This would also be a good time to point out the importance of engaging or working with an agent that specializes in this type of property, especially if this is new to you. If you’re the buyer, the normal and customary practice is your agent will be paid by the seller. In some states and in some cases the same agent can represent both parties as long as all parties agree.

The way apartment house sales work for most part is, offers are made subject to inspection. In other words, you and your broker will evaluate the property by reviewing the operating data provided by the seller and the listing broker and then do a drive by of the subject property. If that all works out to your satisfaction, it’s time to structure an offer for presentation to the seller.

Your broker will then present your offer along with your good faith deposit and evidence of funds to preform including a lender qualification letter. Notice it is a good faith deposit, not a down payment yet, and this process is to demonstrate to the seller that you are a serious buyer and you want to open up negotiations, and have a closer look at the proposition he has in the market.

Let’s assume an agreement is reached and the process goes to the next step. Unlike single family resident deals, the income & expense data supplied by the brokers is what is most important. A process of verification is used to determine accuracy, and the lender will analyze this data for the purpose of determining the loan amount the transaction will qualify for.

Next will be the physical condition of the property and the verification of the utility services is conducted. At this stage you should engage a property inspector who has a sound knowledge of construction, local building codes and permit requirements. This inspection process is an important part of your due diligence and your broker will help guide you through. Your broker will collect disclosures from the seller, agents and third parties as required and will present and explain them to you. If there are some issues that need to be corrected or treatment for termite eradication etc. that needs to be addressed these conditions will be discovered in this due diligence process.

By now you should now have all the information you need to make your decision on the property. Next step is to determine if the deal is as you expected, and if it is NOT, can adjustments be made and agreed so you can proceed with the deal or the deal doesn’t work and you can cancel and move to another deal. It is not unusual to negotiate or adjust terms to align with property conditions discovered on inspections. There are different solutions depending on the issues. I generally favor an adjustment in terms or price that allows the buyer to resolve it to their satisfaction, since they’ll have to conduct business there after close of escrow.

Properties that are well priced go quickly even in this buyer’s market and so it’s best to have a strategy in place to act quickly and efficiently. That strategy should be, identify a likely property, and make an offer that will get you the right to inspect it. Conduct your due diligence inspections and decide if this property is for you or not. Between what you know of the physical condition, the location and the loan offered by the lender, you can determine if this transaction meets your investment criteria.

If you’re an investor doing an IRC Sec. 1031 tax deferred exchange, you’ll have time constraints that you will need to abide by so it is important you follow the process above and nominate this as a property you’d like to use in the exchange process is this is an orderly delayed exchange transaction. The least time spent between the close of the down leg and the close of the up leg the less money you lose by having the money idle in the accommodator’s account.  If this Tax Deferred exchange is new to you, please see the bonus section at the end of this book on the benefits of deferring your taxes.

I know if you haven’t done this before you might be a little nervous about this process. Don’t worry! This will all work and has done so for many times over the years. The key is to hire the best brokers to help and follow their advice.  You’re on your way to building your portfolio and I wish you the best of luck.

Real Estate Returns

From 2004 through 2007 I was securities licensed and participated in Tenant in Common (TIC) market. TIC’s were classified as securities and were essentially sold as a security backed by a  fractional interest in real property. The attraction to the TIC product was it’s qualification for the IRC Sec. 1031 Tax Deferred Exchange and was considered the investment of choice for property investors planning to retire from active management of their investment property. TIC’s just like any investment in real estate in the 2004 – 2007 era are having varying results but the supply of capital they generated for commercial investment market was robust.

TIC investments in apartments are generally doing OK or better than the market and the same can be said of Health Care Properties. The areas of concern and hurt are Office Buildings, Retail Centers including Auto Facilities, Student Housing and Hospitality. There has been some total losses in these property types and there would be a lot more if there were not some form of loan modifications or cooperation from lenders. Don’t get me wrong! Lenders are not accommodating because they’re good guy’s,. They’re doing it because they’ve discovered being a landlord usually costs them a lot more money, headaches and liability. They don’t like that last one!

I decided to not renew my securities a couple of years ago to focus on real estate only. There were several reasons for this but the main one was the amount of mark-up or load by securities folks was getting outrageous and next would be the limitations on available product through securities sponsors. Another was the restrictions placed on me by the Securities license. A lot of the time a successful real estate investor is a Mom & Pop. They invest in real estate because they believe in it. They can go see it everyday. They can look at the history of the country and the history and return of investment in real estate and see a correlation. They don’t care that they’re over weighted in one investment… that’s the way they want it, and they get real peeved at any “Wall Street Type” who tries to tell them different.

Real Estate sales and 1031 tax deferred exchanges are still our main focus. In sales we’ve found a niche liquidating estates for administrators and trustees. For exchanges, it’s not in the best interest of most of the folks I consult with to trade what they have for whats available, which must be the first consideration of an exchange transaction. At times we find exceptions which turn into good and profitable transactions that fits into the investors plans. These are mostly local real estate deal where properties have to be sold to liquidate a probate or trust estate. In terms of TIC’s they’re still around and there are a couple of good sponsors out there in the TIC arena. Likewise TIC sponsors are getting good deals in this market although they’re usually secondary markets and the transaction markup is still over and above the regular real estate. Nevertheless, a good TIC representative can produce a deal that will provide a landlord with a terrific retirement investment.

If you’re an investor looking for an exit strategy from active property management or you’re just tired of tenants, it would be better to focus on finding NNN investments that will give you the same or better returns as a TIC where you’re the only investor and you have almost total control. Lots of these investments exist in properties where ground leases are used. A good example would be a fast food restaurant on a high profile corner. You own the land and the franchise or tenant leases the land on a 20-30 year lease and takes responsibility for paying  the bills on everything. You enjoy the cash flow from the real estate which can be sold, traded, exchanged or borrowed against. Control!

In terms of what is going to happen in the next couple of years… It will depend on the labor market. If we begin to create real jobs, not minimum wage or slightly better middle-man type employment, then things will improve. Also the further away we get from the 2008 collapse the  better chance we have for a new normal. Unlikely we’ll ever get the returns we got in 2004-2007. If you see that happening again, it would be a good time to start shorting the stock of the lenders involved.

The bottom line on sustainable return on investments is controlled by the supply of capital. There is an abundant supply of affordable capital for banks which will is available for qualified real estate investments in the 60-75% Loan to Value ratio. If we return to the days of sensible real estate investment principals, then we look to the lenders rate and add a risk margin for the return on our higher risk down payment. A hypothetical example would be; a lender loan rate of 5% then an investor should be looking at 6-6.25% to compensate for the added risk.

That was a long way to say we won’t have the crazy 2004-2007 market in real estate again for a long time.

A home for Generations

For almost a decade now, every time we talked about real estate we immediately discussed money and how much more we have this month or year. We didn’t talk about the value of a home but instead about the price of the house. We didn’t worry about a roof over our heads but instead the ceiling on our interest rate. We didn’t care as much about where we raised our family as we cared about how much we increased our family’s net worth.

We believe that will change in 2011. We believe very strongly that real estate will return to what it has been for the dawn of independence in this country: a place for us and our families to live comfortably. It will also prove to be a great long term investment as it always has been.

Our parents and our grandparents didn’t buy their homes as a short term financial investment. They bought it so they had a place of their own to come home to at the end of the day; a place to raise their family; a place they could feel safe; a place they would call home.

Sure they dreamed of a ‘mortgage-burning’ party. They realized it was a form of forced savings. They were taught that, if they paid their mortgage every month, they would wind up with a little retirement account decades later.

And, they realized that wouldn’t happen if they rented.

However, in the last decade, we somehow forgot that the financial aspect was the serendipity not the major reason to buy. We believe that 2011 will be the year that people return to the historic reasons families purchased a home. This is the year when we again remember that home ownership is a major part of the American Dream.

Who Gets Your Vote?

The cast of characters—sounds like a Hollywood type of deal. Some of these characters actually think they are in Hollywood, or they are Hollywood material. This is an area where a lot of people screw up, and I don’t want you to be one of them.

Just as in life, the top players in the real estate market get the top dollar. So you pay a little bit extra and you get the best in the class. They usually make the difference up anyhow—they can get you that little bit extra in the sale price or save you that little bit extra in the purchase price that will pay their fee.

Let’s put it this way: if you’re in the bottom of the ninth inning of a baseball game with the game tied and the go ahead run coming to bat… who’d you send to the plate? The 200 hitter or the 340 hitter? That’s right! You’d send the guy that has the best chance to win the game for you. You’d look for that pinch hitter that could bring those runs home for you.

Real estate’s similar in so much as there are specialties, or brokers who work in certain specialties. If you have a real estate property that’s in the rental housing market or the 2-4 unit size, the broker that you hire to assist you in that transaction should specialize in the residential investment section of the market. A similar type of property is the 5 residential units and up or the apartment house investment, but has different requirements for financing and disclosures that the former. Completely different still is the broker that specializes in industrial or office property sales, and still they are different than brokers who specialize in representing tenants and landlords in leasing. So it’s a good idea to select a specialist in the type of property and transaction you’re planning to conduct. Oh! Don’t forget to inquire about the 1031 tax deferred exchange experience of your chosen professional as well.

Another rule of thumb when you’re going out there to select an agent is to interview two or three of them. And you’ll also notice that I said brokers, not agents, not sales persons, not vice-presidents. The reason for that is you need a guy or girl that’s at least taken the trouble to go and get a broker’s license to represent you. Somebody that’s been around the real estate market for fifteen or twenty years and hasn’t considered it worth their while to go and get the extra education to get the broker’s license is somebody that you should not have representing you.

If you’re looking for some additional qualifications, a good way to look at those is to find the agent that took the time and patience to go and get specialty real estate designations. In terms of designations, the top one there is for real estate agents in the commercial field is a CCIM, followed by an SIOR. A CCIM is a Certified Commercial Investment Member, they have a very broad range of knowledge. If anyone can handle cross sections of properties, it would be a CCIM. An SIOR is an agent or a broker who specializes in office and industrial property. Both these organizations have a great network of people all across the country, and indeed, across the world. CCIM’s & SIOR’s are both national and international.

The last designation I’m going to discuss is an RECS, and that is a broker that sells property in cyberspace. That is a Real Estate Cyber Society member. In today’s market, people are buying all over the country, so it is to your advantage to hire a broker that is also Internet-savvy.

Knowing this information will help you find the right agent for the job, not some Hollywood wanna-be. Taking this step will save you both time and money in the long run, and give you a smoother transaction all the way around.

City Living With Style

Here’s the biggest advantage of doing a 1031 exchange? By deferring tax, you have more money in hand to invest in another property. In effect, you receive an interest free loan from the Government, in the amount you would have paid in taxes. A wonderful estate builder indeed! In most cases the tax bite on the profits of a real estate deal fall between 30% to 35%  and by doing an exchange the investor get to roll all the profits into the next deal. Consider what a benefit that is over a lifetime of investing.

Despite this generous benefit some folks elect to sell and pay the taxes. This is often done out of ignorance on behalf of the investor of the broker the used to sell the property. Another reason could be the seller decided to finance the deal for the buyer. Depending on what side of the deal you’re on with this seller financing there are advantages. However, the tax still has to be paid but the question now is, when?

It’s also worth noting here that there are several taxes due if the investor decides to cash out or decide against the exchange option. Here in good old Orange or Los Angeles Counties the investor with a profit or Capital Gain will get the privilege of paying, Federal Tax, State Tax, Depreciation Recapture Tax, County Transfer Tax and in the City of Los Angeles a separate City Transfer Tax. Make sure all of these are considered and what they’ll cost you before committing to a deal. You need to have the exchange option included in your purchase and sale agreements.

Some folks confuse “tax -deferred”  with “tax free”. They are quite different and you don’t want to discover that difference when you’re across the desk from the IRS auditor. Here’s the difference: In a 1031 exchange, you defer paying the capital gains taxes on your relinquished property. Its tax basis is carried over to the replacement property. When you finally sell the replacement property, without doing an exchange, you will pay the tax at that time. However, you may repeat this deferral process over and over again, from property to property over a period of years and under current law your immediate family can inherit the property with a stepped up basis. In other words, the capital gains tax is forgiven. Not Bad!

It’s refreshing to know that there is some break from the IRS in pursuit of capital gains tax.

As you might imagine, there are some rules and regulations to adhere to in a IRC Sec 1031 Tax Deferred Exchange. While the tax deferred exchange has been around since 1921, there have been some modifications in the rules. For this reason, it is very important to use the services of professionals who are familiar with these types of transactions. A mistake here could be very expensive and as everyone’s situation is different a consultation with an expert and some research  of your options is a really good use of your resources.

Now we have established the benefits of investing in multifamily properties or apartment rentals, tomorrow we can now get down to most efficient way to manage them for fun and profit.

Everyone Want's A Beach Community

A few years ago Stephen Covey authored a book titled, The 7 Habits of Highly Effective People® in which he strongly advocated beginning projects with the end in mind. Unfortunately few people took heed of that advice, especially in the multifamily or apartment investment property market.

As a result of ignoring that advice many find themselves in what we metaphorically refer to as the harvesting season for the landlord that’s had enough of tenants, taxes and toilets and would just like to enjoy the fruits of their effort. Shrewd investments and savvy exchange moves for many years combined with careful management, saving and sacrificing to build their retirement nest egg. But even with a plan…would it have prepared anyone for the debauchery of the credit default swaps and the collapse of the funding for the investment property market? It’s no secret the condition of the apartment house market is completely different now than it was in 2007 and that’s not the Landlords fault.

Long gone are the days when lenders were lining up to provide financing, and as I write this post, it has just been announced that Freddy & Fanny have been delisted from the NYSE. It’s too early to tell what effect that will have on their lending programs, but they’re basically the only game in town now for residential investment property loans. It can’t be a good result for the investors of residential income property. As it is we’re looking for buyers with 40-50% down payments to get a deal done. A far cry from the, “tell em a story and get the funds” of the 2004-2007 era.

An argument can be made that Fanny & Freddy’s trouble may bring with it an opportunity to get back to some old-fashioned real estate deal making. The kind of deal that provides security, cash flow and comfort to both sellers and buyers. Eliminate a bunch of “Wall St. Wing Tippers” in the middle to boot. The kind of deals we had before the Wall Street boys got control of the mortgage market. Before franchise real estate companies would only do, or allow their brokers and agents to do only the vanilla cash or cash to new loan transactions. Let’s look at what we have now and what we could do to improve the investor’s security, control and return on investment.

As I see it here are the retiring landlords options and opportunities:

• Sell and pay the Taxes. (Ochs!) 30-35% goes to the taxman.
• Sell a do a 1031 Tax Deferred Exchange. (But I thought you were tired of tenants)
• Donate the property to a Charity for an annuity payment. (Property needs to free & clear and your cash flow is controlled by the Charity and their investments)
• You could do a master lease if the lender allows it. (But you’re still a Landlord)
• Last but not least… In fact it’s the best option of all! Seller Financing. Sometimes referred to as “Owner will Carry.” (Opportunity!)

OK! OK! Lots of seller’s won’t entertain the idea of financing the deal for the buyer’s and in the past I’ve have been in complete agreement with them. But, things have changed in a lot of respects, so please hear me out on this. The last 3 years have shed a lot of light on the security or lack of it, on our investment markets. If you were a believer in the security of real property as an investment, then you’d surely believe in a loan or loans that are properly structured, using cash flowing real estate as security or collateral. Right!?

I fear ye Sacramento

It’s been a while since we last spoke and I wanted to get to what our elected representatives in Sacramento have been up to on their desire to repeal of the IRC Sec. 1031 Tax Deferred Exchanges in Real Estate Transactions. Fortunately, there is no harm done yet as the bill is still in committee as of the last posting date on May 28th 2010.

It has become increasingly obvious that our elected officials either don’t know or worse still, don’t care if we loose all those investment dollars when they place us in such a disadvantaged position of being one of the few states in the union to not match and mirror the Federal Law.

This is not a law change that will effect just the investor’s in the properties. Firstly it will greatly reduce transactions as there is no incentive for investors to leverage the profit from one investment property to a larger one since the the transaction costs and the State Tax will siphon off all the profit. The first causality in this instance is the transfer taxes collected by the counties and some cities on transactions. Next of course is going to sound self serving since I’m a Real Estate Broker, but look at the amount of folks involved in the real estate transaction market here in California… Half of them will have to go, at least!

Now for the obvious… Business doesn’t pay tax, they collect it and forward it, usually including an administration fee for the trouble. Since investment property is owned by investors and administrated by some form of business entity, there is an expectation of profit or return on investment. This means there are going to be some adjustments to accommodate this 10% tax bite into an investors margin. This will have a profound effect in replacement of facilities with new buildings or tenants will have to pay higher rents for functionally obsolete properties. How do you think this will work in the Silicone Valley?

The residential property will be effected just like the retail, office and industrial only over a greater number of investors. Since residential investors tend to be entrepreneurial folks, they’ll look for other places to invest first and avoid the hassle of tenants and toilets for the reduces return. The alternative to all the above is that is a further decline in property values will take place to offset the loss of the 1031 tax deferred exchange. This, of course will will reduce the revenue from property tax and defeat whatever temporary benefit these fools hope to achieve by their misguided attempt to eliminate a section of tax code that has served the nation and the state well since 1921. 89 years… What are they thinking?

It’s time for all responsible citizens to call these folks in Sacramento and remind them they need to defeat this proposed law in the interest of keeping California on the cutting edge and maintaining our standard of living. Please call your state representative and enlighten them to the error in their short sighted proposal.

Sorry I just had to have a rant on this stuff. It’s too important to ignore. Leave us a comment.

California State Capital

The California legislator are attempting to eliminate the 1031 & 1033 Tax deferred exchanges in AB 2640. A bill currently  working it’s way through the process in Sacramento could have a serious effect on the real estate market and investor profits  if passed into law. To make matters worse the bill would be retroactively effective to 1/1/2010.

The IRC Sec. 1031 Tax Deferred Exchange has been around in the federal tax code since 1921 and there is no indication that there is going to be any change there. There has been  several modification’s to the law over the years, usually for the best as far as the investor is concerned, but occasionally some State Government will get a dumb idea and try to  generate revenue from this source. I believe the last to attempt this were Utah and Pennsylvania. Utah had the good sense to repeal the law and I don’t know about Pennsylvania.

The California attempt to impose this tax will also backfire and finish up hurting business’ for a number of reasons. First thing I should mention is that the Federal Tax Deferment will still be in place so the first inconvenience will be the different tax returns and how the different deferments will be treated from earlier exchanges. I’m sure there are several forms and an extra hour or two of CPA’s time can clear this up.

A major problem for the local tax authorities  I believe will be the loss of transaction and transfer fees. Los Angeles  is a decent sized city with a lot of investment property and the transfer taxes on transactions amounts to a neat some of money at $1.10 per $1,000 transferred to the County and a whopping $4.50 per $1,000 to the City of Los Angeles. One of the attractions of Investment Property Investing is the ability to transfer your equity from building to building within the 1031 tax deferred exchange and have the entire gain working for you. If this incentive is removed, not only will it effect property values, it will also reduce transfers and the tax revenue generated by them.

Not only is the regular investment real estate 1031 exchanges effected, they’re also going to include the 1033 tax deferred exchanges used for eminent domain transactions. So not only can your property be condemned and taken for the public good, they’re going to tax you for the privilege as well.

Frankly, I’m puzzled! You’d think that someone in Sacramento would recognize the fact that the last 3 years have been rather brutal on the real estate industry and be smart enough to leave it alone  until we get back to 2007 prices again. Apparently not!

Here’s and idea that might work and save us all a bundle. Since we’re doing a census this year, we’ll have all the numbers we need to eliminate exactly half of the elected officials and commissioners from our State Government.Yea! Good Luck with that 0ne catching on.

Leave a comment or ask a question.

Lifetime Exchange Benefits

Here’s the biggest advantage of doing a 1031 exchange? By deferring tax, you have more money in hand to invest in another property. In effect, you receive an interest free loan from the Government, in the amount you would have paid in taxes. A wonderful estate builder indeed! In most cases the tax bite on the profits of a real estate deal fall between 30% to 35%  and by doing an exchange the investor get to roll all the profits into the next deal. Consider what a benefit that is over a lifetime of investing.

Despite this generous benefit some folks elect to sell and pay the taxes. This is often done out of ignorance on behalf of the investor of the broker the used to sell the property. Another reason could be the seller decided to finance the deal for the buyer. Depending on what side of the deal you’re on with this seller financing there are advantages. However, the tax still has to be paid but the question now is, when?

Before you make a decision one way or the other, it would be prudent to examine the effect of your decision give the choices. In an 1031 Tax deferred exchange you can defer some or all of the taxes. You don’t have to do all or nothing! In a sale where the seller finances the deal, some taxes are paid at the time of sale and the balance are paid as the seller receives them with some exceptions. In an outright sale or “cash out” there’s an assortment of taxes due especially here in Orange & LA Counties. Here’s a list without percentages as they can change depending on your situation, Federal Capital Gains Tax, State of California Income Tax (or your state if the have tax), Federal Depreciation Recapture Tax. There’s also Property Transfer Tax on the entire sale amount even in exchanges. If someone tells you to pay the tax, it’s only 15%… Run! Find a new adviser.

Some folks confuse “tax -deferred”  with “tax free”. They are quite different and you don’t want to discover that difference when you’re across the desk from the IRS auditor. Here’s the difference: In a 1031 exchange, you defer paying the capital gains taxes on your relinquished property. Its tax basis is carried over to the replacement property. When you finally sell the replacement property, without doing an exchange, you will pay the tax at that time. However, you may repeat this deferral process over and over again, from property to property over a period of years and under current law your immediate family can inherit the property with a stepped up basis. In other words, the capital gains tax is forgiven. Not Bad!

It’s refreshing to know that there is some break from the IRS in pursuit of capital gains tax.

As you might imagine, there are some rules and regulations to adhere to in a IRC Sec 1031 Tax Deferred Exchange. While the tax deferred exchange has been around since 1921, there have been some modifications in the rules. For this reason, it is very important to use the services of professionals who are familiar with these types of transactions. A mistake here could be very expensive and as everyone’s situation is different a consultation with an expert and some research  of your options is a really good use of your resources.

Now we have the tax situation established we can examine the benefits of investing in multifamily properties or apartment rentals, and get down to most efficient way to manage them for fun, profit and devise an exit strategy that will work best for you.

Most people I know got into that business by accident! After 18 plus years of dealing with landlords in their day-to-day business, assisting them in buying, selling and exchanging their properties. After many lengthy chats and informal surveys, I have come to the conclusion that most people got into this type of investment property by accident rather than on purpose.

Among the reasons most people finish there was they bought a new home and kept the old one. Some bought a house next door just so they could control who their neighbor would be, others helped a family member or a buddy with a loan and finished up getting the property instead of the loan repayment. There is also a considerable portion of this market who inherited their property and decided to continue in the business of their benefactor.

Another group of investors are those folks who attended a real estate seminar and actually implemented some of what they learned there or in the materials they purchased. Still others invested for the tax benefit and they are mostly large salary or high net worth individuals. Others got started by investing with partners or buddies and some even got started investing in REIT’s and limited partnerships.

And then there are the determined!

The folks with the plan! In my experience over the years, this is the smallest group in number but they’re the investment power in the rental property or multifamily properties.They bought, managed, bought some more, leveraged and exchanged into larger properties,or refinanced the properties they own and bought more. They did whatever it takes to grow their investment portfolio, because these folks recognized that real estate investments are the IDEAL investment for wealth accumulation and cash flow when done right.

Investors using real estate as a vehicle for retirement cash flow are typically the apartment landlord. In most cases their portfolio enjoys a more favored tax treatment while it remains outside the constraints normally associated with a retirement account. The rules,regulations and constraints like those found in IRA’s, 401(k)s 529′s and other tax favored facilities for investments and methods of wealth accumulation have limited flexibility for borrowing against and there are no withdrawal guidelines with respect to age for the real estate investor and his property.

Most all landlords, especially the determined are fully aware of the benefits outlined in IDEAL. which was adequately covered in a previous post here. The largest obstacle that all these folks have is getting good advise and direction from their paid professional advisers. Here I’m speaking of tax and legal advisers, and why it is necessary to only consult with specialists in that area or specialty.

The other area of concern is the type and caliber of real estate investment advisory or broker they use or choose to do business with. In order to successfully landlord, one needs to treat this business seriously, and that should begin with only working with specialized people in the multifamily property arena, and to use an old cliche in the business, “the day you buy, is the day you sell”. Sometimes the better option is to use the IRC Sec. 1031 or 1033 and defer or roll the Capital gain into the next building or real estate transaction.

Tomorrow we’ll expand on Sec. 1031 Tax Deferred Exchanges and and a brief look at the benefits to the investor starting at the beginning of the investment cycle.

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