Buying Decision - 4 plex

[Greg Heden]

When analyzing a deal, should one factor in future appreciation, annual mortgage reduction, and tax savings from depreciation (offsetting other passive investment income) when calculating ROI? I am looking at a property that will take some time to polish out. The COC return doesn't warrant the investment but the total return paints a different picture. From a buy-and-hold standpoint, how much weight should I give to this total return?

[Joseph Palmiero]

Focusing on the potential tax savings, I think that is a personal decision you will have to wrestle with.   For me personally, I like a deal to work on its own and consider the tax benefits to be gravy.  Also, not including the tax benefits will also build in a margin of safety in the deal, just in case one or more of your assumptions turn out to be wrong.

[Greg Heden]

@Joseph Palmiero Great viewpoint! The first year of ownership calcs out to a 38.32% ROI considering all factors but comes with a negative cash flow of $5K. BE ( Cash Flow) is around year 3 conservatively where the overall ROI stabilizes in the low teens.

[Basit Siddiqi]

I am not sure I understand.

You are having a negative $5,000 cash on cash return in year one but project a 38.32% return on investment.
How did you get that?

How much money are you putting into the deal and where is the 38.32% coming from?

38.32% ROI is amazing.

[Nathan McBride]

My advice would be to consider the criteria that you can directly influence in underwriting and consider criteria based on external factors as secondary.

Cash flow and amortization should 100% be in there.

You really can't control appreciation outside of forced appreciation brought about through capital improvements.  This uncertainty is compounded by today's inflationary and interest rate pressures.  

As a qualitative criteria, yes, you want your properties to appreciate on some level, but I just don't think you can quantify it well enough to consider during underwriting/ROI analysis.

Similar situation with tax benefits - we don't ultimately know what tax brackets will look like long term, and "tax reform" is a campaign talking point every election cycle.  Plus, I don't consider it a good idea to spend for the sole pupose of "saving money on taxes."  

Sure, the tax benefits of RE ownership are abundant, but the deal should stand on its own in my mind.

[Greg Heden]

@Basit Siddiqi 500K down - ROI consisted of 2.5% appreciation(No guarantee), principal reduction (guaranteed), and reduction in 2023 passive gain taxes multiplied by my effective tax rate(guaranteed). The biggest contributor is the first-year depreciation with cost Seg.

[Evan Polaski]

@Greg Heden: Should tax effects be considered?  Only if you are comparing this RE investment against, say, a stock investment that would not create any tax offsets.  If you are comparing one 4-plex to two duplexes, the tax effects are likely going to net out between the two, and therefore only make the calculation harder to end up at the same point.

Additionally, let's assume the market softens so you have little to no inflation, you used your tax benefits, and the property is still cash flow negative.  You are now just paying back all your tax benefits by being cashflow negative, and then still having a tax bill when you sell, since you wrote down your basis using bonus depreciation and realizing losses.

All told, back to Joseph's point: you want a property that is a solid investment on its own.  It should cover its own costs.  If appreciation is the game, then you really have a flip, in which case, it could still make sense, but your tax benefits are non-existent anyways. 

[Josh Young]

@Greg Heden I like that you are looking at the whole picture, saving on taxes is better than other types of returns because you aren't taxed on tax savings lol. A lot of people on here are not going to like a negative COC, but if you have cash from other sources and/or reserves then you don't need this deal to cash flow year one. If someone buys land and holds onto it they are negative cash flow and almost all of their return is going to come from appreciation, the reality is that real estate in a good location will appreciate over time and that is often the biggest part of the return, the cash flow is more of a defensive measure to make sure you afford to hold it long term.

[Matthew Masoud]

I'd avoid negative cash flowing assets pretty aggressively. 

I like to focus on COC rather than ROI because COC is how I pay the bills.

Tax Benefits, appreciation, and all that are just icing on the cake. But I consider myself a fairly conservative investor. 

[Jonathan R McLaughlin]

negative cash flow first year of ownership is almost a given...you are putting a down payment down! Even a 50% return is going to be negative on cash!

Assuming you bought under market and under the transaction costs barrier, your first year COC can be negative and your overall ROI positive, especially with the investment credits on taxes. Its mostly math games.

How long till you make your investment back? How easy is it to access the equity? What is your projected hold time?

Answers to that will tell you if its a good deal or not.

[Corby Goade]

Quote from @Greg Heden:

When analyzing a deal, should one factor in future appreciation, annual mortgage reduction, and tax savings from depreciation (offsetting other passive investment income) when calculating ROI? I am looking at a property that will take some time to polish out. The COC return doesn't warrant the investment but the total return paints a different picture. From a buy-and-hold standpoint, how much weight should I give to this total return?

 Yep, always. What you are looking for is IROI- internal rate of return. It's a true measure of all potential modes of revenue from an investment, including forced and passive appreciation. 

People on these boards talk all of the time about how cash flow is the only guarantee and that anything else is just wishful thinking. I'd beg to differ- if you talk to anyone who's been doing this professionally for a long time, that forced and passive equity is where true wealth and freedom will be found. Cash flow is absolutely not a guaratee- a quick scroll through these boards will prove that to be the case. 

Best of luck!

[Greg Heden]

Quote from @Corby Goade:

Quote from @Greg Heden:

When analyzing a deal, should one factor in future appreciation, annual mortgage reduction, and tax savings from depreciation (offsetting other passive investment income) when calculating ROI? I am looking at a property that will take some time to polish out. The COC return doesn't warrant the investment but the total return paints a different picture. From a buy-and-hold standpoint, how much weight should I give to this total return?

 Yep, always. What you are looking for is IROI- internal rate of return. It's a true measure of all potential modes of revenue from an investment, including forced and passive appreciation. 

People on these boards talk all of the time about how cash flow is the only guarantee and that anything else is just wishful thinking. I'd beg to differ- if you talk to anyone who's been doing this professionally for a long time, that forced and passive equity is where true wealth and freedom will be found. Cash flow is absolutely not a guaratee- a quick scroll through these boards will prove that to be the case. 

Best of luck!

 Good to hear someone else sees it that way. I get the positive cash flow stand if it is critical to sustain, but not the only measure of a successful investment!