Owning a beach home at the wonderful Outer Banks of North Carolina is the dream for many, and the reality for more than you may think. Let’s call it what it is……owning a beach home is a huge decision that may be one of the largest financial moves you may make in your life.
What makes sense to you when you look into buying a beach home? Many times, it includes making memories with your family and friends. This is the emotional side of this. ALWAYS, this must make financial sense.
As an Outer Banks Real Estate Professional, I get asked the heading question above many times. My clients that lean more towards investment minded decisions always want to learn about beach rental properties that have strong rental histories that help pay expenses, and paying all of those expenses is ideal.
With the right level of work and educating process, I can provide them, they will see that many homes here can be strong real estate investments that actually pay for themselves.
You may have learned a long time ago that the numbers always tell the truth. Of course, you need to know how to apply the “numbers” into a basic spreadsheet and do the math.
Here on the Outer Banks we have an array of levels of Beach Vacation Rental Homes. Logic tells us that the best performing homes are on the ocean front or near the beach accesses.
What is not so obvious is how the ingredients of a home will affect performance. The numbers include rental income, property management fees, utilities and maintenance. The ingredients specific to fine performance are simple but needed to insure best performance.
There is an old adage in real estate that applies to the investment side of a beach house purchase decision; “Highest and best use”. What do I mean? Well, “location, location, location” is another real estate term mostly used in commercial segments.
As mentioned above, the oceanfront row or close is a good start when seeking the best performing beach rental homes that could pay for themselves. Another is the “highest and best use” ingredient. I have seen tired beach homes here which could be doing a lot better. I have seen a property underutilized in regards to the quantity of bedrooms being lower than the lot/location can support.
The quantity of bedrooms here, especially on the oceanfront or close, is the main driver to get to the highest and best rental income. Parallel to this is the amenity list which always includes a pool, game room and suites.
Overall condition and most current décor elements, as well as technology elements like audio-visual experiences, mean a lot, as well. One could look at the top tier oceanfront homes on various property management sites here and see the list of amenities, as well as the look and feel throughout and imitate this on a home in their price point if the ocean front levels are beyond their ability to buy. I share this because of the topic we are discussing……. a beach home paying for itself.
The best way to accomplish this may be easier than you think when the FIRST goal is to get a clear understanding of your borrowing position.
A good agent will align you with a local lender that understands the market here. You may be surprised to learn that some lending products allow you to include the rental history of a particular beach home as part of the qualification process.
This means your debt to income ratio may not be the only factor to qualify you for a beach home purchase. I call getting together with a lender the FIRST the best decision you can make in the process. It removes all guesswork and allows a focused plan to lead the process.
From there, a good agent will know how to examine the inventory and present genuinely and accurately in regards to matching your ability perfectly. Doesn’t that sound like the best approach?
My role as an agent is to LISTEN first.
When you share that finding a beach home that pays for itself is your primary goal you will get the straightforwardness you need to make a good decision. I must take this opportunity to openly share that I will keep it real with you.
There are times I hear from folks that they want their cake and want to eat it, too. There is a level of investment property here that will cash flow positive at 20% down and that typically means the higher tiered price points.
There are cases of 20% down on mid-level homes that can also cash flow positive.
The lower to mid-level price points may need more than 20% down to be in the “black” but this 20% on a low-priced home typically is able to be handled due to the starting price point being lower than anticipated.
The focused plan you share with me, as long as it is realistic, can and will be achieved. You will be serving the process well when you stick to the numbers, understand them, and apply them to what I call the simple math that always tells the truth.
And, when we have connected you with a lender early on it means the process is not guesswork. It is a focused plan getting you where you want to be…….in an Outer Banks Beach House that can pay for itself.
Lenders often get this questions posed to us as buyers begin to look for property. Many buyers look at the purchase of property on the outer banks as an investment.
Yes they want to use some personally and typically have enjoyed years of coming to the Outer Banks. However, almost all buyers do plan of renting in the summer season under property management agreements to gain rents from seasonal rentals.
For this reason many assume lenders look at the properties the same way they do as an investment. Lenders typically first see if a buyer might qualify by not using the rental income to qualify. This means we add up all the existing debt add the newly proposed payment and calculate a debt to income ratio not to exceed 50% for loan amounts of $424,100.
For loan amounts above this we allow debt ratios of 45% sometimes exceeding by small amounts for well qualified buyers.
As easy example of how we calculate debt ratios is a buyer that has gross monthly income of $10,000 per month or income of $120,000 per year.
This buyer can have up to $5000 per month in proposed total debt. This includes the new home payment on the outer Banks and their existing housing expense where they live and any other debt payments they may have.
This equates to a 50% debt ratio.
Loans amounts above $424,100 are categorized as Jumbo Loans smaller loan amounts are categorized as Conventional Conforming Loans. The advantage of qualifying as a second home means you get the same rate as a primary residence at Citiznes.
On our best days of late we have been as low as 3.875% as a second home. The other advantage is second homes allow for 90% loan to value.
When we see a buyer does not have the income to have the required debt ratio we can fill the gap by using rental income to offset the proposed payment.
An example of this; using the same income we used above but the proposed payments are totaling $6,250 per month making the debt ratio 62.5%. Let’s assume their existing home payment is $2,500 and they have another $750 of other debt from an automobile payment or some amount of credit card debt that shows up.
Even if they pay off their credit cards monthly we will likely count the minimum payment. Total existing debt is $3,250 and the proposed payment is $3,000 on their new beach home. Taxes and insurance make up a lot of the proposed payment.
Let’s assume of the $3,000 that $1,000 is for taxes and insurance leaving $2,000 as principal and interest. This will finance a loan amount of approximately $400,000. The assumed sales price in this example is $500,000. 20% is the best way to finance investment property.
Lenders do offer 85% and some 90% but the cost in rate and mortgage insurance will discourage most buyers from feeling like this is a fair bargain. This is one disadvantage of the investment category it is best and often requires 20% down. The second is the rate will be higher.
I used 4.50% in the assumption of a $2,000 payment to finance approximately $400,000. Our market is unique rents are not guaranteed and come in on a seasonal 3 month basis for the most part. Because of this almost no lender will offer loan amounts above the Conventional Conforming Limit of $424,100.
However, we still need the debt ratio to be at 50% or less and so far we are still at 62.5%. We calculate seasonal rental income by using an Income & Operating Schedule prepared as part of the appraisal process. There is a fee typically of $150 to $200 added to the appraisal cost for this schedule.
Let’s assume our proposed $500,000 priced property has gross rents of $45,000 in a season. The appraiser uses 75% of the gross rents to offset expenses for management fee, taxes, insurance (the big three expenses as I call them) and other expenses such as cable, electricity, or maintenance.
This yields a net income number to be used to offset the payment. Let’s assume the net income number is $24,750 or 55% of the gross rents of $45,000. This yields $2062.50 to make the proposed payment.
The proposed payment is approximately the same as the net monthly yield essentially offsetting the proposed payment. Even if the underwriter counted the entire $3,000 to include taxes and insurance the negative cash flow from the most conservative analysis is only $1,000.
I disagree in counting the entire proposed payment because the income and operating statement takes taxes and insurance into account as an expense and subtracted them already, however underwriters can be hard to persuade and vary lender to lender.
Let’s assume we have the most conservative of underwriting and the negative cash flow in the eyes of underwriting is $1,000. Still this client would qualify as the only payment added to his total debts of $3250 is $1000 making all debt $4,250 and a debt ratio of 42.5% on our example.
The actual negative cash flow is all that is used in determining total debt not the payment itself. This is how we use rental income to offset the payment and allow someone to buy a home on the Outer Banks when otherwise they would not qualify.
For additional information on purchasing an investment home on the Outer Banks, using rental income contact Drew Wright.
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