BUYING THAT PLACE AT THE BEACH

It happens every year. After a week of sun and seafood, after you rinse the sand off everything and reluctantly leave your rented house, you wonder: Could I afford to own a home at the beach?

As with so much in life, the answer is: It depends.

“People always ask, will this pay for itself?” said Myers Barnes, a vice president at Bob DeGabrielle and Associates, which is developing a number of pricey neighborhoods in the northern part of the Outer Banks, an area that until just a few years ago was sparsely built.

The answer, Barnes said, is that if you have the money for a down payment, if you’re willing to rent out the house for almost all of the high season, and if you have the cash to cover out-of-pocket expenses, “It’s a great dream that does work financially.”

Depending on purchase price, expenses, rental income and tax treatment, it’s not uncommon for homeowners to break even or close to it after taxes, Barnes and others said.

“No matter what the price range, every property on the Outer Banks will cost you $350 or less a month to own,” said Madonna VanCuren, a broker with Sun Realty, a real estate company based in Kill Devil Hills, N.C.

Like many beach community homeowners, contractor James Riddleberger, who lives near Harrisonburg, Va., decided to buy a beach house after decades of renting. “Why? I probably had one or two too many martinis down at Awful Arthur’s,” he joked.

Seriously, Riddleberger said, he has considered retiring to his house in Nags Head in five or six years, and for now considers the expense reasonable.

“It’s not possible to break even,” he said. “I think the idea is to have the place and rent it for supplemental income to help pay for it. In my case, the thing probably costs me $250 a month. That’s a pretty cheap way to have a place like that. The only drawback is that if you rent it, you don’t get to use it yourself.” Max Busby, a lawyer from Edenton, N.C., on the mainland, an hour from the Outer Banks, owns two condominium units in Nags Head. Busby made the purchases in part for tax shelter purposes, he said, but even before taxes, the costs are minimal.

“The two units I have show out-of-pocket costs of $80 or $90 a month,” he said. “I figure it doesn’t but take me a couple weekends down there {instead of staying in a hotel} to cover that.”

One unit, which Busby has owned for two years, was “booked solid” for the season by April 1, he said. He bought the other unit this year, he said, and it also is rented for the rest of the summer. He said he plans soon to add a single-family beach house to his holdings.

Estimates of whether a house breaks even don’t take into account the down payment, which traditionally has been 20 percent. About six months ago, according to VanCuren, lenders that specialize in making loans on Outer Banks properties began writing 30-year mortgages with just 10 percent down.

“The hardest part of owning any property here is the down payment,” she said. “Now that they’ve opened up 10 percent-down loans, that’s opened doors for our dreamers.”

As with any real estate purchase, many beach buyers are counting on price appreciation to provide them a better return on their down payment than they would get investing the money elsewhere. But Barnes cautioned against counting on appreciation to produce wealth.

“In the ’80s, real estate used to be that you’d buy this today and it would go up tomorrow. But now, if you buy this today, then within reason it will carry itself.”

People buy beach houses for different reasons. How a buyer uses the house determines how it is treated for taxes and how it works as an investment.

For instance, in the traditional Washington beach areas on the Maryland and Delaware shores, most buyers are looking for a true second home, a place they stay on weekends and rent out for just a couple of weeks, according to Jim Waggoner, sales manager for the Long & Foster real estate office in Ocean City, Md.

“Most people buy with the anticipation of not renting the property,” he said. “Later on for whatever reason, they may decide that they want to rent it. But if you’re buying a home at the beach, your thoughts are that you’re going to be using it.”

In that case, mortgage interest payments and property taxes are generally federal income tax-deductible, as they are on a primary residence, and expenses are not deductible. You can rent the house out for 14 or fewer days and not include the rent in your income for tax purposes.

In the past few years, more and more Washingtonians have been vacationing in North Carolina’s Outer Banks, a strip of barrier islands just south of the Virginia border. Longtime visitors gripe about how traffic and overbuilding are ruining the once-unspoiled towns of Duck, Corolla and Nags Head. But to someone used to Ocean City, the windswept beaches of North Carolina, with their high natural dunes and clean white sand, look almost deserted.

On the Outer Banks, a six-hour drive from Washington, almost all home buyers purchase with plans to rent out their beach house as much as possible, VanCuren said. In that situation, owning a beach house becomes a business.

The tax treatment is generally the same as for any rental property. You report your rental income to the government, and you can deduct all your expenses. In addition, you can depreciate both the building and the furnishings, which can result in big tax savings. In some cases, you can use losses to shelter other income.

The rules can be complicated — particularly the “passive loss” rules that apply solely to real estate — so it’s smart to read a detailed tax guide or discuss your individual situation with an expert. Also, Congress regularly reconsiders many tax rules, so they are subject to change.

“Everything’s deductible, but you have to get with your accountant. It’s a business,” VanCuren said.

Even if a house is a rental property, the owner can get some use out of it. The Internal Revenue Service allows up to 14 days a year of personal use, or 10 percent of the total time rented, whichever is greater. The owner also is allowed to stay at the house to perform maintenance, as well as to open up and close down at the beginning and end of the season.

Companies that specialize in selling vacation property routinely supply cash flow figures on houses to interested buyers. These are based on past rental income and expenses. (See charts for examples.)

Expenses include not only the mortgage, taxes and insurance, but also maintenance and in many cases management fees. Homeowners who don’t live near the beach frequently hire professionals to rent out the house, deal with tenants and keep up maintenance between rentals. These management fees range from 15 percent to 24 percent of the rental income, VanCuren said.

Home prices on the Outer Banks generally are lower than comparable properties at the Maryland and Delaware beaches. The price range in both areas is wide. Location is perhaps the most important factor — both north-south, with different towns commanding different prices, and east-west, with prices climbing steeply near the water.

For instance, in Ocean City, where much of the housing stock is high-rise, condos average $90,000, Waggoner said. But head up to North Bethany Beach, Del., and the rare single-family oceanfront house that comes on the market will average $900,000, he said. You’re unlikely to find a well-kept, single-family home or town house for less than $200,000 anywhere near the water in any of these beach towns.

VanCuren outlined price ranges on the Outer Banks. In Kitty Hawk or Nags Head, on the west side where most locals live, single-family prices start around $60,000, she said. In the area known as “between-the-highways,” a five-minute or so walk to the beach, prices “for something you don’t have to bulldoze” run from $99,000 to $179,000. “For $179,000, you get ocean view across the beach road,” she said.

Oceanside, where another house may sit between you and the ocean but there are no roads to cross to get to the water, prices range from $149,000 up. And for oceanfront, “Something that’s not going to go into the water will go from $225,000 on up,” VanCuren said.

Prices except on the west side are almost always for fully furnished homes, right down to pots and pans.

Prices are slightly lower in Kill Devil Hills, VanCuren said, and quite a bit higher in Duck or Corolla to the north. That’s where new custom houses costing $1 million or more are under construction.

She said she recommends that people who intend to rent out their property buy as close to the water as they can afford, because those are the locations most attractive to tourists and command the highest rents.

But you don’t want to get too close to the water. The Outer Banks, like most barrier islands, are prone to heavy storm damage from hurricanes in the late summer and early fall and nor’easters in the winter. Houses no longer are built directly on the beach; instead, they’re behind the dunes, which provide some protection.

The most desirable beachfront lots are known as “road to ocean,” VanCuren said. These are very deep lots, stretching from the main road down to the water. “If, God forbid, there’s a big storm, you have enough room to move the house and protect the septic tank,” she said.

Because of the weather risks, home buyers on the Outer Banks are required to have federal flood insurance in addition to standard homeowner’s insurance. This insurance currently costs from $149 to $600 a year, VanCuren said.

The federal flood insurance program for years has been a target of environmentalists, who say it fosters unsafe development of expensive beach homes. But this spring, the program survived another attempt in Congress to make changes that would have dramatically reduced construction in eroding coastal areas.

Even with insurance, the physical stability of a property should be a primary concern for possible buyers, said Riddleberger, whose house is 100 yards from the ocean. “We chose this place thinking it’s one of the safer places,” he said.

The process of buying a beach house is similar to that of buying a primary residence. A prospective buyer, working with or without a real estate agent, picks a house, puts down an earnest money deposit, makes a bid, negotiates in writing with the seller and obtains a mortgage loan.

It’s always a good idea to read boilerplate contracts, but because there are some minor differences between standard forms in the Washington area and in North Carolina, it’s particularly important to do so to avoid surprises.

The process of closing the purchase also is different. In the Washington area, settlement companies handle many closings. In North Carolina, the closing must be handled by a state-licensed lawyer. And in Washington, the buyer and seller usually attend a closing in person, but most closings on the Outer Banks are long-distance.

“The buyers and the sellers never see each other,” VanCuren said. “Everybody is from different states. None of our owners live in North Carolina.”

Closing costs usually run from 3 percent to 6 percent of the amount financed, she said.

Waggoner said the usual buyers at the Maryland and Delaware beaches are a couple in their fifties or sixties, with equity in their primary home. Generally, buyers are from the Washington area, he said. Increasingly, though, vacationers and buyers are heading down from Pennsylvania, where the nearby New Jersey beaches are so highly developed they can make Maryland’s beaches seem undiscovered.

“Someone who buys at the beach is first and foremost someone who’s vacationed here over the years,” Waggoner said. “They’ve reached the point where they say, ‘We’ve always wanted a home at the beach. It’s time to go buy one,’ ” he said. “Their children are gone — but one sure way to get them back is to buy a place at the beach.”

That’s also a common profile for Outer Banks buyers, according to VanCuren, but she said agents there also see a lot of Washington area young professionals, many of whom rent their year-round homes because they can’t afford to buy near the city. For them, the beach house is a first-time purchase.

For some Outer Banks homeowners, cost doesn’t seem to be a concern. At one DeGabrielle development, Pine Island near Duck, prices “start at $350,000 and go to the millions,” said salesman Ralph Hodges III.

The smallest oceanfront house in Pine Island is 3,500 square feet, he said, although there are some relatively small 2,000-square-foot houses elsewhere in the subdivision. The average American home totals about 2,500 square feet.

“We are by far the high end for this neck of the woods,” Hodges said.

One Pine Island home now under construction will be 17,000 square feet, Hodges said, who didn’t even attempt to estimate the cost. Its owner is a cosmetic firm executive from New York, he said.

“Seventeen thousand square feet — that’s your typical second home,” he said, laughing. “Doesn’t everybody have one?”

The following table shows how a beach home used as a rental property works financially. The projection is based on actual income and expense figures on a Nags Head, N.C., house, as supplied by Sun Realty. In this case, the owner makes a small after-tax profit, but that is not always true. For instance, lower income or higher expenses will change the results. Many of these numbers, particularly mortgage rates, are subject to variation. All numbers are annual unless otherwise specified.

Description: Six-bedroom, three-bath, 1,844-square-foot contemporary home built 13 years ago. Unobstructed view of ocean across small road and dunes. Furnished in classic, rugged beach house style.

* Asking price: $159,900

* Estimated depreciation values:

Land: …………………………………………….$75,000

Improvements: ……………………………………. $79,900

Personal property: ………………………………… $5,000

* Gross income:

10 weeks high season at $1,295/week ………………… $12,950

10 weeks shoulder and off-season at $575 to $795/week: … $6,995

Total income …………………………………….. $19,945

* Gross expenses:

Taxes: …………………………………………… $1,100

Insurance: ……………………………………….. $1,500

Utilities/maintenance: …………………………….. $2,000

Management fees (19 percent): ………………………. $3,790

Total expenses ……………………………………… $8,390

Income minus expenses equals:

Net income ………………………………………. $11,555

* Mortgage terms: 30-year fixed-rate mortgage at 8.5 percent, with a 20 percent down payment of $31,980

* Monthly principal and interest payment

on $127,920 mortgage ……………………………….. $984

* Yearly principal and interest payment: ……………… $11,808

(principal: $935; interest: $10,873)

* Before-tax expense …………………………………. -$253

(mortgage payment minus net income)

* Annual depreciation

Improvements ……………………………………… $2,905

Personal property …………………………………… $714

Total for first year ………………………………. $3,619

* Tax summation

Combine before-tax expense ………………………….. -$253

and principal payment ……………………………….. $935

= Income before depreciation …………………………… $682

Minus depreciation ………………………………….. $3,619

= Total projected loss for tax purposes ……………….. $2,937

* Assume 28 percent marginal tax bracket, and that produces tax savings of $822.

* THE BOTTOM LINE

Subtract before-tax expense from projected tax savings, and that equals

Annual after-tax profit: ………………………………. $569

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