Don’t Be Seduced By Real Estate Investment’s Version of Hide the Pea
Back in the 80’s when tax shelter Nirvana became law (15 year depreciation schedules), I had folks linin’ up like my office was 31 Flavors, and double scoop cones were a nickel apiece. It was crazy. All of a sudden, real estate was reaching folks who’d been on the fence their entire adult lives.
I’d ask them, “So, you wouldn’t invest for capital growth or cash flow, but if you can save a few dollars in taxes you’re in the front of the line?”
Some would actually be a little offended. Really? I’d then give them an instant replay of the decade they’d just purposefully missed. Did this first around 1983. One client in particular was both astounded and nonplussed when apprised of what he’d missed from 1975-1979. And remember, this was in San Diego where, back in the day we thought 5% appreciation meant we’d experienced a down year. In fact, if he’d invested just $40,000 in early ’75, he’d of easily had close to $250,000 by ’80. No joke. Happened almost routinely. We were to learn much later that that market run-up was merely an audition for the next two, especially the mother of all up markets recently experienced.
Don’t play hide the pea — the game’s rigged for you to lose when it counts.
Since 1976 when I transitioned from the traditional home sales market to investments, there’ve been several times when relatively artificial ‘attractions’ have been created to encourage investment. With one stellar exception, ERTA in 1982 or ’83, they’ve usually been cleverly disguised mirages.
“Man, we can’t give away this crappola. I know! Let’s lobby D.C. for special tax shelter for the region. Private investors will buy our real estate then. Yeah, that’s the ticket!”
Bottom line? If you’re buyin’ poorly located real estate with questionable construction quality to boot, with semi-shady built-in rental ‘guarantees’, I have some advice for ya.
Run! As fast as you can for as long as you can. If you wouldn’t buy the property on its own merits, based on OldSchool fundamentals, why on earth would ya buy it cuz it has a bit more tax shelter? Or a guaranteed rent setup? My question has always been, if the seller wants to guarantee something till it rents out on its own? Fair enough, that makes sense, and I’ll go with it most times. In fact, I do that now sometimes.
That’s the exception though. Most times these so-called rent guarantees, usually for 2-3 years, have to be put in force cuz they simply can’t rent them in the real local market for the guaranteed amount, or to tenants who wouldn’t scare ya. It’s important to be able to discern the difference between a short term guarantee created to bridge a time gap between being vacant and finding a new acceptable, qualified tenant, and guaranteeing rent cuz you know the dang thing can’t be rented unless you give away the store.
Huge difference, don’t ya think? It’s artificial by definition — as is the enhanced tax shelter.
Increased tax shelter
If the location is top drawer quality, and the construction the same, that’s a great start. Then, if you discover that the local rental market is strong and will deliver rents supporting the purchase price, all the better. And if those rents will be paid by a high quality tenant, then you’ve got your fundamental ducks in a row. If the enhanced tax shelter comes on top of all those factors, go for it. If not, let me tell ya what’s in your future.
After a couple three years, the guarantee will have run its course. Since you chose to overlook the fact that the local rental market sucked like a turbo charged Dyson, you’re about to pay the piper. Poor quality tenants with bad credit at rents nowhere near what had been your guarantee. Also, you’ve learned the hard way how mediocre the quality of material and construction was. Too late, big guy.
Hey, how’s that extra tax shelter workin’ out for ya now?
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If you wouldn’t buy the property but for the extra tax savings — don’t buy it. Learn the easy way. Tax shelter, long gone, is not gonna put food on the table and a roof over your head in retirement. ‘Course, there’s always the problem, down the road, of finding the next sucker to buy it when you want/need out.
Don’t let ’em seduce you. They’re hidin’ the pea.