A home for Generations

For almost a decade now, every time we talked about real estate we immediately discussed money and how much more we have this month or year. We didn’t talk about the value of a home but instead about the price of the house. We didn’t worry about a roof over our heads but instead the ceiling on our interest rate. We didn’t care as much about where we raised our family as we cared about how much we increased our family’s net worth.

We believe that will change in 2011. We believe very strongly that real estate will return to what it has been for the dawn of independence in this country: a place for us and our families to live comfortably. It will also prove to be a great long term investment as it always has been.

Our parents and our grandparents didn’t buy their homes as a short term financial investment. They bought it so they had a place of their own to come home to at the end of the day; a place to raise their family; a place they could feel safe; a place they would call home.

Sure they dreamed of a ‘mortgage-burning’ party. They realized it was a form of forced savings. They were taught that, if they paid their mortgage every month, they would wind up with a little retirement account decades later.

And, they realized that wouldn’t happen if they rented.

However, in the last decade, we somehow forgot that the financial aspect was the serendipity not the major reason to buy. We believe that 2011 will be the year that people return to the historic reasons families purchased a home. This is the year when we again remember that home ownership is a major part of the American Dream.

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.

City Living With Style

Here’s the biggest advantage of doing a 1031 exchange? By deferring tax, you have more money in hand to invest in another property. In effect, you receive an interest free loan from the Government, in the amount you would have paid in taxes. A wonderful estate builder indeed! In most cases the tax bite on the profits of a real estate deal fall between 30% to 35%  and by doing an exchange the investor get to roll all the profits into the next deal. Consider what a benefit that is over a lifetime of investing.

Despite this generous benefit some folks elect to sell and pay the taxes. This is often done out of ignorance on behalf of the investor of the broker the used to sell the property. Another reason could be the seller decided to finance the deal for the buyer. Depending on what side of the deal you’re on with this seller financing there are advantages. However, the tax still has to be paid but the question now is, when?

It’s also worth noting here that there are several taxes due if the investor decides to cash out or decide against the exchange option. Here in good old Orange or Los Angeles Counties the investor with a profit or Capital Gain will get the privilege of paying, Federal Tax, State Tax, Depreciation Recapture Tax, County Transfer Tax and in the City of Los Angeles a separate City Transfer Tax. Make sure all of these are considered and what they’ll cost you before committing to a deal. You need to have the exchange option included in your purchase and sale agreements.

Some folks confuse “tax -deferred”  with “tax free”. They are quite different and you don’t want to discover that difference when you’re across the desk from the IRS auditor. Here’s the difference: In a 1031 exchange, you defer paying the capital gains taxes on your relinquished property. Its tax basis is carried over to the replacement property. When you finally sell the replacement property, without doing an exchange, you will pay the tax at that time. However, you may repeat this deferral process over and over again, from property to property over a period of years and under current law your immediate family can inherit the property with a stepped up basis. In other words, the capital gains tax is forgiven. Not Bad!

It’s refreshing to know that there is some break from the IRS in pursuit of capital gains tax.

As you might imagine, there are some rules and regulations to adhere to in a IRC Sec 1031 Tax Deferred Exchange. While the tax deferred exchange has been around since 1921, there have been some modifications in the rules. For this reason, it is very important to use the services of professionals who are familiar with these types of transactions. A mistake here could be very expensive and as everyone’s situation is different a consultation with an expert and some research  of your options is a really good use of your resources.

Now we have established the benefits of investing in multifamily properties or apartment rentals, tomorrow we can now get down to most efficient way to manage them for fun and profit.

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.

California State Building

The California legislator are attempting to eliminate the 1031 & 1033 Tax deferred exchanges in AB 2640. A bill currently  working it’s way through the process in Sacramento could have a serious effect on the real estate market and investor profits  if passed into law. To make matters worse the bill would be retroactively effective to 1/1/2010.

The IRC Sec. 1031 Tax Deferred Exchange has been around in the federal tax code since 1921 and there is no indication that there is going to be any change there. There has been  several modification’s to the law over the years, usually for the best as far as the investor is concerned, but occasionally some State Government will get a dumb idea and try to  generate revenue from this source. I believe the last to attempt this were Utah and Pennsylvania. Utah had the good sense to repeal the law and I don’t know about Pennsylvania.

The California attempt to impose this tax will also backfire and finish up hurting business’ for a number of reasons. First thing I should mention is that the Federal Tax Deferment will still be in place so the first inconvenience will be the different tax returns and how the different deferments will be treated from earlier exchanges. I’m sure there are several forms and an extra hour or two of CPA’s time can clear this up.

A major problem for the local tax authorities  I believe will be the loss of transaction and transfer fees. Los Angeles  is a decent sized city with a lot of investment property and the transfer taxes on transactions amounts to a neat some of money at $1.10 per $1,000 transferred to the County and a whopping $4.50 per $1,000 to the City of Los Angeles. One of the attractions of Investment Property Investing is the ability to transfer your equity from building to building within the 1031 tax deferred exchange and have the entire gain working for you. If this incentive is removed, not only will it effect property values, it will also reduce transfers and the tax revenue generated by them.

Not only is the regular investment real estate 1031 exchanges effected, they’re also going to include the 1033 tax deferred exchanges used for eminent domain transactions. So not only can your property be condemned and taken for the public good, they’re going to tax you for the privilege as well.

Frankly, I’m puzzled! You’d think that someone in Sacramento would recognize the fact that the last 3 years have been rather brutal on the real estate industry and be smart enough to leave it alone  until we get back to 2007 prices again. Apparently not!

Here’s and idea that might work and save us all a bundle. Since we’re doing a census this year, we’ll have all the numbers we need to eliminate exactly half of the elected officials and commissioners from our State Government.Yea! Good Luck with that 0ne catching on.

Leave a comment or ask a question.

California State Capital

Lifetime Exchange Benefits

Here’s the biggest advantage of doing a 1031 exchange? By deferring tax, you have more money in hand to invest in another property. In effect, you receive an interest free loan from the Government, in the amount you would have paid in taxes. A wonderful estate builder indeed! In most cases the tax bite on the profits of a real estate deal fall between 30% to 35%  and by doing an exchange the investor get to roll all the profits into the next deal. Consider what a benefit that is over a lifetime of investing.

Despite this generous benefit some folks elect to sell and pay the taxes. This is often done out of ignorance on behalf of the investor of the broker the used to sell the property. Another reason could be the seller decided to finance the deal for the buyer. Depending on what side of the deal you’re on with this seller financing there are advantages. However, the tax still has to be paid but the question now is, when?

Before you make a decision one way or the other, it would be prudent to examine the effect of your decision give the choices. In an 1031 Tax deferred exchange you can defer some or all of the taxes. You don’t have to do all or nothing! In a sale where the seller finances the deal, some taxes are paid at the time of sale and the balance are paid as the seller receives them with some exceptions. In an outright sale or “cash out” there’s an assortment of taxes due especially here in Orange & LA Counties. Here’s a list without percentages as they can change depending on your situation, Federal Capital Gains Tax, State of California Income Tax (or your state if the have tax), Federal Depreciation Recapture Tax. There’s also Property Transfer Tax on the entire sale amount even in exchanges. If someone tells you to pay the tax, it’s only 15%… Run! Find a new adviser.

Some folks confuse “tax -deferred”  with “tax free”. They are quite different and you don’t want to discover that difference when you’re across the desk from the IRS auditor. Here’s the difference: In a 1031 exchange, you defer paying the capital gains taxes on your relinquished property. Its tax basis is carried over to the replacement property. When you finally sell the replacement property, without doing an exchange, you will pay the tax at that time. However, you may repeat this deferral process over and over again, from property to property over a period of years and under current law your immediate family can inherit the property with a stepped up basis. In other words, the capital gains tax is forgiven. Not Bad!

It’s refreshing to know that there is some break from the IRS in pursuit of capital gains tax.

As you might imagine, there are some rules and regulations to adhere to in a IRC Sec 1031 Tax Deferred Exchange. While the tax deferred exchange has been around since 1921, there have been some modifications in the rules. For this reason, it is very important to use the services of professionals who are familiar with these types of transactions. A mistake here could be very expensive and as everyone’s situation is different a consultation with an expert and some research  of your options is a really good use of your resources.

Now we have the tax situation established we can examine the benefits of investing in multifamily properties or apartment rentals, and get down to most efficient way to manage them for fun, profit and devise an exit strategy that will work best for you.

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.

One Stop Medical Center

We all agree that real estate investing is a cyclical creature but there are specific sections that can provide a hedge to the boom and bust cycles. In previous downward trends in the real estate market, the three types of investment properties for stability and income in good times and bad were the types of properties that fall into the categories that service food, shelter, and wellness. This time around it’s no different.

In the food category shopping centers with grocery store anchored tenants are still holding up quite well for investors, although the big box stores have made a dent on their performance in this cycle. This would make them the slowest performer out of this trio, but then again, much better than any other section of retail. By and large the restaurant section is in lots of trouble with lots of closures and are not included in the food section.

When it comes to shelter everyone has got to live somewhat and that’s what makes this my favorite type of investment. The key to Apartment house or Multifamily Properties investing is “location”. People will drive to own, but will not drive to rent so the location of the property has tremendous importance on the value of the investment. Well located properties are always in demand by tenant residents resulting in less turnover of tenants and they will also command a higher rent when available.

With the huge surge in home foreclosures over the last three years, the apartment market has become a desirable place for both investors and residents. For residents there several advantages to apartment house living. Typically there are better facilities in apartment complexes than in most single-family homes and the renter always has the option of living close to where they work or play thereby eliminating commuting costs in terms of time and auto expense. For most people it’s also a lot more cost effective to rent and live in an apartment that it is a single family residence.

For the investor, apartment houses have the advantage of numbers. A multifamily apartment complex with 100 units is technically not concerned if he has four or five units vacant at a particular time versus the investor with a retail center or an office building that has fewer tenants with larger percentages of the overall income involved in a vacancy. The apartment house investor also has a more favorable tax treatment as his depreciation schedule is 27.5 years versus the 39 years in commercial property. Another advantage here is, that in lean times, tenants can take advantage of government assisted rent programs enabling them to stay in their apartments and in some cases the landlord can get paid a little more. These among other things make multifamily apartment house investing the favorite among savvy rental property income investors.
That brings up the wellness sector. For many reasons the Medical Offices Facilities are always in demand especially where the demographics are trending toward senior. There are pros and cons with medical offices from the investor prospective. First the pros. Stable long term tenants with a steady reliable source of income. Expanded health care insurance coverage to more people will create more demand and increase the value of most medical facilities. A disadvantage or con in Medical Office is the requirement of additional parking in most markets.

Included in the wellness sector are the drug stores. These have long been the darling of the NNN lease investor and favored by many. The concern I have with these leases types are twofold. Firstly, they’re away too long and secondly, the rent adjustments are very low and will effect the value of the property for the later years of the lease. In the liquidation of an estate I recently encountered a franchise lease in the final 5 year leg of it’s 25 year life. The scheduled rent was only 30% of what was considered fair market, resulting in a huge adjustment in the price to allow for the reduce income for the 4 remaining years. Och!

This current week in our local market there has been a rather large Medical Office building deal involving 2 hospitals and 3 medical group facilities. There was also a 128 unit apartment deal right here in Orange County, CA.

If you’d like to ask a question or leave a comment, we’d welcome it and assure you we will respond.

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.