Real Estate Returns

From 2004 through 2007 I was securities licensed and participated in Tenant in Common (TIC) market. TIC’s were classified as securities and were essentially sold as a security backed by a  fractional interest in real property. The attraction to the TIC product was it’s qualification for the IRC Sec. 1031 Tax Deferred Exchange and was considered the investment of choice for property investors planning to retire from active management of their investment property. TIC’s just like any investment in real estate in the 2004 – 2007 era are having varying results but the supply of capital they generated for commercial investment market was robust.

TIC investments in apartments are generally doing OK or better than the market and the same can be said of Health Care Properties. The areas of concern and hurt are Office Buildings, Retail Centers including Auto Facilities, Student Housing and Hospitality. There has been some total losses in these property types and there would be a lot more if there were not some form of loan modifications or cooperation from lenders. Don’t get me wrong! Lenders are not accommodating because they’re good guy’s,. They’re doing it because they’ve discovered being a landlord usually costs them a lot more money, headaches and liability. They don’t like that last one!

I decided to not renew my securities a couple of years ago to focus on real estate only. There were several reasons for this but the main one was the amount of mark-up or load by securities folks was getting outrageous and next would be the limitations on available product through securities sponsors. Another was the restrictions placed on me by the Securities license. A lot of the time a successful real estate investor is a Mom & Pop. They invest in real estate because they believe in it. They can go see it everyday. They can look at the history of the country and the history and return of investment in real estate and see a correlation. They don’t care that they’re over weighted in one investment… that’s the way they want it, and they get real peeved at any “Wall Street Type” who tries to tell them different.

Real Estate sales and 1031 tax deferred exchanges are still our main focus. In sales we’ve found a niche liquidating estates for administrators and trustees. For exchanges, it’s not in the best interest of most of the folks I consult with to trade what they have for whats available, which must be the first consideration of an exchange transaction. At times we find exceptions which turn into good and profitable transactions that fits into the investors plans. These are mostly local real estate deal where properties have to be sold to liquidate a probate or trust estate. In terms of TIC’s they’re still around and there are a couple of good sponsors out there in the TIC arena. Likewise TIC sponsors are getting good deals in this market although they’re usually secondary markets and the transaction markup is still over and above the regular real estate. Nevertheless, a good TIC representative can produce a deal that will provide a landlord with a terrific retirement investment.

If you’re an investor looking for an exit strategy from active property management or you’re just tired of tenants, it would be better to focus on finding NNN investments that will give you the same or better returns as a TIC where you’re the only investor and you have almost total control. Lots of these investments exist in properties where ground leases are used. A good example would be a fast food restaurant on a high profile corner. You own the land and the franchise or tenant leases the land on a 20-30 year lease and takes responsibility for paying  the bills on everything. You enjoy the cash flow from the real estate which can be sold, traded, exchanged or borrowed against. Control!

In terms of what is going to happen in the next couple of years… It will depend on the labor market. If we begin to create real jobs, not minimum wage or slightly better middle-man type employment, then things will improve. Also the further away we get from the 2008 collapse the  better chance we have for a new normal. Unlikely we’ll ever get the returns we got in 2004-2007. If you see that happening again, it would be a good time to start shorting the stock of the lenders involved.

The bottom line on sustainable return on investments is controlled by the supply of capital. There is an abundant supply of affordable capital for banks which will is available for qualified real estate investments in the 60-75% Loan to Value ratio. If we return to the days of sensible real estate investment principals, then we look to the lenders rate and add a risk margin for the return on our higher risk down payment. A hypothetical example would be; a lender loan rate of 5% then an investor should be looking at 6-6.25% to compensate for the added risk.

That was a long way to say we won’t have the crazy 2004-2007 market in real estate again for a long time.

Who Gets Your Vote?

The cast of characters—sounds like a Hollywood type of deal. Some of these characters actually think they are in Hollywood, or they are Hollywood material. This is an area where a lot of people screw up, and I don’t want you to be one of them.

Just as in life, the top players in the real estate market get the top dollar. So you pay a little bit extra and you get the best in the class. They usually make the difference up anyhow—they can get you that little bit extra in the sale price or save you that little bit extra in the purchase price that will pay their fee.

Let’s put it this way: if you’re in the bottom of the ninth inning of a baseball game with the game tied and the go ahead run coming to bat… who’d you send to the plate? The 200 hitter or the 340 hitter? That’s right! You’d send the guy that has the best chance to win the game for you. You’d look for that pinch hitter that could bring those runs home for you.

Real estate’s similar in so much as there are specialties, or brokers who work in certain specialties. If you have a real estate property that’s in the rental housing market or the 2-4 unit size, the broker that you hire to assist you in that transaction should specialize in the residential investment section of the market. A similar type of property is the 5 residential units and up or the apartment house investment, but has different requirements for financing and disclosures that the former. Completely different still is the broker that specializes in industrial or office property sales, and still they are different than brokers who specialize in representing tenants and landlords in leasing. So it’s a good idea to select a specialist in the type of property and transaction you’re planning to conduct. Oh! Don’t forget to inquire about the 1031 tax deferred exchange experience of your chosen professional as well.

Another rule of thumb when you’re going out there to select an agent is to interview two or three of them. And you’ll also notice that I said brokers, not agents, not sales persons, not vice-presidents. The reason for that is you need a guy or girl that’s at least taken the trouble to go and get a broker’s license to represent you. Somebody that’s been around the real estate market for fifteen or twenty years and hasn’t considered it worth their while to go and get the extra education to get the broker’s license is somebody that you should not have representing you.

If you’re looking for some additional qualifications, a good way to look at those is to find the agent that took the time and patience to go and get specialty real estate designations. In terms of designations, the top one there is for real estate agents in the commercial field is a CCIM, followed by an SIOR. A CCIM is a Certified Commercial Investment Member, they have a very broad range of knowledge. If anyone can handle cross sections of properties, it would be a CCIM. An SIOR is an agent or a broker who specializes in office and industrial property. Both these organizations have a great network of people all across the country, and indeed, across the world. CCIM’s & SIOR’s are both national and international.

The last designation I’m going to discuss is an RECS, and that is a broker that sells property in cyberspace. That is a Real Estate Cyber Society member. In today’s market, people are buying all over the country, so it is to your advantage to hire a broker that is also Internet-savvy.

Knowing this information will help you find the right agent for the job, not some Hollywood wanna-be. Taking this step will save you both time and money in the long run, and give you a smoother transaction all the way around.

Everyone Want's A Beach Community

A few years ago Stephen Covey authored a book titled, The 7 Habits of Highly Effective People® in which he strongly advocated beginning projects with the end in mind. Unfortunately few people took heed of that advice, especially in the multifamily or apartment investment property market.

As a result of ignoring that advice many find themselves in what we metaphorically refer to as the harvesting season for the landlord that’s had enough of tenants, taxes and toilets and would just like to enjoy the fruits of their effort. Shrewd investments and savvy exchange moves for many years combined with careful management, saving and sacrificing to build their retirement nest egg. But even with a plan…would it have prepared anyone for the debauchery of the credit default swaps and the collapse of the funding for the investment property market? It’s no secret the condition of the apartment house market is completely different now than it was in 2007 and that’s not the Landlords fault.

Long gone are the days when lenders were lining up to provide financing, and as I write this post, it has just been announced that Freddy & Fanny have been delisted from the NYSE. It’s too early to tell what effect that will have on their lending programs, but they’re basically the only game in town now for residential investment property loans. It can’t be a good result for the investors of residential income property. As it is we’re looking for buyers with 40-50% down payments to get a deal done. A far cry from the, “tell em a story and get the funds” of the 2004-2007 era.

An argument can be made that Fanny & Freddy’s trouble may bring with it an opportunity to get back to some old-fashioned real estate deal making. The kind of deal that provides security, cash flow and comfort to both sellers and buyers. Eliminate a bunch of “Wall St. Wing Tippers” in the middle to boot. The kind of deals we had before the Wall Street boys got control of the mortgage market. Before franchise real estate companies would only do, or allow their brokers and agents to do only the vanilla cash or cash to new loan transactions. Let’s look at what we have now and what we could do to improve the investor’s security, control and return on investment.

As I see it here are the retiring landlords options and opportunities:

• Sell and pay the Taxes. (Ochs!) 30-35% goes to the taxman.
• Sell a do a 1031 Tax Deferred Exchange. (But I thought you were tired of tenants)
• Donate the property to a Charity for an annuity payment. (Property needs to free & clear and your cash flow is controlled by the Charity and their investments)
• You could do a master lease if the lender allows it. (But you’re still a Landlord)
• Last but not least… In fact it’s the best option of all! Seller Financing. Sometimes referred to as “Owner will Carry.” (Opportunity!)

OK! OK! Lots of seller’s won’t entertain the idea of financing the deal for the buyer’s and in the past I’ve have been in complete agreement with them. But, things have changed in a lot of respects, so please hear me out on this. The last 3 years have shed a lot of light on the security or lack of it, on our investment markets. If you were a believer in the security of real property as an investment, then you’d surely believe in a loan or loans that are properly structured, using cash flowing real estate as security or collateral. Right!?

I fear ye Sacramento

It’s been a while since we last spoke and I wanted to get to what our elected representatives in Sacramento have been up to on their desire to repeal of the IRC Sec. 1031 Tax Deferred Exchanges in Real Estate Transactions. Fortunately, there is no harm done yet as the bill is still in committee as of the last posting date on May 28th 2010.

It has become increasingly obvious that our elected officials either don’t know or worse still, don’t care if we loose all those investment dollars when they place us in such a disadvantaged position of being one of the few states in the union to not match and mirror the Federal Law.

This is not a law change that will effect just the investor’s in the properties. Firstly it will greatly reduce transactions as there is no incentive for investors to leverage the profit from one investment property to a larger one since the the transaction costs and the State Tax will siphon off all the profit. The first causality in this instance is the transfer taxes collected by the counties and some cities on transactions. Next of course is going to sound self serving since I’m a Real Estate Broker, but look at the amount of folks involved in the real estate transaction market here in California… Half of them will have to go, at least!

Now for the obvious… Business doesn’t pay tax, they collect it and forward it, usually including an administration fee for the trouble. Since investment property is owned by investors and administrated by some form of business entity, there is an expectation of profit or return on investment. This means there are going to be some adjustments to accommodate this 10% tax bite into an investors margin. This will have a profound effect in replacement of facilities with new buildings or tenants will have to pay higher rents for functionally obsolete properties. How do you think this will work in the Silicone Valley?

The residential property will be effected just like the retail, office and industrial only over a greater number of investors. Since residential investors tend to be entrepreneurial folks, they’ll look for other places to invest first and avoid the hassle of tenants and toilets for the reduces return. The alternative to all the above is that is a further decline in property values will take place to offset the loss of the 1031 tax deferred exchange. This, of course will will reduce the revenue from property tax and defeat whatever temporary benefit these fools hope to achieve by their misguided attempt to eliminate a section of tax code that has served the nation and the state well since 1921. 89 years… What are they thinking?

It’s time for all responsible citizens to call these folks in Sacramento and remind them they need to defeat this proposed law in the interest of keeping California on the cutting edge and maintaining our standard of living. Please call your state representative and enlighten them to the error in their short sighted proposal.

Sorry I just had to have a rant on this stuff. It’s too important to ignore. Leave us a comment.

Most people I know got into that business by accident! After 18 plus years of dealing with landlords in their day-to-day business, assisting them in buying, selling and exchanging their properties. After many lengthy chats and informal surveys, I have come to the conclusion that most people got into this type of investment property by accident rather than on purpose.

Among the reasons most people finish there was they bought a new home and kept the old one. Some bought a house next door just so they could control who their neighbor would be, others helped a family member or a buddy with a loan and finished up getting the property instead of the loan repayment. There is also a considerable portion of this market who inherited their property and decided to continue in the business of their benefactor.

Another group of investors are those folks who attended a real estate seminar and actually implemented some of what they learned there or in the materials they purchased. Still others invested for the tax benefit and they are mostly large salary or high net worth individuals. Others got started by investing with partners or buddies and some even got started investing in REIT’s and limited partnerships.

And then there are the determined!

The folks with the plan! In my experience over the years, this is the smallest group in number but they’re the investment power in the rental property or multifamily properties.They bought, managed, bought some more, leveraged and exchanged into larger properties,or refinanced the properties they own and bought more. They did whatever it takes to grow their investment portfolio, because these folks recognized that real estate investments are the IDEAL investment for wealth accumulation and cash flow when done right.

Investors using real estate as a vehicle for retirement cash flow are typically the apartment landlord. In most cases their portfolio enjoys a more favored tax treatment while it remains outside the constraints normally associated with a retirement account. The rules,regulations and constraints like those found in IRA’s, 401(k)s 529′s and other tax favored facilities for investments and methods of wealth accumulation have limited flexibility for borrowing against and there are no withdrawal guidelines with respect to age for the real estate investor and his property.

Most all landlords, especially the determined are fully aware of the benefits outlined in IDEAL. which was adequately covered in a previous post here. The largest obstacle that all these folks have is getting good advise and direction from their paid professional advisers. Here I’m speaking of tax and legal advisers, and why it is necessary to only consult with specialists in that area or specialty.

The other area of concern is the type and caliber of real estate investment advisory or broker they use or choose to do business with. In order to successfully landlord, one needs to treat this business seriously, and that should begin with only working with specialized people in the multifamily property arena, and to use an old cliche in the business, “the day you buy, is the day you sell”. Sometimes the better option is to use the IRC Sec. 1031 or 1033 and defer or roll the Capital gain into the next building or real estate transaction.

Tomorrow we’ll expand on Sec. 1031 Tax Deferred Exchanges and and a brief look at the benefits to the investor starting at the beginning of the investment cycle.

Check back in tomorrow or add us to your RSS feed.

Pride of Ownership Multifamily

Here’s why we think  Apartment House – Multifamily Properties are key to wealth building.

Income

Properties like these are usually referred to as investment property. Apartment Investments, multifamily properties deals, properly structured with enough down payment, will generate a positive cash flow equivalent to, or perhaps better the interest rate of the mortgage on the property. This cash flow will increase in most markets, even a highly leveraged, negative cash flow property can turn into a positive cash flow investment with the passage of time.

Depreciation

Depreciation is the tax deduction one can use against the income real estate produces. Here’s the layman’s version of how this works. The Government in an effort to encourage investors into the multifamily rental property or residential income property allows the value of the improvement (that’s jargon for the buildings) to be written off or depreciated over 27.5 years. (39 years for commercial) This was a solution to the problem of Government providing housing to the poor or low income citizens. Only the improvements are covered under this law, not the land as that is expected not to decline in value during the hold period.

Equity

Growth Build-up – Most folks grow their equity over a period of years because the historic trend in real estate has been upward. However, they also get equity buildup results from the periodic pay down of the principal amount of the loan, usually through monthly payments on an amortized loan. Even if there is no appreciation over the life of the loan, the property owner would end up with a free and clear property at the end of the loan payment period on a fully amortized loan. This is usually a 30 year period on residential property but it is exceedingly rare to find such financing.

Appreciation

While the amount of appreciation varies from market to market, real estate is a growth asset and often the largest part of the return on an investment in real estate is the equity gained through appreciation. Even small amounts of appreciation year after year can be considerable. Usually, the longer you hold on to a property, the better. The effect of appreciation is greatly magnified by the use of leverage. Since the late 1970′s real estate has been a tremendous inflation hedge. Some would claim that is away better than hoarding gold or other precious metals.

Leverage

Through the use of a mortgage or borrowed money along with a small (but increasing recently) amount of money of your own, you can control a real property. The best leverage most of us can obtain in the stock market is 50%. In real estate, it is not unusual to obtain 65%, 70%, and even 75% leverage. If we take the latter, you can control a dollars worth of property for a quarter. With leverage usually comes the risk of lower cash flow after operations costs, but also with that risk comes potential for greater investment return.

Bonus

In addition to the I.D.E.A.L. as stated above, multifamily real estate investments have potential additional tax benefits including the aforementioned IRC 1031 Tax Deferred Exchange and cost segregated treatment by your CPA. There’s always a way to use real estate as a bank or reserve for a college fund for kids or grand kids, additional source of down payments for expanding your holdings or just plain borrowing against. Remember if real estate is part of your retirement savings, there’s no rule against borrowing from it or taking a withdrawal in the form of a loan anytime either. Bonus! No immediate taxes due! But check with your CPA for your particular case.

Leave a comment or ask a question below.

A Suburban Multifamily Community

Never! I don’t believe you’d come to that conclusion if read the articles in the financial press, but real estate has always been, and continues to be, the ideal investment for the average American. While it’s true, the best real estate most of us will ever own is the real estate we invested in at the beginning of our investment process. It’s just like the trees we plant, the best ones were planted a long time ago and if we use the same care in managing both the trees and the investments we’ll have the shade and shelter we need for retirement.

It’s interesting that most investors I speak with now are cautious about real estate investments, Why they’re cautious after nearly four years of declining prices at least here in Orange County, CA and almost record low interest rates for mortgages is a mystery to me.  In my humble opinion, this is precisely the time to make an investment even if it’s your first one.

Three years ago in our Orange an LA Counties market, most people would have told you that they wish they had purchased, and held on to more real estate over their lifetime. Now, is the best time to begin or add to your real estate portfolios especially if you’re  smart about the way you make your deals. Beginning or investors in the accumulation stage of their investment cycle can make great headway by using the IRC Sec 1031Tax Deferred Exchange to leverage their nest egg exponentially.

The one issue with real estate is the need to work at managing it yourself or give up some of your profit margin for a property manager. However, when all is said and done, this is no different than any of the other investments, except that in most of the others you do not have a choice. The investment is managed by a professional money manager or Wall Street type where the management fee is paid somewhere in the agreement. Nobody works for free or at least they didn’t in my 18 tears of financial markets.

The age old arguments against real estate as an investment is management and liquidity. The opinion or objection most offered by financial advisers about real estate is it’s lack of liquidity. This is a hollow argument. While it is true, one cannot execute a sell order an liquidate the real estate holdings immediately, real property priced right sells quickly and in most cases real estate can be borrowed against which are two ways to raise cash should the need arise.

The other advantage real estate has over the equity markets is you won’t be forced to sell at the wrong time by margin calls. You have more control over your own destiny and you can sell when the market will yield it’s highest return.  As in all markets,”Buy low, sell high” is sage advice, but when it comes to real estate. “Buy Now, hold for a long time, then use the IRC Sec. 1031 to defer your capital gains tax and roll all the profit into a larger deal is the real home run play.

More about IRC Sec 1031 later, but for now using this method, an investor will almost always yield fantastic overall investment results. Having spent a considerable amount of time (30 plus years) working in both market I’ve seen the good, the bad and the ugly in them both. Depending on where in your investment cycle, find an adviser you feel comfortable with and plan a strategy that will accomplish what you want.

If you’ve got a question or comment, we’d love to hear from you.

Highest & Best Use Always

Under all is the land. Upon its wise utilization and widely allocated ownership depend the survival and growth of free institutions and of our civilization.

The above statement is borrowed from the preamble of the National Association of Realtor’s Code of Ethics. I have tried long and hard to find words to better  describe the ethos of this business of Commercial and Investment Real Estate and have failed. A statement this powerful and encapsulating brings with it responsibility, opportunity, vision, diversity and above all, the land with it’s finite supply is the best leading indicator we have of the state of our economy.

What we use the land for matters little in the long term. The life of improvements or utility are temporary and whomever has the best idea for generating cash flow from the piece of land is holding what we call the “highest and best use” utility as long as the stream continues. When the stream begins to dry up, a new idea or utility will replace the old one and we will again have a new “highest and best use” utility. Therein lies the the real estate cycle that brings opportunity and wealth to the investors and serves the community by its use.

There are many different uses for real estate and the opportunities are in abundance. The purpose of this blog is look at some of these commercial uses and point out the opportunity or reveal the risks of others. We are located in Orange County, California and have a birds eye view of our Southern California Commercial and Investment Property  Market and our network of CCIM practitioners all over the country provide us the eyes and ears of what’s happening in their markets.

My reason for starting this blog, is to provide a source of information that will at least enable the reader to form a list of questions for their advisers, that will assist them or help them in getting the answers they need instead of looking for the, “how do we get out of this mess” solutions. Shortly, I will be adding a facility to this blog where you can ask your most burning question and get an answer either in the blog or directly through your email.

The information contained in the blog is purely my opinion, and in some cases its the experiences from deals and transactions I’ve learned a lot from. I share this information, in the hope that it will help other investors and their advisers, or at least raise enough of the right questions to get good answers.

Nothing contained herein, should be considered investment legal or tax advice. Before making decisions or changing your investment strategies, you should consult a professional who is competent in that area, so you can get the information that will enable you to make the correct decision. Everyone’s situation is different and there is seldom a one fits all answer. Get the answers that apply to you and your situation only by consulting with the appropriate professional!

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