You are here: Home / 2009 / Archives for April 2009

How to Make Your First Rental Income Property Sale

April 16, 2009

Once you make the decision to sell rental income property, you cross the largest obstacle between you and closing your first income property deal: The desire to sell more than residential real estate is foremost.

In this article, I’ll show you four things you must now do that will help you seize every opportunity, perhaps avoid missed opportunities, and maybe bypass months (perhaps years) of trial and error before you close and subsequently collect your first rental property sales commission. It’s not exhaustive, but guaranteed to get you started on the right foot.

1. Learn some basic terms and formulas. After numerous years of assisting countless residential real estate agents in a large real estate brokerage frantic for rental property advice, I strongly recommend that you understand just two real-estate-investing-related terms (and/or formulas) in the beginning. Comprehension of other terms and formulas can wait and follow later.

  • APOD – An APOD is a report that shows the income, expense, and cash flow of an investment property for the future first year of the property’s operation. It’s an assumption because it’s based upon current property data subject to change; still, it does offer a valuable indication of how a property will perform after one year of ownership. APOD is an acronym for Annual Property Operating Data (in case you’re wondering).
  • Cap Rate – Understanding how cap rate (or capitalization rate) is calculated is likewise paramount to working with rental income property. You will not mingle in real estate investing circles very long without hearing about or seeing a cap rate. I’ll forego the textbook definition and cut to the chase: here’s the calculation (memorize it):   Net Operating Income (NOI) divided by Sale Price = Cap Rate

2. Determine what typical cap rates are in you local market. Conduct your own comparative market study.

Start with your local MLS. What cap rates are income-producing properties listed and/or sold? Cap rates are commonly included in rental property listings so it shouldn’t be difficult. If cap rates are not shown then make the calculation yourself (you only need the property’s net operating income and sale price). If the NOI isn’t shown then derive one by computing the gross income and deducting about 45% for vacancy allowance and operating expenses. If the gross income isn’t shown, then call the listing agent or scrub it and move on to the next property.

Local real estate appraisers are another excellent resource. Call around until you find someone who appraises income property and is willing to share with you. Then ask them what cap rates are for multifamily and commercial properties in your area. While you’re at it, be sure to subscribe to their newsletter if they provide one.

If you know an agent that specializes in multifamily and commercial properties, likewise discuss it with them. Depending on how well you know them, they can give you a plethora of good information about the cap rates for your area.

3. Invest in real estate software. Yes, I know that it sounds like a shameless plug for my real estate investment software, but not so. Honest. Having sold income property for nearly twenty years, I can attest that quality cash flow presentations got me listings, sales, and real estate investor customers time and again. Truly, you would be wise to invest in real estate software (some software) that enables you to create real estate analysis and marketing presentations. Consider it as a way to develop your income property skills further, and as a tool to build your business.

4. Let others know you are working with rental property. Call your residential customers and alert your colleagues. You might be surprised how quickly you gain traction toward your first rental income property sale after mastering steps 1-3.

Here’s to your success.

Filed Under: other

How to Prepare for Real Estate Investing

April 10, 2009

This article presents six things real estate investors should do to prepare themselves for a successful real estate investing endeavor. From attitude to real estate investment software, each of the six suggestions, if practiced, will better prepare you for the challenges associated with real estate investing that lay ahead.

1. Develop the correct attitude. Foremost, bear in mind that real estate investing is a business, and that you are about to become the CEO of that business. You are not a home buyer. So look beyond curb appeal, exciting amenities, and desirable floor plans unless they contribute to the income and focus on the numbers. Real estate investment property is a matter of the head, not the heart. “Only women are beautiful,” an investor once told me. “What are the numbers?” Lay emotions aside, and prepare to make your investment decisions based on the property’s cash flow and rate of return.

2. Develop an investment goal with meaningful objectives. Have a plan with stated goals that best frames your investment strategy. What do you want to achieve? By when do you want to achieve it? How much cash are you willing to invest comfortably, and what rate of return are you hoping to generate? <!– /* Style Definitions */ p.MsoNormal, li.MsoNormal, div.MsoNormal {mso-style-parent:”"; margin:0in; margin-bottom:.0001pt; mso-pagination:widow-orphan; font-size:12.0pt; font-family:”Times New Roman”; mso-fareast-font-family:”Times New Roman”;} @page Section1 {size:8.5in 11.0in; margin:1.0in 1.25in 1.0in 1.25in; mso-header-margin:.5in; mso-footer-margin:.5in; mso-paper-source:0;} div.Section1 {page:Section1;} –> A stated investment goal with meaningful objectives is one of the most important elements of successful real estate investing. Have it prepared and worked out in your mind before you start purchasing.

3. Research the real estate market. Understand as much as possible about the conditions of the real estate market when you plan to invest. Learn property values, rents, and occupancy rates. You can turn to a qualified real estate professional to run a comparable market study for you, or have the county tax assessor help you. You must always be prepared to recognize whether an investment opportunity is fairly priced or not; whether it offers a potential to make real money or not.

4. Learn the terms and returns and how to compute them. Get familiar with real estate investing terms such as APOD and Proforma, and rates of return such as cap rate and cash-on-cash. Learn the formulas and calculations. There are sites online that provide free information, so prepare to do some home work and gather as much data on the terms and returns as you can . It will keep you from looking like a deer staring into the headlights of a car when hear them discussed.

5. Invest in real estate investment software. Having the ability to create your own rental property analysis gives you more control about how the cash flow numbers are presented and a better understanding about a property’s profitability. So prepare to purchase quality real estate investment software. The benefit it will provide you is well worth the meager investment.

6. Create a relationship with a specialized real estate professional. The emphasis here is to work with a real estate agent that knows the local real estate market and understands rental property. It won’t advance your investment objectives to spend time with an agent unless that person understands the nuances of real estate investing and is adequately prepared to help you make wise investment decisions. If you’re planning to get assistance from a real estate professional, prepare to seek out a real estate investment specialist.

Filed Under: articles

How Rental Property Depreciation and Recapture Tax Works

April 7, 2009

One of the true benefits of owning rental income property is that real estate investors can depreciate the property and enjoy the positive cash flow resulting from writing off the tax depreciation—just one of the tax shelter benefits associated with real estate investing.

Here’s how it works.

The tax code assumes that the investment property buildings (not the land) are wearing out over time and therefore becoming less valuable.  As a result, they permit income property owners to take a deduction for that presumed decline through the depreciation deduction (or cost recovery as it’s now called in the tax code) which in turn helps the investor shelter rental income that is subject to “ordinary income” rates.

Let’s assume, for example, that you purchase a multifamily property for $500,000 of which $400,000 is attributable to the buildings (the remaining portion is land value). The IRS assumes a life of 27.5 years for residential property (39 years for non-residential) and therefore allows investors to take an annual depreciation deduction of about $14,544 ($400,000 / 27.5). Except in the first year and selling year, which is slightly less ($13,940) due to what is termed the mid-month convention.

The boon for real estate investors, of course, is that the depreciation deduction is a noncash deduction—it is not an operating expense, therefore you can take it without having to write a check for it as you would other costs associated with running the property. Moreover, if the depreciation deduction is large enough to exceed the property’s income, investors can use it to offset other investment income and therein reduce other tax liabilities as well.

Okay, that’s the good news.

On the flip side, because the depreciation taken reduces our investment property’s tax basis and effectively increases our tax gain when we later sell, if the property is later sold at a gain, the IRS assumes that our gain in part may have resulted from the depreciation we took and in turn imposes a recapture tax on the gain attributable to depreciation taken (imposed at 25% in the Taxpayer Relief Act of 1997, but subject to change so always consult your tax advisor).

Okay, let’s look back on our previous example and assume that you sell your multifamily property at a gain greater than your accumulated tax depreciation (which we’ll say is $144,232). Since your gain is greater than your tax depreciation, the recapture rule will apply.  As a result, your tax on sale will include the recapture tax of $36,508 ($144,232 x .25) plus a capital gains tax on the adjusted net capital gain.

Here’ the bottom line. You should always account for depreciation recapture tax when performing your real estate analysis on potential investment opportunities. Otherwise, you might be unpleasantly surprised to discover that you owe the IRS more taxes than planned when you sell your rental property and that will not be good.

Filed Under: analysis
« Older Posts
Newer Posts »