The Myth of Second Dwellings

(This was originally written on yackon.com in February of 2005, so it is a little dated. But there are some interesting points in it. And the ultimate conclusions are still true.)

Bruce Watts said at the BOS meeting the other night with regard to second dwellings: “People on Nantucket who have second lots have them for their kids, for their parents, for income when they get old,” he said. “To take away a lot is wrong, and I will stick to my guns on this until Hell freezes over. You can not tell people they can’t have a second lot.”

Similarly, Tim Soverino said, “In many ways, second dwellings have been the salvation of the average Nantucket resident. They’ve become the new tool that allows Nantucketers to live here. My sense is that the equity in a person’s home is the key to their future, and by placing covenants on that equity, you’re taking future away.”

These comments just show how out of touch Soverino and Watts are. They clearly do not understand the economic realities of the situation. All it takes is a little math to realize that the time when second dwellings become a way for islanders to really get ahead is over. In fact, it’s practically impossible to build a second dwelling affordably any more.

They are clearly not a new tool, as Mr. Soverino states, but a tool that has long since lost its real value.

Doing the math

It used to be, not too long ago, if you had a second dwelling, you could rent it out and pay your whole mortgage with it. A lot of people still do, but I put it to you that those are the people who bought and built their second dwelling before the year 2000.

The days of doing so and getting ahead are pretty much over. Here’s an example using conservative numbers.

Let’s say our sample homeowner here has a home, they bought in the late 90s or so let’s say they were lucky enough to find a house for $350K (not even a reality any more, but like I said, these are conservative numbers) and they got a first-time homeowners deal for 10% down (lucky) and have a mortgage of $315K at 5%.

Pretty good. Better off than many.

Their monthly housing expense is what? Around $1690 a month. But things are still tight. So they think, yeah, let’s build a second dwelling and rent it out and we can make extra money to get by.

So they hire an architect and they dig a hole and they put up a house that’s a modest 1200 square feet. But today it costs, on average, $250 a square foot to design and build anything.

So they spend $300K on their 1,200 square foot second dwelling and they are lucky to refinance for $615K, at 5% (probably more) with a thirty-year fixed jumbo loan and what does their monthly housing expense come to? $3300 per month, minimum.

So they go out and they see the rental market and they find that their little cottage in the mid island can rent out for what? $1600 a month?

So now they have $1600 extra coming in a month from the rental, but the rest of the mortgage is $1700. How much further ahead are they a month?

They’re not. They’re in the hole for an additional $10 a month.

Upping the ante

So what do they do then? They rent instead during the season for $1700 a week for 10 weeks. As do all their neighbors. They have to. It’s the only way to make the numbers work. And all of these obnoxious awful people from Fairfield county and Newton come there every week, and the couple makes jokes about which visitor is more annoying… And they make a tidy $17,000 during the summer. On which they pay income tax. 22%. So it’s more like $13,300

They rent the place out for $1500 a month during the rest of the year, because the people doing the shuffle cannot afford much more.

But averaged out over the whole year that is equal to $2,320 a month of income. Plus, their rental needs to get cleaned every week in the season for four hours x 50 x 10 weeks = $2000. And they have to perform upkeep on the property to keep it looking nice for the tourists, maybe $500 per season. And that adds another $2500, or $208 per month onto their expenses, so when all is said and done, they still have a net expense of $1,202 a month. They’ve cut their original $1,690 mortgage, by $408 per month.

Which is still better than before, but not a whole lot better. They could work a part-time job (which is essentially what they have as landlords catering to rich folks all Summer) and make more than that every month.

The bottom line is, the second dwelling was not their savior. They are still not “making” money. They’re not getting ahead. And look at that, the town comes along and says, hey, your property is now assessed at $600K, and up go their taxes, adding even more expense. And they find that those $80 bags of groceries are really taking their toll, and the schools are not the best in the world and lo and behold their improved property goes on the market for $1.2 million, they sell, pay off their $615,000 mortgage, move to Plymouth, buy a house and have $70K left over.

Another scenario

What about a first-time homeowner today? They are lucky to find a starter home for $600K they build a 1,200 square foot second dwelling for $300K and they have an $800K mortgage, and their monthly housing expense is $4,294. Most mortgage companies will tell you that you can spend up to 1/3 of your income on housing. So this couple needs to find someone who makes $155K per year to rent their second dwelling so they can break even.

It’s not going to happen. The market is pricing out first-timers unless they have an “in.” A wealthy relative. A parent willing to subdivide. A gift or inheritance.

So I ask Mr. Watts and Mr. Soverino, is the second dwelling the savior it once was? Clearly the days of renting out your second dwelling to cover your whole mortgage are long gone or pretty much gone. The numbers just don’t add up, unless you originally bought your home for next to nothing, or it was gifted to you, in which case you are better off not incurring the construction costs in the first place.

That ship hit the iceberg back in 2000, and we’ve been bailing, but the vessel is sinking fast.

A better solution?

Now let’s look at the second dwelling tied to the Housing Needs Covenant. Say you want a place for your kids to live when you get older. You can build the second dwelling with the proviso that it is condo-ized and is established under the auspices of the Housing Needs covenant and sell it to them for well below market rates. They, in turn, can build equity and hope to someday put a down-payment on a non-covenant house.

Perhaps you rent it out under the proposed rental covenant. Maybe to a family member. Or a close friend. (As in the example above, you’re not covering your expenses, but at least you are helping your kids and the community by creating affordable housing stock.) Maybe you sell it to your spouse for below market value, live in it and rent out your larger house when you retire at market rates for extra income (My wife and I may do that someday…).

Maybe you don’t build at all but declare your lot under the proposed housing needs covenant lot program, and you sell part of your lot, essentially as a condo, for below market rates allowing a local family to build affordably, perhaps with the help of a “non-profit builder.”

Maybe you build the covenant house for $300K and sell it for $425 and use the additional dollars to pay down your mortgage.

Look at it this way. The second dwelling “right” may be something that a lot of folks are not going to want to give up. But are they going to want to live on an island that is overrun with smaller cottages all hooked into sewer or incredibly expensive septic systems? Are they going to want to live with all the cars and the increased taxes to pay for it all? Are they going to want to have to build a bigger school and pay for that? Are they going to be able to stomach the decline in water quality, scallop harvest and tourism dollars when people form America realize that Nantucket has just gotten too overrun with human beings?

These are not easy choices. I think we need some leaders who are willing to look at all of the choices. Pick up a pencil and do some math. Be willing to make a decision that is the right way to go even if it means taking a political hit with their base.

It’s time to stop living in the past. Look to the future. Let’s make some decisions that will ensure that at least some of us can still be here in 40 years and that the island has not changed so much that we still want to be.