So, you are thinking of buying a rental property on the beach. Historically, real estate investments have proven to be a wise investment strategy. The name of the game has always been to maximize cash flow. Years ago, one could earn a good rate of return based on cash flow generated from rental income alone, however, with property costs rising, the number of beach properties with substantial positive cash flow it is decreasing. Fear not investors! The objectives have changed, but the market is still strong. In the current scenario, the goal is to break even or slightly positive cash flow, while capital grows through equity capital. With annual appreciation rates of 30-40%, investors are eager to deal with a little negative cash flow! Let’s see a real example:
Mr. and Mrs. Mainland purchases a rental property in the Outer Banks in February 2003 for $575,000. They finance 75% of the purchase with a mortgage rate of 4.5% ($2,250 P/I per month). The 2003 season generated $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 continent with a negative cash flow of $2,283 per year, or $190 per month.
In March 2004, Mainlands decides to sell the house, netting $740,000 from the sale. In the year they owned the cabin, their out-of-pocket expense was $2,283. By contrast, your capital gain was $165,000.* Not a bad rate of return! In this case, the United States used an IRS 1031 exchange and did not have to pay any capital gains tax on the sale of the property.
What to look for when choosing the right property.
* Proximity to water ~> The closer the property is to the ocean (or sound/bay), the more demand there will be from prospective tenants.
* Amenities ~> Today’s beach houses have all the bells and whistles imaginable (swimming pools, elevators, game rooms, tiki bars, etc.). You will need to make sure that 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 life cycle. If you plan to keep the house long-term, this will keep your maintenance and utility costs low. If your goal is to exchange the property in a year or two, a newer house will be more marketable.
* Protection ~> One of the most essential elements for a comfortable beachfront property is the protective sand dune. You want to choose an area with a line of dunes with tall, established vegetation. This will protect your investment in the event of a tropical storm system.
* Rental History ~> If available, obtain accurate rental records for the cabin. This will illustrate the rental rates for the house as well as the regular tenants.
* Respected and hard-working property manager ~> Your property manager ultimately controls your cash flow. They have the power to book every available week in their cabin, increasing positive cash flow, or they can do a poor job and leave the main weeks unrented, increasing negative cash flow. They also have a responsibility to keep their tenants happy.
* Keep your emotions in check ~> Remember, you are buying this property for the renter’s comfort, not yours. You may not think that a country house is decorated to your standards, but it is not you who lives in it, but the tenants.
How to start:
The most important things you will need to get started are:
^ Your target area (city, subdivision)
^ Prequalification letter from local lender
^ Down Payment Amount
^ A reputable real estate professional to help you find suitable properties and generate cash flow analyzes (CFAs).
Buying a rental property in the Outer Banks has proven to be a wise choice in today’s investment world. This is evident in the number of investors who continue to reinvest in the market. With property values half those of 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 performance in today’s stock market!
*number based on pre-closing costs