Real Estate Investor · Greensboro, NC · Member since 2008 · 6 posts · 0 votes
Seems like there are two methods which all the books, videos and articles put forth: Cash Flow and Appreciation.
Landlording seems to lend itself to the Cash Flow side of things, with possible returns several years down the road when the property has appreciated.
So take this property that I'm looking at as an example:
4-unit apartment selling for $209,900.
Currently fully rented for $580 each unit.
Now, I'm a newbie, and if I'm doing the calculations right, this seems like a good deal with some real cash flow.
But I can't help but get caught up with the part that I need to plunk down $40k plus closing costs just to get into the deal.
So I am tying up my $50k to get about $1,200 per month, or about $15,000 per year. So I don't even get my original $50k back for over 3 years.
Now, the first 3 years I will be building equity in the property that really my tenants will be paying for, as well as some cash flow. After that 3 years, I could either sell it and take the profit or keep it and continue getting cash flow for as long as I own and maintain the property?
Is this the proper way to be evaluating a potential deal?
I'd appreciate any feedback, especially if you are good at more complicated calculations like ROI and the TVM.. things which make my head hurt!
Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
17y
For my buddy from Ohio
1.Newbies and you and I didn't start with adaquate cash flow. It grows over time.
2.Ohio banks must be very liberal. In every county I've bought in, as property gets older, ratio of land to improvement increases and causes less depreciable basis.
3.nada
4.I don't suggest paying MORE. Just get some properties mortgaged to the hilt to obtain maximum tax benefits.
next- most real investors are not in lower tax brackets, at least in my experience
Your comments on apts don't jive. "every single one is a money pit". and yet you have them on your tax return???? Why did you buy them?
next- get a new acct or hire one. Your depreciation schedule is wrong. 4 units and up is commercial and 39 year period is required.
If you're going to play the real estate game well, you better become a "tax expert", or hire one that is, or at least knows depr rates..
My business model is one that works, and allows me to use ALL my gains for creating wealth, not padding the Govt.
This is fun and I'm sure many are benefitting from having different viewpoints. You are a worthy debater!!
Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
17y
You just said in an earlier post that you paid no taxes, so you are by definition in the lowest tax bracket. That's the great thing about rentals, with the depreciation, and of course all the other deductions, we don't pay much in the way of taxes.
Of course, you can't start with enough cash flow to survive with just one or two rentals. However, I suggest only buying properties that do have cash flow.
You misread what I said. I said that I've never seen an apartment COMPLEX that had cash flow. I have seen a LOT of apartment buildings that will cash flow and have bought some of them.
What I quoted you was right off the IRS Form. I've had my accountant for 15 years and never had a single issue with the IRS.
Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
17y
I almost forgot, does anyone want a dog? I had a tenant's father call me yesterday afternoon to tell me that his daughter had moved out (without notice) of one of my one bedroom houses (she allegedly moved out of town for a new job). I went to check it out this afternoon. All her things were gone except she abandoned her chihuahua! From the amount of dog doo, I'd say that she left about 4 or 5 days ago. The dog is thin but otherwise OK and I'll be working on finding a home for it.
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
17y
Don't confuse residential vs. commercial for depreciation purposes vs. financing. I did that early on. A 5+ unit property where people live gets a 27.5 year depreciation schedule even though it needs a commercial loan. That commercial vs. residential distinction for the loan is based on Fannie Mae guidelines and has nothing to do with the IRS guidelines for taxes.
For the appreciation question and the NAR data, note that that data is nominal. The Case Shiller data is inflation adjusted. It shows home prices flat from 1968 (actually, more like 1946) until 1997. Only since 1997 have prices, in real terms, appreciated. Graph. Most current data.
Like brokerage houses for stocks, the NAR is a cheerleader for housing.
Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
17y
Thank you Jon, I'm glad to hear that my accountant was right!
That commercial vs. residential is actually more complicated that even the information you posted (at least in Ohio). We have the IRS guidelines for taxes, where 5+ units is residential. We have the 5+ units being commercial for Fannie Mae loan purposes. Then, at least in Ohio, 4+ units is commercial for the purposes of the BUILDING CODE! Why can't it be simple???
Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
17y
I'm here to eat crow. It appears that ALL real estate is 27.5 years for depr. I don't deal in apts since you could use acceleated methods like sum of the digits, 200% of DB etc. I was looking at something eroneous.Having beem involve in real estate sales in the 70's, I still accept the unadjusted yearly appreciation rates listed in the chart posted by RealestateABC.com using NAR figures from 68 for the national market.
Mike, are you saying your bank makes you a standard loan to your LLc, with no income verification from LLc, not caring that the building is old and your personal guarantee being sufficient for the loan? Length of loan and LTV?
Real Estate Consultant · Member since 2008 · 792 posts · 30 votes
17y
It shows home prices flat from 1968 (actually, more like 1946) until 1997. Only since 1997 have prices, in real terms, appreciated.
Amen. Thank you for the visuals Jon.
Any appreciaters out there dispute the Case Shiller inflation adjusted graph? That graph pretty much sums it all up. By the way, all the "appreciation" to the right of graph is pretty much all gone now.
Real Estate is a phenomenal investment vehicle for a number of reasons. Banking on appreciation at ____% per year isn't one of them.
Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
17y
Rich,
No need to eat crow, this tax stuff is beyond belief - which is why I don't do my own taxes.
Almost all of my loans are commercial loans. The do require financials and tax returns for the LLCs and a personal guarantee from me also. They always require an appraisal, using their appraiser and they know the age of all the buildings. As I said earlier, no-one has ever said the first word about the age of the property. Almost all my loans are 20 year loans; with a 5 year arm; 2% maximum adjustment at the 5 year adjustment; and a 5% cap. The LTV on every one of my loans is below 70% and most of them are closer to 50%. Most of the loans, I borrowed 100% of the purchase price. On some of them, I borrowed the purchase price plus enough for the rehab. On a few of them, I put a little money down, but certainly not 20%. On a couple, I paid cash and then refied to get my money back. All of the loans that I took our were with small local banks who hold their commercial loans in their portfolio. I do have some more creative loans that are with others; like sub-2, owner financing, etc.
Investor · Clarksville, TN · Member since 2008 · 122 posts · 53 votes
17y
Spectacular debate... But I have this somewhat rhetoric question to the debate which im sure is just me looking too far into it that it becomes simple again.... Can you not have your cake and eat it too? Buy at a discount, do a little rehab, make a little cashflow, gain almost instant "lien able" equity, and repeat? make your system repetitive, utilizing your equity for Down payments?
Though I know its more complicated, Isn't this the idea of it all? To set a wheel in motion and constantly get bigger and better.. I mean, Ive heard naysayers around here (my hometown) discouraging buying real estate, saying quote "it's too much stress". Im sure these people are everywhere but.. I love stress.. I love worrying about the money im making.. At least more so than not making any. And lets say you do make a bad deal.. you dont cash flow like you wanted to, or you haven't appreciated enough to pull out that DP for those new *discounted condos across town... so what? real estate will *always be for sale... there will *always be renters, cash buyers, And more importantly, Windfall sellers.. Leaving the opportunity to recoup almost any possible loss in just one deal. Thank you everyone for your insightful information...
Dustin
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
17y
Boy, if it were that easy Dustin, there wouldn't be anyone here on BP asking questions! They would be too busy making money.
There will always be naysayers in anything you do. It is up to each person to overcome them. The model of your plan is correct, it is just not as simple as it was listed.
Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
17y
That's funny, but believe me, it's not about worrying about the money you're making. It's not about worrying at all. It's about the very real issues that arise with tenants and properly dealing with them.
The idea is to buy EVERY property at a big enough discount that you WILL make money on each property. There is no excuse for making a bad deal.
Yes, there will always be property for sale; there will always be renters; and there will always be cash buyers. However, offering a property for sale and making a profit are two completely different things. Offering your property for rent and renting it at a profit are two completely different things. Having cash buyers in your community and having them buy YOUR property are two completely different things. The point being is that you must buy at the right price if you're going to be successful.
Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes
17y
Originally posted by Rich Weese:
I'm here to eat crow. It appears that ALL real estate is 27.5 years for depr.
Rich,
All RESIDENTAL dwellings are depreciated over 27.5 years, even the 100+ unit apartment complex.
The buildings that house your business, your warehouse, your shopping center, and your manufacturing plant are all examples of commerical use real estate and depreciated over 39 years.,
Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes
17y
As I see it, there are three reasons an investor owns rental property.
1. Cash Flow
2. Appreciation
3. Tax Benefits
Rental property investors buy the cash flow. You need a positive cash flow to sustain the property while you wait for appreciation. If there is a positive cash flow, then your tenants are buying the property for you, and paying all your costs of ownership and rental operation. Eventually, your tenants pay off your debt and you own the property free and clear. Can't get there without positive cash flow.
Appreciation does not happen every year, nor does it happen at a constant rate. Indeed, over the short haul, appreciation is not guaranteed. Hold the property long enough, and the property usually does appreciate. Now, appreciation does not help you if you bought during a market peak and are forced to sell at a market bottom. Most of us are not forced to sell when the market is soft. If we sell, we nearly always sell at a profit -- so, appreciation is usually a payoff for the rental property owner.
Tax Benefits come in several forms. The largest immediate benefit is the depreciation expense. Depreciation does not cost me anything, does not take any money out of my pocket, yet it does reduce my taxable rental income. Even if I have a negative income, depreciation makes that tax loss even greater so my net passive loss allowance is larger. Either way, I have a lower tax bill than I might have otherwise without the depreciation expense.
I agree that after a certain number of years, the depreciation expense goes away. But by then, I will own the property free and clear, and will have added other depreciable properties to my portfolio with the excess cash flow..
If I am in the 25% tax bracket, then when the property is fully depreciated, Uncle Sam will have "paid" me 25% of the cost of my rental dwelling structure through income tax savings, while letting me keep 100% of the title.
There are other tax benefits too. Rental property owners enjoy capital gains tax treatment when their property is sold in a taxable event. The capital gains rate is a preferred rate that is always lower than the rate charged on your ordinary income, including your taxable rental income.
Rental property investors can defer capital gains taxes indefinitely with a 1031 exchange.
None of these reasons should be the single deciding factor in deciding to become a landlord. If you have one, you usually get all three.
That said, if you are going to pick a single reason to NOT buy a rental property, it should be a negative cash flow. Even a negative cash flow property has tax benefits and may appreciate over time, but it is not generally an efficient use of your investment capital. If I don't have a positive cash flow, I don't even bother with the property regardless of the potential tax benefits or potential for future appreciation.
Real Estate Investor · Vancouver, WA · Member since 2008 · 387 posts · 8 votes
17y
The original topic of this discussion is "Cash Flow is king, right?"
I would have to say no, cash flow is not king, the combination of the 4 factors already talked about is king.
You know what else is king? # of leads coming in! The reason we're even having this debate is that mikeoh probably has a huge network/marketing system in place getting so many leads coming to him that he is able to pick the best deals aka reaching the 50% mark. What is your % that you are buying off retail right now on average. Is it not 50%? Would twice as many leads coming in get it to that? That is really the key to all of this. Then you won't need to try to make marginal deals work.
Stop trying to rework deals that shouldn't be purchased and spend more time getting leads coming in. Then you'll have more "better deals" aka ones having a combined % return based on the 4 profit areas.
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
17y
If you have true positive cash flow, or at lease break even, they you won't be forced to sell. But ask all the folks who bought in 2003-2006 assuming 1) prices always go up, and 2) its OK if the rent doesn't quite cover the mortgage payment. They are now in deep doo-doo as they discover there really are expenses besides taxes and insurance.
It also has to be repaid when you sell. Depreciation recapture is currently 25%, so if you're currently in the 28% or higher tax bracket, you don't pay it all back.
Assuming you mean long term capital gains, this is true. Short term capital gains rates are the same as ordinary income.
Specialist · USA · Member since 2008 · 40 posts · 5 votes
17y
What type of vacancy rate are you using?
Some areas have high turn over and you would want to use a vacancy rate around 25% and other areas you could use 10%.
Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes
17y
"What type of vacancy rate are you using?" Like you say, it depends on locale. My city is 6%, but I had a townhome that would rent within a couple hours each time I did an open house, as that complex was 100% occupied (for ready units).
Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
17y
Lee,
Keep in mind that the vacancy rate will change over time as the economy changes. Supply and demand are constantly in flux and the vacancy rate today may be VERY different than the vacancy rate next year.
Real Estate Investor · Reading, PA · Member since 2008 · 227 posts · 7 votes
17y
Tex and OH,
Thanks for the great debate. I respect you both for your opinions (not that I agree with them all). I commend your positions and ability to debate in a professional manner and stepping up when you are wrong. Those ethics have made you both the sucessful REIs that you are today.