All Forum Posts by: Jered Sturm

When it comes to real estate investment the two most powerful things are debt (leverage) and taxes. Typically you receive neither of those benefits in other businesses

Apartment building investment:

$100k down payment on a $500k building. At an 8% capitalization rate (very achievable) you are left with $40k net operating income. lets assume when you borrowed the $400k from the bank they lent it to you at 4% interest over a 25 year term. This means your year one mortgage payment is $25,332 ($15,827 interest, $9,505 Principle) leaving you with $14,668 in cash flow or a pre tax cash on cash return of 14.6%. BUT we haven't even started on all the other benefits of investing in real estate.

So you cash flowed $14,668 do you pay tax on $14,668?? NO! Another beauty of real estate and leverage is the depreciation tax benefit. Even though you only put 20% of the $500k in to the property you get ALL of the depreciation. Apartment buildings/houses are depreciated over 27.5 years, which means you get to depreciate the building value. The buildings value does not equal the property value because the building sits on land and that land also has value. The IRS does not allow you to depreciate the land. A typical percentage of a property value to allocate to land value is 20%, or in this example it would be $100k. This leaves you with 400k of building value to be depreciated $400k/27.5=$14,545. What does this mean? It means you barely pay any tax on that $14,668 cash flow you made on the building. You actually only have a taxable gain of $9,628 ($14,668 + $9,505 - $14,545) we add back the principle amount of your mortgage payment because it is not deductible and subtract out the deprecation we listed above. Again assuming a 35% tax bracket the gain of $9,628 would result in cutting a check for $3,370 to the IRS. This means your after tax return is 11.3%. 

There is one more major piece to this puzzle.

Another huge difference between other businesses and owning investment real estate is the power of debt and with debt comes amortization. Wealth is built in the amortization of the debt you put on the property. Back to our example the $400k in debt you put on the building will have an army of tenants paying down your mortgage month after month. In our example after 10 years you will only owe $285K on the building IF the property never appreciated one cent and it was still worth $500k in 10 years you would have $215K in equity. You could then sell it or refinance it (again tax free).

Now lets wrap the amortization into our example. Using the loan terms I mentioned the first years of the loan will result in a $9,505 reduction in principle or if the value stays the same that would be seen as a $9,505 increase in equity. If we add that $9,505 to the cash flow and tax benefits we are left with an all inclusive after tax return of 20.8%.

This is just the basics. You can accelerate depreciation benefits through cost segregation, Structure loans for quicker amortization depending on your goals and many other tricks.

@Alec Sithong When it comes to real estate investment the two most powerful things are debt (leverage) and taxes. Typically you receive neither of those benefits when doing hard money lending that you mentioned. Flips are sort of a middle ground between the two. Flips are a ton of work, and far from a passive investment like you mentioned you wanted. 

I have wrote this out for another example so I used $100k rather than $125k but the example should still illustrate the principles.

Here is an example of two investment channels you mentioned:

Hardmoney lending:

$100k lent out for 1 year at 12% interest w/ 2 points will give you a gain of $14k or a pre tax COC of 14%. Lets assume you are in a 35% tax bracket. You will cut a check to the IRS for $4,900, leaving you with $9,100 or a after tax cash on cash of 9.1%. Also keep in mind HML your money turns over quickly you have to be active to be sure you have another qualified borrow lined up needing your money at your terms or else your money just sits dormant between loans, and dormant money is decreasing money.

Apartment building investment:

$100k down payment on a $500k building. At an 8% capitalization rate (very achievable) you are left with $40k net operating income. lets assume when you borrowed the $400k from the bank they lent it to you at 4% interest over a 25 year term. This means your year one mortgage payment is $25,332 ($15,827 interest, $9,505 Principle) leaving you with $14,668 in cash flow or a pre tax cash on cash return of 14.6%. This beats your total pre tax return of 9.1% from the HML above BUT we haven't even started on all the other benefits of investing in real estate.

So you cash flowed $14,668 do you pay tax on $14,668?? NO! Another beauty of real estate and leverage is the depreciation tax benefit. Even though you only put 20% of the $500k in to the property you get ALL of the depreciation. Apartment buildings/houses are depreciated over 27.5 years, which means you get to depreciate the building value. The buildings value does not equal the property value because the building sits on land and that land also has value. The IRS does not allow you to depreciate the land. A typical percentage of a property value to allocate to land value is 20%, or in this example it would be $100k. This leaves you with 400k of building value to be depreciated $400k/27.5=$14,545. What does this mean? It means you barely pay any tax on that $14,668 cash flow you made on the building. You actually only have a taxable gain of $9,628 ($14,668 + $9,505 - $14,545) we add back the principle amount of your mortgage payment because it is not deductible and subtract out the deprecation we listed above. Again assuming a 35% tax bracket the gain of $9,628 would result in cutting a check for $3,370 to the IRS. This means your after tax return is 11.3%. A 2.2% increase on after tax return when compared to hard money lending

That's all great and will make you a lot of money, but HML has no tenants, no phone calls, no toilets. That piece of mind in its self is worth not receiving the additional 2.2% return owning real estate provides right? I don't think so because there is one more major piece to this puzzle.

Another huge difference between HML and owning investment real estate is the power of debt and with debt comes amortization. Wealth is built in the amortization of the debt you put on the property. Back to our example the $400k in debt you put on the building will have an army of tenants paying down your mortgage month after month. In our example after 10 years you will only owe $285K on the building IF the property never appreciated one cent and it was still worth $500k in 10 years you would have $215K in equity. You could then sell it or refinance it (again tax free).

Now lets wrap the amortization into our example. Using the loan terms I mentioned the first years of the loan will result in a $9,505 reduction in principle or if the value stays the same that would be seen as a $9,505 increase in equity. If we add that $9,505 to the cash flow and tax benefits we are left with an all inclusive after tax return of 20.8%.

This is just the basics. You can accelerate depreciation benefits through cost segregation, Structure loans for quicker amortization depending on your goals, force appreciation through several types of improvements, and many other tricks.

Everyone has their own specific investment tastes and beliefs. I post this here to hopefully help you make your choice. Good luck on your new venture! 

@Boris Grinberg I am no tax expert either. All I wrote above is simply picked up through my own investing experience. In regard to your question, I believe you are correct and the term for this is commonly know as depreciation recapture. HOWEVER our ever so generous government incentives real estate investing in so many way they even give us a way to avoid depreciation recapture! This is called a 1031 exchange. I have never completed a 1031 myself but my understanding is all of the gains you would realize in the sale of property (including depreciation recapture) can be rolled into the next property you purchase. You can do this unlimited amount of times, and when you die all those built up gains you have sheltered through 1031s just disappear. When you die the tax burden dies with you. Just another great gift from our IRS to incentives real estate investing.

There are a ton of rules on 1031 exchanges  so dig into them if you're thinking of utilizing them. 

@Katy Oh If you're just beginning and "sort of" grasping all those moving parts then you're ahead of the game! the key is too pick up the very basics terms... Cashflow, NOI, Debt service, etc. This way you can begin to build on those and eventually see the whole picture of investing including taxes, amortization and all the other crazy moving parts. If you're on BP and reading it wont take you long!

I realize my message wont align with Dave Ramsey’s teachings but I also do not personally agree with them so I would like to show you an alternative. Also I know you mentioned flipping, but flipping can be very similar to lending so read below for some of my thoughts on which strategy I like best. 

When it comes to real estate investment the two most powerful things are debt (leverage) and taxes. Typically you receive neither of those benefits when doing hard money lending that you mentioned.

Here is an example of two investment channels you mentioned:

Hardmoney lending:

$100k lent out for 1 year at 12% interest w/ 2 points will give you a gain of $14k or a pre taxCOC of 14%. Lets assume you are in a 35% tax bracket. You will cut a check to the IRS for $4,900, leaving you with $9,100 or a after tax cash on cash of 9.1%

Apartment building investment:

$100k down payment on a $500k building. At an 8% capitalization rate (very achievable) you are left with $40k net operating income. lets assume when you borrowed the $400k from the bank they lent it to you at 4% interest over a 25 year term. This means your year one mortgage payment is $25,332 ($15,827 interest, $9,505 Principle) leaving you with $14,668 in cash flow or a pre tax cash on cash return of 14.6%. This beats your total pre tax return of 9.1% from theHMLabove BUT we haven't even started on all the other benefits of investing in real estate.

So you cash flowed $14,668 do you pay tax on $14,668?? NO! Another beauty of real estate and leverage is the depreciation tax benefit. Even though you only put 20% of the $500k in to the property you get ALL of the depreciation. Apartment buildings/houses are depreciated over 27.5 years, which means you get to depreciate the building value. The buildings value does not equal the property value because the building sits on land and that land also has value. The IRS does not allow you to depreciate the land. A typical percentage of a property value to allocate to land value is 20%, or in this example it would be $100k. This leaves you with 400k of building value to be depreciated $400k/27.5=$14,545. What does this mean? It means you barely pay any tax on that $14,668 cash flow you made on the building. You actually only have a taxable gain of $9,628 ($14,668 + $9,505 - $14,545) we add back the principle amount of your mortgage payment because it is not deductible and subtract out the deprecation we listed above. Again assuming a 35% tax bracket the gain of $9,628 would result in cutting a check for $3,370 to the IRS. This means your after tax return is 11.3%. A 2.2% increase on after tax return when compared to hard money lending

That's all great and will make you a lot of money, but HML has no tenants, no phone calls, no toilets. That piece of mind in its self is worth not receiving the additional 2.2% return owning real estate provides right? I don't think so because there is one more major piece to this puzzle.

Another huge difference betweenHMLand owning investment real estate is the power of debt and with debt comes amortization. Wealth is built in the amortization of the debt you put on the property. Back to our example the $400k in debt you put on the building will have an army of tenants paying down your mortgage month after month. In our example after 10 years you will only owe $285K on the building IF the property never appreciated one cent and it was still worth $500k in 10 years you would have $215K in equity. You could then sell it or refinance it (again tax free).

Now lets wrap the amortization into our example. Using the loan terms I mentioned the first years of the loan will result in a $9,505 reduction in principle or if the value stays the same that would be seen as a $9,505 increase in equity. If we add that $9,505 to the cash flow and tax benefits we are left with an all inclusive after tax return of 20.8%.

This is just the basics. You can accelerate depreciation benefits through cost segregation, Structure loans for quicker amortization depending on your goals and many other tricks.

I realize this is very different from Dave Ramsey but I thought I would at least put it out there for you and others to read.

I hope this helps!

Thank you to all the above posts. I am humbled by your kind words!

I was told the other day that after doing something for 10,000 hours you are an expert in that field. That had me doing the math. How many hours have I put into my real estate investing career? If a normal person works 40 hours a week for 50 weeks out the year that’s 2,000 hours, multiply that by 5 years and you have 10,000 hours.

I started investing early 2012 the catch is for the past 4 years I have put in 70-80 hour weeks so I’m not certain on where I land in total hours. I am certain that I am at least over the 10,000 hour mark.

Reflecting back on the last 10,000 hours of work, I thought what did I really learn? What actions caused the success I have accomplished over those 10,000 hours? What have those 10,000 hours shown me that I didn’t know prior?

The more I thought of the answers to the question the more I realized how simple the answer was. Its so simple I thought there is no need to spend 10,000 hours to realize these things I should share it with the new investors that may be wondering how to make REI work. For that objective there is no better channel than BiggerPockets. So I decided to write a post on the 5 simple things 10,000 hours of investing have thought me.

• 1)Be Responsive
• This may be the simplest and easiest action on my list, but it’s a big one. I have found all those in my network who answer their phone promptly, return emails quickly, and respond to messages reasonably always seem to have people raving about them. This can be from Handymen, to attorneys, to Investors if people are never waiting on you for communication then you are bound to stand out amongst the rest. If you are so busy you cant respond to most items with in 12 hours its time to hire someone that can take that task off your plate.
• Example: I have built many of my business relationships around this characteristic. I choose lenders who are small because when I call I get to talk to the person who makes the decision on my loans. I have won deals by being the person who picks up the phone over the people who sends it to voicemail. Our vacancies on rentals are always very low because we answer the phone or email. We don’t wait around to respond
• 2)Ask for what you want/need
• Unfortunately this took me a while to realize the power that this action carries. We are thought in school that we have to learn how to solve the problem and asking someone else to do it for you or even just advice is considered bad, or cheating. In the real world asking can do amazing things. If you don’t know something ask. If you don’t know something ask for someone who does know. If you want something but don’t know how to get it ask. If you want something but you don’t think its possible ask any way. Simply asking what ever was on my mind with out fear of looking stupid has opened so many doors and informed me more than I could have ever done with out asking.
• Example: I once went to buy a $50 dryer off craigslist. When I arrived to pick the dryer up I asked the seller of the dryer if he knew anyone looking to sell property in the area. He said “yeah me” After talking he said he had a duplex he had renovated and was ready to retire from the day to day of managing it. We drove to look at the property and It was a really nice duplex. I went home ran numbers on the property, and called the owner back and again asked what he was going to do with the sale proceeds. He mentioned things like CDs and banks. I asked if I could send him some numbers on his returns if he were willing to seller finance the property. Eventually the seller agreed to a 5% interest 30 year amortization loan for 90% of the purchase price. My point of this example is I went to buy a $50 dryer from someone, and a week later they loaned me close to $100k to buy their property. All of this happened because I asked.
• Example 2: Recently I was negotiating the loan terms on a 42 unit apartment building we are purchasing. The lender I have a long relationship with only does 75% LTV loans on commercial loans. I asked for a 80% LTV and they said no we never ever go to 80% LTV. This purchase was for just over 2 million dollars so the difference in 75% to 80% LTV was just over $100k. I then asked if I put $100k into a 6 month CD at your bank will you go to a 80% LTV on the loan? This would allow the bank to increase their lending limits and make more money by lending out my $100k. In 6 month I get my $100k back and I'm left with the loan I wanted. The bank agreed to my structure with a 12 month CD. Until this loan this bank had never done a 80% LTV. That changed because I was willing to ask.

3) When you feel friction you’re on the brink of growth

• Over the years I have noticed this intangible friction in the business from time to time. The feeling that things just are not clicking. The wheel of your business just isn’t greased right and you feel it through that friction. I have found this friction is change, although it is uncomfortable to go through it is the best indicator that if you stay focused, problem solve and push through that is when progress and growth happens. As humans we don’t like change, but being aware of why you feel this friction and knowing something good is coming from it helps you preserver.
• Example: When we were at roughly 10 units we could feel the intangible friction of inefficiency and a need to change in our business. This is when we implemented property management software into our company and for the first year it was a learning process. The whole time learning how to implement this new software into our business felt like friction. Once we had it down it allowed us the ability to scale and push to the next level. There are countless examples in our business of this feeling of friction being the first indicator to growth If you can focus and preserver.
• 4) Show gratitude and apperception.
• We have all heard find your “why”. It is the reason why you push forward. Why you work so hard to achieve you’re goals. I agree that is important, but something that doesn’t get talked about enough that I think is equally if not more important than your “why” is your “who”. The “why” is looking forward where the “who” looks back. “Who” asks, who has helped you achieve your successes in business and in life?
• If someone successful tells you they did it on their own they either are lying about doing it on their own or lying about being successful because it cant be done alone.
• Reflecting back over your life to find those who have helped you grow along the way has two important purposes. First it motivates you personally to do even better. For your self, and for those who have helped. This thought process breeds inner drive to make those people proud. The second reason is to show gratitude and appreciation. Taking the time to tell people thank you, and that the fact they did XYZ for you helped so much and you now realize it and will forever be grateful. These thanks need to be sincere. By giving them, great things continue to come from those relationships.
• 5) Understand the responsibility of money and wealth
• Money is a powerful thing and should be respected. In the business of real estate investment the dollar amounts you’re working with can be very large even as a beginner. It is vital to understand the responsibilities you take on when entering this industry.
• I added this point because over the years I have heard a lot of beginners ask me about no money down, and how to raise money from other people. I did most of my deals with my own money. I did this because I realized what it meant to borrow someone else’s money. When I borrow money from an individual I know they are giving me dollars, but at some point in that person’s life those dollars were traded for time. What I mean is if someone lends you $100k and back when they earned that 100k it took them 3 years to do so it means your not borrowing $100k from this person your borrowing 3 years of their life. When you hold money to this level of importance you understand the responsibility it carries with it.
• In 10,000 hours of business these 5 simple traits surface around the successful over and over. I see so many people far smarter than myself sitting on the sidelines running numbers, setting up entities, building a website, creating spreadsheets, and the list goes on and on. There is a place and time for all of those things, but in the beginning so may smart people over whelm them selves into stagnation. If you simply follow these 5 points success will find you. 

@Adrienne Greer  You came the right place. BP is a great place to learn! 

Congrats on Jumping into real estate. There is no better way to build true wealth. 

One big word of caution. Private Money should be held to a very high standard. When I use other people's money I always consider the days, months, and usually years that person traded to earn that money. When you take other peoples money you should be holding it to a standard as if you were responsible for the years of their life that person traded to earn those dollars. Always keeping this in mind helps me stay focused, and disciplined on when and how I use other peoples money to be sure I not only wont loose money but will always return it with more. 

Good Luck!

UPDATE: 

Unfortunately I did not meet my net worth goal but did get very close. 

With a rising market we transitioned to fix and flip in April of 2015 and completed 16 very successful flips in just over a year. 

I am happy to say that next week we will be closing on a nice 42 unit building. This will take our rental portfolio to near 4 million dollars of rental real estate. 

It has been a really fun Journey, I feel the momentum building and cant wait to see what the next few years has in store. 

Thank you for everyones kind words and encouragement, it only pushed me further!

Thanks Everyone!

Once I close on the Apartment I will write another post explaining the numbers and details of that purchase. 

@Sean Cole Congrats on making the transition, and the property! 

Let me know If I can ever be of help as you learn the ropes of buy and hold.