The real estate investment cycle involves acquisition, holding, and disposition.

Immediately upon acquisition of a real estate investment property, the real estate investor should have a holding period management strategy in place. How long does the investor plan to hold the property and what will the investor look for to trigger a disposition? The disposition should also be given careful consideration. A rational real estate investor must not only decide the timing of the disposition but also include in that decision how the net proceeds will be reinvested.

Maximizing an investor’s wealth position may require a decision to continue to operate the property rather than dispose of it. Retention of the property may be the best use of resources in terms of risk and rates of return. In other words, does the investor want to retain or dispose of the property?

The reversion decision, then, typically involves a decision to retain the investment or dispose of it. If disposition is warranted, then it may be marketed in:

1. an outright sale
2. an exchange
3. a sale and leaseback arrangement

The reversion decision is important because it’s one of the two major sources of cash flow received from any rental property investment. During the holding period, an investment generates annual cash flows (before and after tax), and upon termination, it generates a final cash flow resulting from settling accounts at the sale.

If you’re about to sell a rental property that you’ve owned for more than one year then prepare to pay the Feds a depreciation recapture tax. Real estate sold one year or less is classified as a short-term gain and gets taxed as ordinary income so it’s irrelevant; recapture tax only applies to an income property held for more than one year.

What is depreciation recapture tax? The tax you have to pay on accumulated depreciation taken during the years you owned your rental income property. Namely, when you sell real estate investment property with a recognized gain, the recapture tax is the Fed’s way to “recapture” back a part of the tax shelter benefit you’ve enjoyed during ownership.

For example, if you sell an income property and realize a gain of $300,000 of which $100,000 is attributable to depreciation, your accumulated depreciation of $100,000 gets taxed at 25% (the current tax rate) meaning that you owe the IRS a $25,000 recapture tax.

Planning for this tax is important so always consult a tax specialist before you sell rental income property. I can keep you from getting blindsided at tax time, and likewise prevent unrealistic expectations that result in an unpleasant disappointment later.

by Kimberlyn Williams

If you’ve grown weary of paying rent for your current business space, or have considered purchasing commercial real estate as a long-term equity investment, there are several important factors that can maximize your financial opportunities and minimize your risks.First of all, do your homework and educate yourself on the various costs involved. Unlike residential real estate, commercial property has extra fees and costs, which are not immediately apparent. So make sure you have the complete picture before you buy. Potential property expenses include (but are not limited to):

* Property taxes - Underwriters use the real tax numbers instead of an estimate used for residential properties.

* Insurance - The requirements the underwriter will have are often different (and more) than what the owner is currently and usually carrying. The buyers will have to comply with the underwriter’s insurance requirements.

* Management fees - Costs will vary depending on your set-up. If you will be taking care of things like landscaping contracts and building maintenance, you may be charged a simple flat fee for managing the tenant administration. If you outsource everything to the firm and the building has several tenants, the fees may be based on a percentage of the rentable square feet (RSF) or usable square feet (USF) for each tenant.

* Replacement reserves - These are funds set aside for the replacement of things like pavement, HVAC and other systems that have a limited, predictable lifespan. On many transactions, replacement reserves are established by having a Property Condition Assessment (PCA) done by a qualified engineer. The amount of reserves required will be determined by the engineer’s estimates of the remaining life of the major systems.

* Tenant Improvements and Leasing Commission (TILC’s) - Expense to improve the property to attract new tenants to new or vacated space, which may include new improvements or remodeling. This expense applies to office, retail and industrial properties.

These expenses don’t include ongoing fees such as maintenance and administrative costs. All such costs need to be figured in and the predicted cash flow determined when considering the cost of the property.

Once you know your what your expense outlay is going to be, it’s time to assess your financing. Where will your money be coming from? Options include other investors, business partners, your own capital, borrowing against other investments or properties, and bank loans.

Many purchasers jump immediately to the last option. However, it is not uncommon for banks to turn down business owners even if they have great credit and a positive cash flow. Reasons include:

* Loan size - The loan amount requested might exceed the limit the bank can lend to any one borrower.

* Borrower can’t prove income - In a large percentage of cases, the tax returns and financial statements of small business owners do not support the loan amount. Most small business owners do not show an income; instead they show a loss to avoid taxes. This results in an automatic decline for most banks.

* Portfolio management - A high quality loan request may be denied because the bank has to keep its portfolio balanced. Regulators keep an eye on the particular property types a bank has in its portfolio. If the portfolio contains too much of a particular property type, the bank may not be allowed to lend on this property.

* Property type is outside of their specialty - Many banks specialize in a particular type of lending (such as non-owner occupied commercial property loans). If a borrower requests financing for a property type other than their specialty (such as owner occupied commercial property loan), the loan request will be denied.

With good credit and at least 10% to 20% down payment, you should be able to secure some form of financing. Your company’s current bank may be the place to start since you have a history with them. To find more options and competitive rates, consider commercial brokerage firms, which specialize in matching commercial real estate buyers with commercial lenders.

Finally, you need to know your financial risk and decrease it whenever possible. For example, a multi-tenant building is almost always a safer bet than a single-tenant option, since it’s unlikely that all your tenants will depart at the same time. Also, several pre-existing tenants with long-term leases will make getting a loan an easier sell than trying to pitch the bank on financing a vacant, single-tenant building that’s not currently producing income. Knowing your risks and taking steps to mitigating them may make the difference between a continual financial burden and a sizeable financial gain.

About the Author

Kimberlyn Williams is president and owner of KRT Commercial Brokerage Loans & Leasing (www.krtcb.com), a financial service firm specializing in mortgage loans and equipment leasing for commercial industries.