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My wife and I love going to the beach. The sand between our toes, the sound of the crashing waves, and the smell of the ocean air invigorate us. Every year, my wife and I dream about moving down to the beach and forgetting about our busy lives in the DC area. Admittedly, the allure of leaving our area and living down at the beach full-time sounds better and better every year.
However, then reality sets in. I remember that I can’t telecommute for work and that we would miss out on living close to family. Speaking of family, our families completely disagree on where the best beaches are.
My In-Laws think that the best beaches are found in the Caribbean. Meanwhile, my parents love Sunset Beach in North Carolina, which was voted by National Geographic as one of the greatest beaches in the world. On the other hand, my wife and I are partial to the Outer Banks (OBX), also in North Carolina. We like it mostly because of its proximity to us. Any longer than 5 hours of driving results in Pterodactyl screams from our children. It’s like being trapped in Jurassic Park.
As much as I would be to live at the beach year round, since we couldn’t use that property full-time, my wife and I have thought about buying and renting out a beach house as a passive stream of income.
We have had some friends who have done it over the years. While it sounds great in theory, I know that they experienced some hiccups along the way.
Rental Properties in the Outer Banks
While we were down at the beach recently, I began to look into what it would cost to buy a rental property.
For those not familiar with OBX, it is a 200-mile long peninsula off the coast of North Carolina. It has some of the best beaches north of Florida. OBX is about 4-6 hours from the DC area (depending on traffic or how many times you have to stop due to unhappy kids). In the summer down there, I feel like I see more Virginia and Maryland license plates than North Carolina ones.
My wife and I stayed in Nags Head this past vacation. We really loved it. The beaches were clean, there is a great new playground for the kiddos, and there is delicious food all around. Overall, Nags Head has a really nice family atmosphere.
The property that we stayed at this summer was a 3 bedroom, 2 bathroom home. It was about 100 yards from the beach. While we had a very slight ocean view when we stood at the perfect angle on the top deck, we could hear the ocean in the distance. Built in 1986, its tax-assessed value was around $524,000. While this property wasn’t for sale, I thought the assessment of $524,000 for this property seemed pretty reasonable in comparison to others in the area.
So I thought today, I’d run through the numbers to see if buying that beach house would be a good idea.
Income
In general, the Outer Banks rental season is typically between 15-20 weeks. The majority of beach rentals occur in June, July, August and September with peak pricing lasting roughly 8 weeks long.
During these 8 weeks, this $524,000 property can normally fetch $5,000 a week or $40,000 over the peak season. The remaining 12 weeks normally receive between $1,500 (for offseason) to $2,500 (for the shoulder season). If we calculated that there were an additional 8 weeks of shoulder season and 4 weeks of offseason, the property would receive an additional $26,000, for a total of $66,000 per year.
Expenses Associated with Renting a Property
Mortgage
Mortgage standards are more stringent than ever due to the Great Recession, although they seem to be loosening up recently. My wife and I are lucky to have FICO scores of 800+. In order to receive the most favorable interest rates, we would need to put a down payment of at least 20%. This translates to a down payment of at least $105,000 in order to even potentially qualify for this particular beach house.
For this example, let’s say that I qualified for a $419,000 mortgage to cover the remaining 80%. This would equate to a $2,154 monthly mortgage payment, based on a 4.625%, 30-year fixed interest. Right off the bat, $2,154 doesn’t sound too bad, but I haven’t included any of the other fees.
Insurance
Insurance in a beach town routinely costs more than a regular property. From my research, insurance routinely costs somewhere around 2% of the assessed value of the home. This is due to all the additional coverage that a homeowner needs such as flood insurance, homeowners/hazard insurance, wind insurance and liability insurance. Based on this, insurance would amount to about $10,500 for this beach house.
Taxes
Property taxes in Dare County, where Nags Head is located, costs $0.697 per $100 or 0.697%. This means that this $524,000 property would owe $3,652 in real estate taxes.
Maintenance
I’m going to go a bit conservative and say that the home maintenance for beach rental will normally run 1% of the home value, or about $5,000 in this case. While you may not need to spend the whole amount each year, because of wear and tear, appliances, carpets, and roofs will eventually need replacing.
If you don’t plan to live close to the rental property, you’ll probably need a property manager. Even if you do live close by, you may not be interested in receiving late night phone calls about issues like a broken toilet. Property management fees are normally between 15%-22% of the rent price.
On top of that, many out-of-town owners decide to set up contracts with HVAC service and repair, pest control services, and carpet cleaning services, to name a few. This can run between $1,500-$2,500 per year, depending on whether there is also a pool and/or hot tub.
Updating
If you’re like me, it’s nice walking into a beach house that is kept up-to-date. I’m definitely not a fan of beach houses that look like the owner hasn’t touched it since the 1980’s. It’s important to ensure that artwork is appropriate, the bedding is still in good shape, and the curtains still look good, so add another $1,000 a year.
In the chart below, I have summarized Income and Expenses when it comes to the beach house.
| Rental Income | $66,000.00 | $66,000.00 |
| Mortgage | $25,848.00 | $25,848.00 |
| Insurance | $10,500.00 | $10,500.00 |
| Property Tax | $3,652.00 | $3,652.00 |
| Home Maintenance | $5,000.00 | $5,000.00 |
| Service Contract | $2,500.00 | $2,500.00 |
| Cable/Internet | $1,200.00 | $1,200.00 |
| Misc. Costs | $1,000.00 | $1,000.00 |
| Property Management Fee | – | $14,520.00 |
| Total | $16,300.00 | $1,780.00 |
As you can see, if you manage the property on your own, you could have a positive cash flow each year around $16,000 in this specific example. If you use a property manager, you would receive a measly $2,000 at best. And, these are under the huge assumptions that you are able to rent the beach house property every week during peak season, along with the shoulder season, and then get an additional month with snow birds. While this may seem aggressive, it looks like with some positive marketing, it may be possible to eek out a small profit, but it would be tight.
Rental Depreciation
While this doesn’t show up in your cash flow analysis, another expense you can claim on your Schedule E is rental depreciation. Rental depreciation only applies to the value of the home or any building structures (e.g. pool). The land value cannot be included in this depreciation. For example, let’s say you bought a rental home for $524,000, with land worth $100,000 and home structure worth $424,000. Per rental home IRS guidelines, you would only be able to depreciate the house value at $424,000, divided by 27.5 years. So each year, you would be able to deduct roughly $15,418 on your Schedule E for this particular property.
Tax Implications
There’s an aspect of renting out a beach house that most people don’t realize. If you choose to rent out the vacation home while also using it for personal use, there are limitations to the expenses that you can deduct on the property.
According to IRS regulations, “You are considered to use a dwelling unit as a personal residence if you use it for personal purposes during the tax year for more than the greater of:
- 14 days, or
- 10% of the total days you rent it to others at a fair rental price.”
Personal Use of Property
That means that the maximum number of days that you and your family could reside in the home is a total of 33 days. In that scenario, you would have to rent out the property at fair market value for the remaining 330 days. I don’t know about you, but that is an incredibly high bar to meet for a rental property. Oftentimes, there is a week or two throughout the year that a beach house probably goes unrented, like during Thanksgiving or Christmas time.
If you reside more than 14 days or more than 10% of the total days that you rented, the property would be considered personal in use. Thus, you would no longer be able to claim expenses if they exceed the amount of income received throughout the year.
So much for using your beach property when it’s not being rented.
Deduction Limitations Due to Income
Let’s make the assumption that you follow the letter of the law and only utilize the beach house for two weeks. Great news: you’ll be able to deduct your rental expenses on your Schedule E up to $25,000.
Now, here is the bad news.
If your modified adjusted gross income exceeds $100,000, the expenses for the beach house begin to get phased out until they reach $150,000, when the allowance is no longer allowed. So, if you make more than $150,000, you can no longer deduct losses on your current year’s taxes.
While a beach rental property situation sounds amazing in principle, I realized that I’d really need to buy at a very low price in order to receive a substantial profit.
Yes, I owned a beach rental in Myrtle Beach South Carolina. While it did make small annual profit, after pain management fees, we decided that profit wasn’t high enough to justify us dealing with it. So we wound up selling back and reallocating those investment dollars elsewhere.
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Thanks for sharing Brad!!! I’ve had other friends share that they had similar experiences and unloaded the rental over time!!!
Thanks for breaking it down. The beach house is looking less and less attractive.
Hahaha…sorry to break the bad news. It’s a tough way to make money 🙁
Great article Rob, and a topic that I’ve got considerable interest in personally! When we’ve looked at these types of properties, we’ve always focused on positive cash flow but one of the aspects that we always forget about with our other rental property is net equity gain as the mortgage approaches maturity and you are paying down more principal. For us it is our “forgotten savings account”. Not considering market appreciation, we’ve found that it’s a good way to forget a $20 bill in your jeans.
What do you think?
It’s definitely a forced savings account that allows you to diversify away from the stock market. I was a little shocked by the tight margins, especially with a property manager. But if you think that beach houses will appreciate significantly, the equity might make it worth it 🙂
It does sound great in theory and I get tempted when I watch shows on HGTV of people acquiring properties and getting rental income. My personal view is to avoid getting another mortgage and being kind of obligated to visit the same property each time. I’d rather visit different beaches and different properties to get more experiences. 🙂
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I’m right there with you SMM!!! I would hate to feel like I have to go on vacation to the same place every year. While my wife and I enjoy OBX, when the kiddos are older we’d like to branch out and go to some more exotic locations 🙂
Some day we might do this with a lake home. Hopefully cheaper then ocean . But I think the defining factor would be less the investment itself and more setting up a home to retire to later on.
Great points Full Time Finance!!! BTW…I am a huge fan of lakes and think I would prefer a lake house, but my wife loves the ocean and the sand. So if we did buy one in the future, it’ll probably be a beach house.
You don’t mention anything about the risk posed by rising sea levels due to climate change. Furthermore, the Outer Banks have been subject to severe beach erosion (regardless of CO2 levels) since their formation.
https://news.nationalgeographic.com/news/special-features/2014/07/140725-outer-banks-north-carolina-sea-level-rise-climate/
http://www.wbur.org/news/2017/08/09/north-carolina-outer-banks-erosion
Although the links are specific to the Outer Banks, this risk is true for all coastal property.
You may want to consider buying vacation property inland.
Great points Dan!!! I didn’t even consider global warming and have seen some beach houses in Ocean Isle, NC fall in due to erosion of the beach. It’ll be interesting to see how beach communities look 50 years from now.
Thanks for the analysis. I live in New Jersey, which has some of the best beaches on the eastern seaboard, and the road network that North Carolina beaches lack (yep, been to NC, been stuck in traffic for 2 hours to go 10 miles).
I’ve thought about it, but haven’t done the deep analysis that you show here. Still haven’t pulled the trigger, and after reading this, probably won’t.
thanks again!
Mr. 39 Months
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I haven’t been up to NJ beaches in a decade or so but I was definitely impressed. Definitely a hidden secret for those that live South 🙂
My wife and I have been back and forth on this same issues for 5 years now. We actually determined that a lakeside cabin in the mountains would be better because of it’s year-round versatility (swimming/golfing in the summer, skiing/snowmobiling in the winter).
Just when we thought we were ready for a vacation home, time and money cons far out weigh our commitment to the home. Are we really committed to going every weekend? This is the question we have never been able to answer, so we continue to rent for now.
If you have the Rambling Fever and a Gypsy Soul, like us, probably best to throw time and money at a rental each year and all the other places you have on your wish list.
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I’m right there with you. I’d rather take the money and create new memories around the world than be locked into one location. I’m sure I’d feel different if I found a place that I really loved. However, I haven’t found that one special location that I’m drawn to go back to over and over again.
I look at it more like our rental revenue makes the lake cottage pay for itself, so it’s like we have it for free. P.S. Property management is more like 10% here. But then again your property taxes are 60% less than I pay(MI), different areas I guess.
That’s interesting to hear how different taxes/expenses are in different areas. That’s crazy to hear that property taxes are 60% cheaper. That’s awesome!!!
Having had rental properties – including one near the beach, I feel what is often left out of the calculations (especially when managing it yourself) is the time, management effort and emotional stress that is extracted from you. I’ve had leaking roofs, a botched burglary and intimidating neighbors to say the least. Contrast that with having a share portfolio. It does require a good deal of homework to pick good companies and the will to withstand some ups and downs, but I’ve had far better returns and with no angst.
Great points Simon!!! This is one of the main reasons I prefer stocks. Low maintenance and no late night calls 🙂
A few years ago my husband and I asked our CPA about rental property and here is her answer:
Real estate generally does not appreciate as fast as good investment funds. There are boom markets when real estate does appreciate faster but with interest rates due to rise, that may be a long time coming. Also, you have to consider if you want to be a landlord. Things break – I see hot water heaters, new AC or heating systems, major roof repairs, etc. all the time. Tenants who “small” dogs tear up the place. Tenants who have pets when it’s not allowed. Etc., etc. Some people don’t like the bother, others like having something to occupy their time.
We heard her loud and clear, if we need something “to do” buy a rental property.
An add-on to her thoughts is we have very dear friends who owned a Hilton Head, SC beach house they rented for a number of years. When my friend showed me her spreadsheet of expenses I was surprised to find her rental income covered everything but the mortgage payment. So although she was further ahead than if she didn’t rent at all she wasn’t making a profit. Even though her expenses such as utilities, insurance, etc would be paid for by renters rather than herself, the best she could hope for in the future once the mortgage was paid off was to break even. They ended up selling once their own children got careers and moved too far away to enjoy it the house with them.
All that said, a beach house does not have to be a monetary investment. It can be an investment in family and making memories. I have three neighbors who own beach houses that they do not rent them out. My one neighbor bought his beach house with a 10 year plan. Once his last child graduated from high school he sold it. He simply wanted his children to have childhood memories of summers at the beach. They didn’t surf and sunbathe all day though. When old enough they got jobs scooping ice cream at the local ice cream store and bagging groceries at the local grocery store. As parents they had to do some creative juggling since both parents couldn’t always be there at the same time. But, it worked for them. My other two neighbors continue to own and are now making memories with their grandbabies as well.
So my takeaway is, our friends and neighbors who have not become disenchanted with beach house ownership are the ones that have treated their second homes as an emotional anchor for their family, using it to make mental, emotional, social and physical memories, rather than a monetary investment.
Thanks for sharing MSM Mama!!! That’s incredibly true. Not every decision that is made has to be a financial decision. What are memories really worth compared to money 🙂
Good analysis here, Rob. I think you’re right on with your numbers. Maybe even a little rich charging $5k for a 3 bed place during peak season but again, probably not far off(!) I think there are many people who look at rental places for AirBNB and it turns out the same. If your purchase price is amazing or you do a lot of repairs and can rent for more, or you manage it yourself (congrats you now have a 2nd job!), it doesn’t really work all that well.
Like you said you do benefit from the principal payments and if you already lived at the beach and the management was easy? That may work. I agree with MSM Mama, though; just invest it and go enjoy life!