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Buying in the “
Part 1 of 3
TWO RULES FOR BUYING AND SELLING
How many times have you heard it said, “The three most important things to remember when investing in real estate is location, location, location”? Or, “If I'd bought that property 10 years ago, I would be a millionaire today.” Knowing what, when, and where to buy is not only the key to sound real estate investing, it is the key to all investing.
John Paul Getty said, “Buy when everyone is selling and sell when everyone is buying.” This simple statement represents the cornerstone of our investment philosophy. When buying, find out where everyone is selling, evaluate the area, and negotiate the best deal possible. Sell when everyone else is buying. This is our Standard Operational Procedure (SOP). In this chapter, you learn how to apply this SOP.
THE BENEFITS OF BOTTOM FISHING
Remember, there are always pockets of opportunity for real estate investments. Good markets exist all over the world at varying times. Concentrate on weak markets, not weak properties. A weak market is the most favorable condition in which to buy. Prices are depressed and profit potential is high. Sellers just want to get out. Buying in a depressed market is called “bottom fishing.”
The Key to Evaluating Locations
Focus on areas where the local economy is basically strong and the current downturn is caused primarily by overbuilding. The U.S. Bureau of the Census publishes building permit activity for buildings five units and up for Metropolitan Statistical Areas (MSAs). Identify markets with the largest gains in building permits from one year to the other. If you discover a “construction bubble,” it could mean you've located an ideal market. With a diversified local economy, the overbuilding should be absorbed. A weak market caused by conditions other than overbuilding should be scrutinized carefully.
Apartment buildings often make money for the second owners in overbuilt markets, not the first. Builders get paid for building and they will keep on building as long as they get paid. More often than not, banks are the ones doing the paying.
The market becomes deluged with an excess of inventory. This is when you should step in.
Employment Trends
Base employment is probably the single most important factor contributing to the economic health of an area. In evaluating employment trends, be careful of construction employment. During boom-and-bust building activity, the labor base can become distorted by construction related jobs. If possible, eliminate construction employment figures when plotting trends. Predicting growth industries and where they will be located can give you a further indication of where future employment growth will take place.
Talk with the local city planner to determine the direction of city growth. Plans for shopping malls, universities, and business parks create a potential demand for employment and desirable apartment locations.
Demographic Factors Affecting Apartments
Demographic factors are also important in evaluating demand. People tend to marry later and divorce is on the increase, both of which result in a larger single population. In addition, people are living longer, and we have the empty nest syndrome, as grown children move away from the family home usually into apartments. The parents no longer need a large private home and many choose an apartment as well. The number of households is increasing, and the size is decreasing. The affordability of single-family homes is also decreasing.
Demographically, look for an area in which there are a higher percentage of females to males, younger and/or older adults as opposed to middle aged, singles rather than married, smaller families over larger families and renters over non-renters in evaluating favorable rental areas.
APARTMENT BUILDING CYCLES
The “when” to buy and sell is just as important as the “where.” With bad timing you'll strike out every time. To improve your timing, you must become familiar with apartment cycles.
Cycles results from the influence supply and demand have on the marketplace. Economists spend countless hours trying to accurately predict them, and gurus for the current year are the ones who guessed correctly the previous year. As long as their crystal ball remains clear, they will continue to be called on for their advice. One false prediction and they are ousted from the Nostradamus Hall of Fame.
Apartment cycles are difficult to forecast. Yet, it’s essential to have projections when buying and selling. Understanding them will give you the insight to make intelligent decisions.
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How to Effectively Employ Consultants
Part 1 of 3
TWO RULES FOR BUYING AND SELLING
How many times have you heard it said, “The three most important things to remember when investing in real estate is location, location, location”? Or, “If I'd bought that property 10 years ago, I would be a millionaire today.” Knowing what, when, and where to buy is not only the key to sound real estate investing, it is the key to all investing.
John Paul Getty said, “Buy when everyone is selling and sell when everyone is buying.” This simple statement represents the cornerstone of our investment philosophy. When buying, find out where everyone is selling, evaluate the area, and negotiate the best deal possible. Sell when everyone else is buying. This is our Standard Operational Procedure (SOP). In this chapter, you learn how to apply this SOP.
THE BENEFITS OF BOTTOM FISHING
Remember, there are always pockets of opportunity for real estate investments. Good markets exist all over the world at varying times. Concentrate on weak markets, not weak properties. A weak market is the most favorable condition in which to buy. Prices are depressed and profit potential is high. Sellers just want to get out. Buying in a depressed market is called “bottom fishing.”
The Key to Evaluating Locations
Focus on areas where the local economy is basically strong and the current downturn is caused primarily by overbuilding. The U.S. Bureau of the Census publishes building permit activity for buildings five units and up for Metropolitan Statistical Areas (MSAs). Identify markets with the largest gains in building permits from one year to the other. If you discover a “construction bubble,” it could mean you've located an ideal market. With a diversified local economy, the overbuilding should be absorbed. A weak market caused by conditions other than overbuilding should be scrutinized carefully.
Apartment buildings often make money for the second owners in overbuilt markets, not the first. Builders get paid for building and they will keep on building as long as they get paid. More often than not, banks are the ones doing the paying.
The market becomes deluged with an excess of inventory. This is when you should step in.
Employment Trends
Base employment is probably the single most important factor contributing to the economic health of an area. In evaluating employment trends, be careful of construction employment. During boom-and-bust building activity, the labor base can become distorted by construction related jobs. If possible, eliminate construction employment figures when plotting trends. Predicting growth industries and where they will be located can give you a further indication of where future employment growth will take place.
Talk with the local city planner to determine the direction of city growth. Plans for shopping malls, universities, and business parks create a potential demand for employment and desirable apartment locations.
Demographic Factors Affecting Apartments
Demographic factors are also important in evaluating demand. People tend to marry later and divorce is on the increase, both of which result in a larger single population. In addition, people are living longer, and we have the empty nest syndrome, as grown children move away from the family home usually into apartments. The parents no longer need a large private home and many choose an apartment as well. The number of households is increasing, and the size is decreasing. The affordability of single-family homes is also decreasing.
Demographically, look for an area in which there are a higher percentage of females to males, younger and/or older adults as opposed to middle aged, singles rather than married, smaller families over larger families and renters over non-renters in evaluating favorable rental areas.
APARTMENT BUILDING CYCLES
The “when” to buy and sell is just as important as the “where.” With bad timing you'll strike out every time. To improve your timing, you must become familiar with apartment cycles.
Cycles results from the influence supply and demand have on the marketplace. Economists spend countless hours trying to accurately predict them, and gurus for the current year are the ones who guessed correctly the previous year. As long as their crystal ball remains clear, they will continue to be called on for their advice. One false prediction and they are ousted from the Nostradamus Hall of Fame.
Apartment cycles are difficult to forecast. Yet, it’s essential to have projections when buying and selling. Understanding them will give you the insight to make intelligent decisions.
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Part 5 of 6
THE SECRET TO WORKING WITH ACCOUNTANTS
An accountant can help you with statistical analyses and income tax strategies. The accountant should be able to give you a written report that includes projections and tax implications on your real estate transactions. Most accountants who specialize in real estate have computer programs to facilitate this kind of reporting. In a matter of one or two sessions, the components of your transaction can be inputted into the computer, and with the help of specialized computer programs, the accountant will be able to answer questions as to the “what ifs” scenarios and resulting tax implications.
Accountants, by the nature of their profession, tend to be conservative. Accountants should be employed for their accounting and tax ability, not to decide whether your purchase is a “good deal.” Your investments must be extremely aggressive in order for you to become wealthy. Don't be discouraged if your accountant gives your real estate deal a “thumbs down.” It’s an accountant’s nature! The advice is given out of the fear of being aggressive rather than the investment itself.
GETTING THE MOST FROM THE ESCROW AND TITLE COMPANIES
The key to getting a good escrow company is complete independence. Use a national title company to escrow the transaction whenever possible. Smaller local companies are more susceptible to playing favorites to selected clients. In addition, if interstate transactions are involved, communications improve when you use the services of a national firm. Again, use a company experienced in apartment transactions. A competent escrow company must display a high degree of proficiency in tax-deferred exchanges, bulk sales transfers, perorations, and various forms of ownership.
Another advantage in using a national title insurance company to escrow your transaction is the cost. As an incentive to purchase title insurance, some companies reduce escrow fees. If the quality of the service remains the same, it’s an excellent opportunity to save money.
THE CONSULTANT WHO WILL SAVE YOU THE MOST TIME AND MONEY
The one consultant who can save you the most time and money is a real estate investment broker. Notice we said investment broker. Once again we ask you to work with a specialist. All real estate brokers do not have the same qualifications. A real estate professional who you can rely on has the Certified Commercial Investment Member (CCIM) designation.
You should be able to delegate many of the tasks involved in buying and selling to a qualified real estate investment broker. However, keep in mind their services are not free. This has to be taken into consideration when calculating a rate of return. If the selling broker is also the listing agent, according to agency law, the broker/agent primarily acts on behalf of the person or entity to which the broker/agent is contractually obligated. So, if the selling broker is functioning as a listing agent, the broker/agent is primarily representing the seller.
An
There is no such thing as a standard broker’s commission. Commissions are negotiable. Generally, the higher the selling price, the lower the commission. A reputable broker will not sell you a piece of property just to earn a commission. But, always be careful and analyze all potential conflicts of interest.
Remember, agents working strictly on a commission basis, do not get paid until the sale occurs. It’s important to negotiate the commission and the services to be performed up front before anyone starts working.
Understanding How Multiple Listing Services Work
Most larger apartment buildings do not get put into the multiple listing services (MLS) book. Members who belong to the MLS are required to submit all new listings, and/or changes, to the board of realtors literally within hours so that it can be disseminated to other board members quickly. However, not all “hot” listings get on the board or, when they do, it occurs in a matter of days, not hours.
The MLS book provides information on real estate activity for Realtors. It is distributed by the local MLS boards to members who subscribe to the service. Some real estate boards make this information available to the general public.
A knowledgeable investment real estate broker who belongs to the MLS service normally is in the best position to find properties. The broker’s continual full time effort to stay abreast of market conditions provides a decisive edge in finding the best deals.
If you decide to use the services of a real estate investment broker, work with several. You should be exposed to as many properties as possible. Be sure to let the broker know your parameters (building size, price range, down payment, age, unit mix, and so on). A good relationship with a qualified real estate investment broker can be your best ticket to wealth.
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IRS Service’s Best Kept Secret
Income tax liability is derived by multiplying taxable income by the applicable tax bracket rate. The lower the taxable income, the lower the rate, thus the lower the tax liability. Here in lies the secret to significant tax savings. Reduce taxable income, and, in turn, tax liability will be less. According to John T. Reid in his book Aggressive Tax Avoidance for Real Estate Investors (Reed Publishing: Danville, CA, 1994), the goal for tax planning is to maximize after-tax income, not minimize taxes. To maximize after-tax income, you have to reduce the income tax liability. That’s the primary goal of all tax planning. Let’s find out how this is accomplished.
WAYS TO LOWER TAXABLE INCOME.
This chapter gives you a basic understanding of the following three simple underlying concepts used to reduce taxable income:
1. Spread income over time
2. Spread income to various entities
3. Group income and expenses
Knowing something about each of these concepts will permit you to intelligently implement a sound tax program. With the assistance of a competent tax advisor, your tax savings will be significant.
Spreading Income over
Time Real estate provides the opportunity to spread income over several years using the installment sales method of reporting. By accepting a relatively low down payment and spreading the principal payments over several years, total taxable income for any one year is reduced.
In the tax-deferred exchange method, income can also be spread over time. Both methods can be structured to give you maximum re-porting flexibility.
If you’re a real estate licensee purchasing a property and you want to spread taxes on your commissions over time, have them contingent upon some event taking place to avoid constructive receipt, if the situation warrants. For example, your commissions could be conditioned upon the property maintaining certain levels of cash flow and/or profits.
Spreading Income to Various Entities
Spreading income to various entities reduces the income any one entity has to report. By transferring ownership of assets to corporations, partnerships, relatives, or trusts, an effective transfer of income can be accomplished as well.
Relatives in low-income brackets can be paid for services provided. As long as these services represent legitimate business transactions, spreading income in this manner can save you thousands of tax dollars.
When operating entities have dissimilar tax reporting years and basis (cash or accrual), it’s possible to spread income and expenses over different years to take advantage of the tax laws.
Group Income and Expenses
Grouping income and expenses can lower taxable income. Real estate provides the flexibility to implement this kind of tax-planning tactic. More specifically, apartments do, because they fit nicely within the definition of active participation rules (which allow a $25,000 write-off against salaries and other active income). This write-off alone represents a substantial tax savings to many individual investors. See the section on this loophole on p. 167.
When changes in either income or expenses can be projected, the benefits of grouping are phenomenal. For example, refinancing will create a higher interest expense deduction to offset anticipated increases in rental income. Short-term loan contracts with high points will accomplish the same thing.
If expenses are projected to increase, offset them by increasing receipts from installment contracts. Avoid reporting income when notes become due by renegotiating an extension of time. If the senior mort-gage matures before your note, subordinate it to new financing to avoid payment.
Investing in midsize apartments gives you the advantage of acquiring properties outside your hometown. As a result, travel and transportation expenses related to your investments can be deducted. These deductions should be timed to give you the maximum tax savings using the “grouping method.” By rearranging the selling price and interest rate (within certain limitations), it is possible to create either higher or lower interest and/or depreciation expense deductions.
Capital gains and losses can also be grouped to maximum tax benefits. With restrictions, capital losses may be used to offset capital gains plus additional amounts of ordinary income.
These represent only a few of the many techniques available. Always consult your tax advisor to assist you in making these moves.
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