Hide Away

Kiplinger's Personal Finance Magazine, July, 2001 by Mary Beth Franklin

HOMES | Tempted to buy a SUMMER PLACE? Don't kid yourself about the real costs.

AS YOU HEAD OFF to your favorite beach or mountain getaway this summer, paying peak seasonal rates for a week or two of relaxation, you might wonder what it would be like to own a vacation home of your own--and have somebody else pay you those outrageous rents. You're not alone.

But don't let idyllic surroundings cloud your good judgment.

Yes, the vacation-house market is hot--so hot that even a volatile stock market and plunging consumer confidence can't cool it off. In fact, the softening economy may actually be turning up the heat, as lower interest rates make second-home mortgages more affordable and skittish investors turn to real estate to diversify their portfolios.

Purely from an investment standpoint, it's doubtful you can justify putting a vacation home in your portfolio. But if you love the lifestyle, can afford the extra outlay required to maintain a second home, and choose your location wisely, your investment will likely appreciate in the coming years.

Financial wellspring

AFTER SEVERAL summer vacations at the beach when their children were young, Paul and Margo Hallisay decided they loved the relaxed lifestyle but not the high price tag of nearby Bethany Beach, Del. So they traveled five hours south from their southern Maryland home to Nags Head, N.C., where their dollars would stretch further.

That was in 1984, and the Hallisays found the ticket to second-home ownership right inside their own front door: They refinanced the mortgage on their home and pulled out $14,000 of equity for the down payment on a $140,000 oceanfront house. To maximize the tax breaks that helped foot the bills (see the box "UNCLE SAM'S ROLE IN YOUR DREAM"), the family limited personal use of the home to just two weeks a year. The Hallisays also took full advantage of a rule that says time spent fixing up a vacation home doesn't count against those 14 personal days. Initially, income from the home's $750-a-week summer-rental fee covered some, but not all, of their expenses. But as the years went by, they made improvements, rents went up faster than costs, and the place almost paid for itself.

When a neighboring cottage went on the market several years ago, the Hallisays decided to buy it. They used the same strategy, refinancing their primary home and pulling out money for a down payment. They rented the side-by-side houses as a pair to accommodate large families or groups, boosting their rental income to as much as $3,500 a week in 1998--and doubling the amount of non-maintenance time they could enjoy at the beach without violating the 14-day rule.

Last year, Paul and Margo sold the two cottages so they could buy the five-bedroom beachfront house of their dreams. It needed work, including a new roof, siding and some cosmetic updates inside, but that held the price to an affordable $475,000.

Between the sale of the two cottages and yet another refinancing of their primary home, the beachfront house is mortgage-free. The $45,000 they anticipate in annual rental income will cover the cost of the mortgage on their primary home.

"It was a good 16-year investment that didn't cost us a dime in the long run," Paul says. In the future, they may make "Hal-A-Sea" their full-time home. The tax rules encourage second-home owners to do just that: make a vacation hideaway a full-time residence at some point. If you do, and live in it as your home for at least two years, up to $500,000 of profit when you sell will be tax-free on a joint return ($250,000 on a single return).

Break-even point

WHILE THE Hallisays have benefited from years of property appreciation, can someone buying a vacation home in today's market hope to break even with seasonal rentals? Yes, but not much more than that--at least initially--says John Myers, a sales agent with Twiddy & Co., in Kitty Hawk, N.C. Tax deductions can help pay the bills, but probably not nearly as much as you may think. Here's how it might work:

You buy a $400,000 beach house with a 20% down payment and a $320,000 mortgage at 7.625%. Payments on the 30-year loan are $2,266 a month. If you add insurance and property taxes of about $4,000 a year, that brings your annual fixed costs to $31,200.

Rental properties in North Carolina are usually available from Easter through Thanksgiving, with peak rates during the summer months. Farther north, in New Jersey, New York and New England, you may be able to count on only ten or 12 weeks of rental income.

A four-bedroom home near the beach in Nags Head might rent for $3,000 a week in the five peak weeks of the summer, dropping to $2,500 a week for early June and all of August. Add the rent for four weeks in September at $1,500 a week and your summer income comes to about $36,000. If you snag a few early-spring or late-fall rentals for about $1,000 a week, you could rake in $40,000 a season, exceeding your $31,200 in fixed mortgage-interest, insurance and property-tax expenses.