So, you’re thinking of purchasing a rental property at the beach. Historically, real estate investments have proven to be a wise investment strategy. The name of the game has always been maximizing cash flow. Years ago, one could realize a healthy rate of return based on cash flow generated from rental income alone, however, with rising property costs, the number of beach properties with a substantial positive cash flow are dwindling. Fear not investors! The goals have changed, but the market is still strong. In today’s arena, the goal is break even or slight positive cash flow while capital is grown through equity. With annual appreciation rates of 30-40%, investors are eager to tackle a small negative cash flow! Let’s look at an actual example:
Mr. and Mrs. Mainland purchase an Outer Banks rental property in February 2003 for $575,000. They finance 75% of the purchase with a mortgage rate of 4.5% ($2,250 monthly P/I). The 2003 season nets $30,577 in rental income. They cover their mortgage expense ($27,000) with the income generated. Other expenses (taxes, insurance, utilities, property management, etc.) add up to $5,860. That leaves the Mainlands with a negative cash flow of $2,283 for the year, or $190 per month.
In March of 2004, the Mainlands decide to sell the house and net $740,000 from the sale. In the one year that they owned the cottage, their out of pocket expense was $2,283. Conversely, their equity gain was $165,000.* Not a bad rate of return ! In this case, the Mainlands used an IRS 1031 exchange and did not have to pay any capital gains taxes from the sale of the property.
What to look for when choosing the right property.
* Proximity to the Water~> The closer the property is to the Ocean (or sound/bay) the more demand there will be from potential renters.
* Amenities~> Today’s beach homes have every conceivable bell and whistle (pools, elevators, game-rooms, tiki bars, etc.). You will need to make sure your potential investment home is competitive with other properties in the area.
* Age of Structure~> Only consider homes that have years of enjoyment left in their lifecycle. If you plan to keep the house for the long haul, this will keep your maintenance and utility expenses down. If your goal is to exchange the property in one or two years, a newer home will be more marketable..
* Protection~> One of the most essential elements to comfortable ocean front ownership is the protective sand dune. You want to choose an area with a high, established, vegetated dune line. This will protect your investment in the case of a tropical storm system.
* Rental History~> If available, get accurate rental records for the cottage. This will illustrate the home’s rental rates as well as any repeat tenants.
* Respected, Hard Working Property Manager~> Your property manager ultimately controls your cash flow. They have the power to book every week available in your cottage, thus increasing positive cash flow or they can do a poor job and leave prime weeks un-rented, therefore, increasing negative cash flow. They also have the responsibility of keeping your tenants happy.
* Keep Your Emotions in Check~> Remember, you are buying this property for the renter’s comfort not your own. You may not think a cottage is decorated up to your standards, but you are not the one living in it, the tenants are.
How to get started:
The most important things you will need to get started are:
^ Your target area (town, subdivision)
^ Pre qualification letter from local lender
^ Down payment amount
^ A reputable Real Estate Professional to help you find appropriate properties and generate cash flow analysis’ (CFA’s).
Purchasing an Outer Banks rental property has proven to be a wise choice in today’s investment world. This is evident in the number of investors that continue to re-invest in the market. With property values half of that in other coastal markets and historically low interest rates, there is still a fantastic opportunity for growth. One thing is for sure, it would be hard to mirror this yield in today’s stock market!
*number based on pre-closing costs