Paul Meloan – Vested Interest

After twenty years in practice, I cannot think of any one concept that has generated more passion, fury, anger or ecstasy than the Beach House. The idea of owning a second home is both enticing and intimidating. If one were to try it would be difficult to conjure any single topic more likely to cause emotional bloodshed than putting down good money to acquire real estate that is by definition unneeded.

I’ll skip to the conclusion up front: I’m cool with them, but we must get a few things straight.

It represents escape from the rat race, or triumph over it. It is viewed as the magnet that will draw in all the loose metal filings of children and grandchildren and bond the family together in shared experience. Sometimes, that’s exactly the way it all works out too.

Somewhere between being wealthy and rich many families become enamored with the idea of a second residence. Usually located in some more idyllic location than their home (no one, for example, owns a second home in Youngstown, Ohio) it becomes the physical embodiment of their success. A beach house means no longer being at the mercy of winter climates. A second home may perhaps convey a more accommodating tax structure. It represents escape from the rat race, or triumph over it. It is viewed as the magnet that will draw in all the loose metal filings of children and grandchildren and bond the family together in shared experience. Sometimes, that’s exactly the way it all works out too.

Of course, sometimes it doesn’t work out. Clients pick the wrong place; or maybe they pick the right place for when the kids are little but when they become teens the place becomes wrong.  Budgets (even big ones) get blown. Things break, or wear out. Of course all homeowners know this, but somehow the costs become more aggravating when knowing they are 100% optional.
So with all that said, let me try to encapsulate a few guidelines to remember when considering the ultimate acquisition.

It’s Not an Investment (or maybe just a bad one…….)

This is the first sign of denial. Someone quotes what their friend’s parents paid for their beach house on the Cape back during the Nixon administration and how much it’s worth today. Ok, sure. I get it. Good real estate appreciates over time: the better question to ask is “Compared to what?” Just to cherry pick an example, imagine someone who bought that beach house on Cape Cod in 1975 for $30,000 and today it’s worth $1 million. Nice work if you can get it, certainly. In that same time, a $30,000 investment in the US stock market would have grown to $4 million by the end of 2017. We don’t even need to take on stock market risk to get those returns. An investment in long term US government bonds would have given almost identical returns as the real estate. The bottom line: that second home isn’t going to make you wealthier than you are right now. It almost always represents a significant opportunity cost in building wealth.

Also, to would-be landlords: a second home you rent is not an investment, it’s a business. Between accounting, taxes, regulations and lawsuits be certain of how much time, energy or money you would like to devote to this new entrepreneurial venture. Say what you will about index mutual funds none of them ever sued a shareholder. Any landlord who’s owned property for more than a few hours knows it’s only a matter of ‘when’ not ‘if’ they will need their attorney to deal with a property or tenant issue.

Rust Never Sleeps

All houses are falling down. Some houses are falling down faster than others. In our daily lives as home owners we see this decay gradually and typically deal with it incrementally. Hopefully the furnace, A/C and roof don’t all decide to die at the same time. What comforts us economically is that the primary benefit of owning our homes is that we are essentially our own landlords. We get the economic benefit of not having to pay rent to a third party. We cannot be subject to rent increases or even the refusal of our landlord to continue the lease.  With a second home that logic goes out the window, or at least cut in half. Because the laws of time and space dictate we can only wake up in one place at a time this imputed rent benefit is gutted when someone owns multiple homes. Think of it this way: how much would you pay per month to live in your own home? Now how much would you pay if you only woke up there 90 days per year? Imagine a store had a sign that said “Buy 365, get 90” for any expensive item and you get the meaning.

The real litmus test: what does it cost to rent the equivalent dwelling during the equivalent period of use? If you only intend to be at the beach for three weeks in the summer and maybe during the Christmas holidays do you want to pay for the other 11 months of the year? (see caution above about being a landlord)

Run the numbers hard. We’ve done it multiple times and an interesting heuristic (rule of thumb) has emerged. If you aren’t spending 100 nights per year in the second home then owning is always vastly more expensive than renting. Sometimes it’s more expensive even with at least 100 nights, but light use is never, ever cheaper.

Who Else Feels Like You Do?

People in a family think differently from each other. I’ve never worked for a married couple that felt exactly the same about every decision they made regarding their money. Most of the time this is quite healthy: different perspectives often make for better choices. With the issue of real estate this becomes a touchy subject. It is human nature to be highly emotional about the place we call “home.” Human nature is immutable, and we each hold deep convictions about what we do or do not want in our homes. I have seen couples reach agreements on real estate many times, but almost always it requires much more discussion, debate and heartache than, for example, how to invest their 401k plan. Disputes about real estate also reveal fracture lines in relationships and expose long-suppressed emotional difficulties.

So What’s the Upside?

The bottom line is that a beach house, or any second home, is an expression of how a family has chosen to spend its time and money. It’s ultimately an expense. If the budget for this expense matches up with the family’s means and desires it can be a source of profound joy and contentment. I’ve seen it happen many times. It’s not for everyone, but that fact seems to make it more enticing for those who choose to pursue it.

    Paul Meloan is the co-founder and co-managing member of Aegis Wealth Management, LLC, in Bethesda, Maryland USA. Before Aegis Paul was a practicing attorney as well as working in the tax practice of Ernst & Young, LLP.

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