve Board.

In the private sector, Kling was recruited by giant US financial institution Freddie Mac (FM), where he oversaw the development of option pricing models for mortgage default risk and prepayment risk. He also pioneered research into automated underwriting, where he led the field in the use of credit scores and statistical methods for house appraisal.

Arnold Kling has published multiple scholarly books and articles on economic subjects. He is an Adjunct Scholar for the Cato Institute and is affiliated with the Mercatus Center.

It is safe to say that Mr Kling is a man who 'knows his way around numbers.'

Timeshare pitch

The Kling family attended a timeshare sales presentation at Hilton Head's Spinnaker Resort in South Carolina. Arnold and wife Jackie opted not to sign up and left, with the piqued salesman's hissed words "I don't believe you're really an economist," ringing in their ears.

Kling recalls with quiet amusement that the salesman had just drawn a picture of a trash can to illustrate in simple terms for Arnold and Jackie where their vacation rental payment money was going.

Aside from the excruciating embarrassment of a scenario where a timeshare salesman is simplifying financial concepts with facile drawings for the benefit of a field-leading economist, what exactly was the issue for Kling?

Profitability formula

"I had determined that the deal was a loser," says Arnold, "based on (the salesman's) figures and an economic formula for the profitability of buying vs. renting.

Arnold's formula? Profitability = Rental rate + Appreciation rate - Interest cost

"When profitability is positive," explains the economist, "you should buy. When it is negative, you are better off renting."

When people take a week's vacation, they generally rent their accommodation. People who spend a lot of time in that vacation spot might buy a condo or apartment there. With a timeshare they neither buy the unit, nor rent it. They buy a membership that gives them one week of accommodation every year.

But isn't buying always better than renting?

Arnold says no. "If you have to pay $500,000 to buy something, and you could rent it for a nickel a year, would you still buy it? No. In fact, the decision to rent or buy depends on prices, rents, and other factors that go into the profitability formula."

Renting vs owning

Owning something usually comes with the advantage of retaining value for when you finish using it, leading to a net gain. Right?

"The value of a piece of property will depend on the rate at which the price appreciates," says Arnold. "That is why the appreciation rate is in the formula.

"When you own the place where you are staying, you do not have to pay rent. Therefore, you can add in the rental rate (the ratio of the rent to the purchase price) to the profitability calculation."

Buying anything comes with the disadvantage of needing to tie up or borrow cash. Therefore interest has to be taken into consideration.

The salesman's figures used in Arnold Kling's formula

• For the rental rate: the Kling family's vacation rent was $1200 for that week. The timeshare cost was approximately $12,000 ($11,900). Dividing cost by vacation rate gives a 10 percent rental rate, which at first glance seems excellent.
• However Arnold then adjusts this calculation for fees. The timeshare maintenance fee was $433.25 per year, plus a membership fee of $200 per year, a publication subscription fee of $67 per year, and another 'processing fee' of $93 per year.
• The fees added up to $793, so every year instead of saving $1200 in rent, the net savings were $1200 - $793, or $407.
• Dividing $407 by the price of the time share, $11,900, gives 3.4 percent for the rental rate, which is the first figure required by the formula.
• When he was giving his pitch, the salesman used the classic timeshare assumption that rent and prices will go up by 10 percent per year, so Kling generously used that for the appreciation rate.
• The financing rate for the sale was quoted at 17.9 percent, so this was used for the interest cost.

When all of these figures were entered into the formula, the result was:

Profitability: 3.4 + 10.0 - 17.9 = minus 4.5%

The minus number means that buying this time share would cost 4.5 percent more annually than renting.

"To illustrate the economic value of this timeshare, you should draw an even bigger trash can," noted Arnold dourly.

A second illustration

Arnold couldn't stop himself from adding up the cost of all 52 weeks to compare it to the value of the apartment.

"The total price for all the weeks came to about $600,000. My guess is that the condo did not cost more than $200,000. And on top of that $400,000 in profit for the timeshare company come all those lovely annual fees.

"I don't want to generalize and say that all timeshare salesman are sleazebags, only the ones that I've met. Nor do I mean to criticize people who buy timeshares. I'm sure there are some happy owners. However, the economics are very unfavorable for the buyer."

Industry expert's advice

"The people who benefit from timeshares are not the customers," agrees Andrew Cooper, CEO of European Consumer Claims. "The only winners in a timeshare sale are the resort owners and the sales team."

Any timeshare owners who no longer feel like their membership presents value, or that they were mis-sold should get in touch with our team at the Timeshare Advice Centre for advice on their options.