All Forum Posts by: Llewelyn A.

@Mike Dymski

You are absolutely right, Mike, in regards that the quote about IRR Investors was meant as a effect so that there is an understanding that the two are different and implies different Markets and Investment needs.

The following is for the readers (not Mike Deymski only).

I will say that there is another reason why those that do have the ability to Invest using IRR valuations (in other words, they don't REALLY need the cashflow but would like to have it) DO NOT simply because they have not spent the time (and I would say it may take months to years) to truly understand the Calculation and how it works.

It's the most comprehensive calculation you can have and requires you to do a pro-forma 10 year projection.

The problem I find with a lot of BPer's is that they easily dismiss IRR because it's either too complicated and sophisticated that the newbie will need to spend time to learn it before jumping into Real Estate Investing.

My personal opinion is that if you truly love Real Estate Investing and are truly motivated, you will eat, sleep and dream about Real Estate. Not wanting to understand IRR is telling me that your motivations may lack the discipline and drive to understand such a critical Analysis. You will certainly be shut out of desirable large Metropolitan areas and wind up concentrating where anyone can do a GRM, CoCR, 1% rule, etc. which are really, non-sophisticated, non-complex calculations.

Once you can understand and use IRR, you can evaluate ANY Investment.

If you want to evaluate only Cashflowing Investments using IRR as an example, you set up a series of cashflows which only has the `10 annual Cashflows of the Investment over the 10 year holding cycle. You just assume zero appreciation. Your IRR then acts like all the other Calculations, but it's going to be easier to understand the results because it is entirely comprehensive.

The Great thing about the IRR calculation is that if you are expecting ZERO cashflow, but you are expecting the Mortgage to be reduced, say a $1 Million mortgage reduced to $500k in 10 years, then that applies to the IRR since you need the Investment for the Purchase and the HYPOTHETICAL Sales Proceeds after the sale of the Investment. The IRR may tell you that this zero Cashflow Investment may be better than a All Cash, cashflowing investment.

When you learn how to use IRR, then all Markets can be analyzed. Otherwise, you are limited to markets in which the narrow calculations you have learned will work in.

Investor Llew

@Mark A.

The Answer is actually quite easy.

The Valuation of an Investment is underwritten using an Internal Rate of Return (IRR), not just a simple Cash on Cash Return (CoCR).

So, what does an IRR take into account? EVERYTHING. So why would you use just CoCR? Beats me. But as others have mentioned, if the Cashflow isn't a necessity upfront (but typically an IRR Investment Property will give you large cashflow in later years), then it is difficult for someone who needs the Cashflow NOW to invest in IRR Investments. This debate has been going on an on on this forum.

I invested with Partners and we own approx. $15 Million of Brooklyn Properties that we bought in the span of 20 years. We have been making Millions in profits and a very healthy Cashflow over time. We are expanding our portfolio of MF properties in Brooklyn. The last Property we bought was last November for $1.71 Million. We are now targeting MF properties around $2 Million plus.

Our IRR target is around 15% IRR given a 10 year holding period. That's quite doable. You just have to know how to do the calculations and work out the details with the properties and future economic developments.

IRR can evaluate everything, including hot Markets like Brooklyn and Cashflowing Markets like the ones mentioned by others on BP.

CoCR can only evaluate Cashflow Markets.

Here is a really good Article everyone should read by Ben Leybovich of BP:

Cash Flow vs. Appreciation: What Experienced Investors Know About the Debate That You Don’t

Here's one of the quotes: "I've written about the IRR a lot; please look up the other articles. Having said this, have you ever wondered why big time investors never give a hoot about things like cash on cash (CCR) and capitalization rate (Cap Rate), and all they want to know is the IRR? Why is this?"

I recommend reading the Article. However, it will take some time to understand IRR.

Once you get an understanding of it, then you can make your decision on whether or not you want to own in Markets where the CoCR doesn't make sense to own the Investment but the IRR tells you it's a Fantastic deal!

Personally, those that only use CoCR keeps my competition away from the best deals. That's the way I like it.

Investor Llew

@Joe Splitrock

Thanks for the response Joe.

In regards to the increase in the Standard Deduction offsetting the Home Mortgage Interest Deduction, I'm wondering if my particular Market will be affected. Almost every home in my Investment Area is over $1 Million. Most Home Owners will be very sophisticated such as Hedge Fund Managers, Lawyers, Doctors, etc. It certainly seems that less wealthy markets will not be affected and most likely, as you pointed out, they don't understand or care about the Tax Reform proposals, even if they go into effect. Wealthier markets with more sophisticated Home Owners, that might be a different story.

However, I own multi-family properties. If the Tax Reforms causes demand to drop for SFHs in my area, I'm hoping it will equally increase the demand for Rents.

Another aspect of SFH is that there is a Cap on Conforming Loans which Maxed out at $636k. In my Market, there is a large percentage of people with a significant down payment (20% or better) and a large percentage are all cash deals (probably 25% of all purchases).

There is a lot of variables here. I'm not sure that all SFH markets, A, B, C and D areas, will be affected equally.

What do you think?

Investor Llew

@Joe Splitrock

Thanks for pointing out that I AM talking about 2 different kinds of deductions.

I'm the OP of the thread. This Thread is about BOTH the Home Mortgage Deduction, which is listed on Schedule A - Itemized Deductions on line 10 and 11.

AND, for business purposes, ESPECIALLY for Real Estate Investors, Schedule E - Line 12

I want to point out that BOTH are called Mortgage Interest, but the Sch. A has HOME as a prefix. Sch. A is for Primary Residents and Sch. E is for Rentals.

The Topic of this Thread is: "What happens to House Prices if Mortgage Interest deduction ends?"

I'm sorry if you feel that when I mentioned "Mortgage Interest Deduction" that you feel it was ONLY about HOME Mortgage Deductions.

I assure you that this topic is about BOTH Home and Business.

However, the larger the units in an Investment Property, the less likely your Investment property will be affected by the Market where there is a preponderance of Home Buyers.

The argument I would like to bring forth is that if the Standard deduction is increased, lowering the incentive for Home Owners to purchase a property, this will potentially lower the value of your SFH Investment Property as well.

One of the reasons why that's the case is that SFHs are generally appraised using COMPs.

However, the larger the AMOUNT of Units in an Investment Property, the more it will be appraised using Commercial Business Analysis such as Cap Rates and NOI, DSCR, IRRs, etc.

There are two major proposals that affect BOTH Mortgage Interest Home and Investment Properties.

For those that are Investing in SFHs, how do you feel about the Standard Deduction increase, which reduces the incentive to buy a Home for Home Buyers, which may then lead to lower priced Comps?

For Investors in larger than SFHs, duplexes, Quads, and bigger, what do you think of the proposal where you will lose your Mortgage Interest Deduction entirely in favor of Full Expensing of the Purchase and carrying forward the loss to future years?

Also, I couldn't find any proposals on what will happen to current Investment Properties. If you owned your Investment Property, will they suddenly just do away with the Mortgage Interest deduction? Will there be a Grandfathering in period? Maybe someone else knows something of this details?

Our BP Community is LARGE with all kinds of Investors. I'm trying to get the thoughts of both the SFH Investors, Multi-Family, and Commercial Investors.

Sorry if it seemed like this thread is all about "Home Mortgage Interest." However, that was not the Topic. The Topic is "What happens to House Prices if Mortgage Interest deduction ends?" Mortgage Interest... meaning BOTH Home and "Mortgage Interest" for your Investment Properties.

Investor Llew

Great! So now we are at the same question I have been trying to address all along. You said "I have also looked through the GOP: A Better Way and it doesn't say they are getting rid of the mortgage interest deduction."

But on Page 26 it reads as follows: "job creators will be allowed to deduct interest expense against any interest income, but no current deduction will be allowed for net interest expense. Any net interest expense may be carried forward indefinitely and allowed as a deduction against net interest income in future years. The benefit of immediate expensing of business investment operates as a more beneficial and more neutral substitute for the deduction of interest expense associated with debt incurred to finance such investment. Allowing investments to be immediately written off provides a greater incentive to invest than is provided through interest deductions under current law; allowing both together would be distortive as it would result in a tax subsidy for debt-financed investment. The elimination of deductions for net interest helps to equalize the tax treatment of different types of financing and reduces tax-induced distortions in investment financing decisions." 

This whole thread is about interpreting that quote. If, as a business, you borrow money to finance the purchase of that business, according to the quote, you will only be allowed to "deduct interest expense against any interest income, but no current deduction will be allowed for net interest expense."

What you are saying is that, while Real Estate Purchases are financed through Mortgage Debt, the above is not inclusive of that Mortgage Interest? Can we be completely sure of that? That would make me very happy. But are we absolutely sure?

The quote you have on page 21 addresses Primary Residence Mortgage Interest. But that is being watered down by the larger proposed Standard deduction as others here have already commented.

My concern is about the "Business Interest Deduction." Am I incorrect to assume that Mortgage Debt is a "Business Interest Deduction?"

Investor Llew

 Hi Joe.... surprisingly, it's not at all a liberal article. In fact, it's not an article at all. This came from the GOP. Here is the Link: GOP: A Better Way

It's funny, but I think that when you look at the real issues being pushed, Liberals and Conservatives are very much alike. People are using the terms to somehow label people as if it's all black and white.

The problem I'm having is that those who Voted Republican and had NO IDEA about what the Republicans are actually addressing, which probably is a Majority of Voters (both Democratic and Republican), the only thing they know is the label of Liberal or Conservative. People just don't know what they are really voting for.

I'm just addressing that the document, A Better Way, is sponsored by Paul Ryan and the GOP.

Investor Llew

@Account Closed

Got it. Just a small correction if you don't mind. Residential Real Estate is 27.5 Years for depreciation purposes.

Yes, I understand that for NEW purchases, the Tax Reform allows you to expense the entire purchase rather than depreciate it over 27.5 years, and at the same time, disallow the Mortgage Interest. That would give you quite a bit of time for the Purchase Expense to work itself out.

However, for those of us who have owned Investment Properties for say, 10 years, the devil is in the details. Will we be allowed to deduct the original purchase price? Will it be some combination of Purchase price minus the already depreciated amount? Will it be Grandfathered in because it's too complicated to work out for existing purchases? Really, this could be a really bad if the details in existing Investments are handled in a bad way.

The worst way would be to just take away your Mortgage Interest Deduction and not allow you to at least deduct your original purchase price.

Now lets say they did allow you to use your original purchase price for the "New" Purchase price expense while they took away your Mortgage Interest deduction. This could be really bad for those Investors that took money out of their property after it appreciated significantly.

For instance, let's say you bought a property in the year 2000 in Brooklyn for $140k and a Mortgage of $120k. 15 years down the road in 2015, you refi'd the property because it was worth $1.2 Million (yes, this is a true story and yes, I know it's a hell of a profit so I shouldn't complain). If you are only allowed to deduct your original purchase price of $140k but you are paying Mortgage Interest on a $1 Million Mortgage..... there is no way you can justify keeping this property because you will take an otherwise positive cashflow property and convert it to a hugely negative cashflow with the stroke of a pen.

I suspect this is a very common scenario because, like you, many people refi'd their house when the values all went up and the interest rates went down.

However, we'll see what happens. My suspicions is that there must be a Market Price Adjustment for this because lots of home owners and Investors refi'd into lower rates but much larger loans, especially because they benefited from the Mortgage Interest deduction.

I guess we'll see what happens. I don't think it's so clear cut and dry.

Investor Llew 

@Account Closed

Ed.... what's really confusing me in your previous posts is when you say the following:

"As an investor, you will no longer be required to depreciate the home you purchase...you will take it as an expense the year you purchase it."

If you are buying a "Home".... you are not allowed to take business deductions like depreciation.

Can you clear up whether or not you are talking about buying a "Home" or an "Investment?"

I think you are not talking about a Home at all but an investment property? You continued using the word home again when you state "I can continue to buy and accumulate homes..." and then here: "I've refinanced my home loan at a very low rate"

I didn't want to make the assumption but would rather you clarify it.

Really.... I'm confused! Please clarify.

@David Krulac

Hi David. Thanks for responding. In regards to this: "And if the mortgage interest rate would be totally knocked out it would apply only to personal residences and vacation homes, not investment properties." I believe that the link I have in my previous post in this thread shows that the Republican Tax Reform proposes to eliminate ALL BUSINESS INTEREST.

Here is the quote from the Proposed Tax Reform:

"job creators will be allowed to deduct interest expense against any interest income, but no current deduction will be allowed for net interest expense. Any net interest expense may be carried forward indefinitely and allowed as a deduction against net interest income in future years."

My interpretation of this is that you are not allowed to deduct interest on any borrowed money to finance a business, including Real Estate. So that loss gets carried forward unless you can give someone else a loan and deduct that Business Interest against your Business Interest Income. But you cannot deduct Business Interest otherwise.

If you want to read it directly.... click here and go to page 26:

A Better Way Tax Reform

Also, I run a group of Investors that own $15 Million in multi-family Brooklyn Real Estate. I'm very familiar with the Schedule E. What I'm contemplating is that they will just remove the Mortgage Interest Deduction but may allow it to go into an "Unallowed Business Interest Loss" until you can actually use it.

@Account Closed

The 15% tax bracket is for non-pass-through entities.

For pass-through entities, this is the literature in the above link on page 16:

"Millions of small and closely held businesses are organized as pass-through entities – such as partnerships and S corporations – that are taxed under the individual rate structure rather than at the corporate rate. These businesses often compete directly with businesses that are subject to the corporate tax, with the differential in tax treatment creating potential distortions and inequities. As discussed below, the Tax Reform Blueprint will create a new business tax rate for small businesses that are organized as sole proprietorships or pass-through entities, which means that small business income will no longer be subject to the top individual tax rate – not even the lower 33 percent top rate in this Blueprint – thus leading to a maximum tax rate of 25 percent on small business income. This approach to the tax treatment of business income will build on concepts developed by Rep. Vern Buchanan of Florida in his Main Street Fairness Act (H.R. 5076)."

C-Corp tax rates will max out at 15% or 20%. That's because they want to lower the double taxation of C-Corps.

BUT, for entities that do not suffer from double taxation, which are Pass-Through entities like LLCs, S-Corps, Schedule E's... etc. you will pay up to a max of 25%.

At least that's the way i'm reading it.

Maybe we can put our heads together to determine if I'm interpreting this correct AND does this have any serious possibility of passing now that we have both a Republican Congress and a President that may just rubber stamp it?

Also, if they actually pass these Reforms, that may only apply to new businesses AFTER the passage since those of us who have already bought the Investments (or businesses) was not able to write off the purchase of that business in the beginning.

This is going to be REALLY messy.

Investor Llew

@Account Closed

Let's say you buy your property with very little money down so that your Cash on Cash Return is great, say 20%. 

However, because the Mortgage Interest is no longer deductible, we have to now add back the Tax that would you have otherwise had deducted because now you will have to pay more tax.

So, if you invested $10k which is $5k down and $5k in closing and renovations, 20% Cash on Cash Return = $10k x 20% = $2k per year.

HOWEVER, because the Mortgage Interest is NOT deductable anymore.... your CoCR is completely reduced taking this into effect.

The 1st year Amortized Mortgage looks like this:

The $5,668 would have offset your Tax obligation. But because we cannot deduct the Mortgage Interest, it will increase your normal tax obligation by $5,668 x 25% (what ever is your tax bracket) = $1,417 more taxes for the first year. 

Taking into account the $1,417 HIGHER tax obligation, your real CoCR is $2k minus $1,417 = $583 per year or $583 / $10k = 5.83% CoCR.

Is that really worth it?

Maybe someone else can check my math?

Investor Llew