Buying Income-Producing Real Estate - The Fundamentals Are
By Thomas` | November 20, 2008
Buying Income-Producing Real Estate - The Fundamentals Are
Still Good!
A private investment in real estate can be anything from the
corner lot to a fractional ownership interest in a strip
center on the other side of the country. We are going to
focus on income-producing investment properties, like retail
strips, office buildings, warehouses, and apartment
complexes. The principles discussed below also apply to
single tenant net lease investments, like drug stores or
fast-food outlets and virtually any other type of investment
real estate including the newest structure, a Tenant in
Common or TIC.
Three Keys
There are three key reasons for buying income-producing
investment real estate; cash flow, appreciation, and the tax
benefits.
A word of caution here, if the deal does not work without
the tax benefits, do not let them be the deciding factor.
Tax benefits are purely a deal sweetener and should never be
relied upon to make the difference.
Cash Flow is defined as the positive income stream generated
from rentals paid by the tenants, less any operating
expenses incurred in the operation and ownership of the
property, including debt service. In general, investors look
for a positive cash flow, where the income exceeds the
expenses at an annual rate of return commensurate with the
risk. The higher the risk, the higher the expected return to
the investor. In some cases, investors see opportunities
even if there is negative and/or little cash flow. In this
case the investor sees a clear trend that will create a
"value added" opportunity.
Appreciation - defined as the increase in value of the
property during the period of ownership. Typically, the
investor anticipates that the property will increase in
value, and the debt owed on the property will decrease, thus
the investor's equity in the property, as well as their net
worth, also increases. The beauty of investment property is
that the tenant is doing all of the work and is paying down
the debt. I like to think about that on days when I am on
the beach and my property is working for me.
Tax Benefits can be defined in several ways but the two most
often cited are mortgage interest deduction and property
depreciation. A second word of caution is that this is a
very technical area, and a qualified tax professional should
always be consulted prior to making any decisions. You are
allowed to deduct any interest paid on the debt used to
acquire the property. In the early years, this can be a
significant amount. Later on, as the interest on the loan is
reduced and you are paying down more on the principle, you
may wish to look at selling and trading into another
property. The other benefit typically taken is depreciation
or cost recovery. The IRS provides for several different
means of determining the amount of depreciation an investor
can take on a property. Some of the keys to how large your
write off is to determine the investor "basis" in the
property, whether they are engaged in the business of real
estate, and the adjusted gross income of the investor. A
second consideration is whether or not the property is
acquired through a 1031 exchange. While cost recovery
deductions increase an investor's after-tax cash flow, a
Section 1031 Exchange allows for an investor to continually
"trade up" to higher value properties while deferring the
capital gains taxes due on the appreciation.
Who invests in real estate?
Private real estate investors are a wide cross-section of
people: a fireman, a lawyer, a retired businessman, a
regional manager for a Fortune 200 company. I've worked with
all ages, creeds and points of view and they all have a
couple of common interests. They enjoy making money, they
feel good about investing for their retirement and they love
the tax benefits. Most use the tax-deferred exchange method
on a regular basis to upgrade their portfolio and defer the
tax until later. Some investors start young while others
wait until their kids have completed school and they have
some extra money each month. All of the investors I have
worked with believe strongly in the wisdom of real estate
investing, have a good sense of value, and are great with
"the numbers."
How do I get started?
You can do it the old fashioned way and drive around taking
note of the income-producing properties you see. They're
everywhere. You probably won't see "for sale" signs on many
of these properties, but that doesn't mean that they can't
be bought. You will have to visit the Courthouse and check
the ownership records. In some counties, you will be able to
access the property ownership on-line through the assessor's
office.
As the saying goes, "everything is for sale, at the right
price."
Poking around and doing it yourself is time consuming and
unless you have the right skill set, it will be frustrating
and not very fruitful. I would recommend you retain the
services of an experienced investment property broker, to
help you investigate, analyze, and acquire property.
The final means of acquiring investment property is to
investigate acquiring a Tenant In Common interest in a
stabilized property. The advantages of a TIC investment are:
they are tailor made to the exact amount you are investing
(because it is a fractional interest);higher leverage
(pre-arranged by the sponsor); institutional properties with
credit-worthy tenants; predictable cash-flow;easy tax
reporting; no management obligations; and all of the due
diligence has been completed and ready for your review. The
primary disadvantages include high loads; the potential lack
of liquidity; some unscrupulous sponsors, primarily lacking
in experience; risk of partnership treatment; and the nature
of the TIC itself (it can be burdensome). Further, TIC
investors generally must be accredited investors, meaning
they must meet certain income or net worth thresholds.
Nevertheless, for passive investors, the advantages of TIC's
clearly outweigh the burdens.
I always recommend that you work with a professional
adviser, be it a CPA, a lawyer or a real estate broker to
determine a target price for an acquisition. Other
professionals can include a property manager, a commercial
insurance broker, a commercial appraiser, and a commercial
lender. The lender can play an important role in qualifying
the buyer prior to an acquisition, or in pre-qualifying a
property for financing before acquisition.
Overall, an investment in income-producing real estate is a
great long term investment, realizing that it is not as
liquid as stocks and bonds; it should be approached with a
healthy dose of estate planning first. The TIC industry has
made investing even easier and deserves a good hard look
into the possibilities.
Here comes my own disclaimer
IRS Circular 230 Disclosure: Exchange Equity, LLC and its
affiliates do not provide tax advice. Accordingly, any
discussion of U.S. tax matters contained herein is not
intended or written to be used, and cannot be used, in
connection with the promotion, marketing or recommendation
by anyone unaffiliated with Exchange Equity, LLC, of any of
the matters addressed herein, or for the purpose of avoiding
U.S. tax-related penalties. You should always seek the
advice of a tax adviser, lawyer, or real estate broker when
investing.
James P. McNamara is the Managing Principal of Exchange
Equity, LLC. The Firm is a private real estate investment
company that acts for its own account and for the account of
co-investors in quality real estate properties that is
headquartered in New Orleans, LA.
The Company created a Tenant In Common program to offer
small and medium size investors, the opportunity to acquire
the quality net-leased properties previously the exclusive
purview of only the largest of institutional investors. The
program is designed to accommodate the first time real
estate investor looking to diversify their portfolio or for
a passive investor looking to preserve and protect equity in
a relinquished property exchange through an IRC 1031
Exchange.
For more information on the product, or to order online,
visit http://www.exchangeequity.com or call 866-362-1031.
Media contact: James P. McNamara jamesp@exchangeequity.com
Phone: 504-897-1299
Topics: Investing |
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