Marvin Kau

Bluestone & Hockley Real Estate Services

We’ve all heard the old adage about selecting real estate to invest in…look for “Location, Location, Location”.

In today’s market we think that needs to be modified to “Location, Location and Cash Flow”.  There are numerous properties on the market that if evaluated with this new adage in mind will build value for those looking to grow their wealth through real estate ownership.

Prior to the real estate boom that ended in 2007 most investment property was evaluated by looking at a number of components – CAP Rate, Price per unit or square foot, Cash on Cash return, anticipated appreciation and overall rate of return on investment.

The Gold Rush

During the real estate “gold rush,” this detailed evaluation was mostly ignored.  Just being available for sale was enough for a property to generate an overwhelming amount of interest regardless of the deal economics.  Transactions were based on the pride (or thrill) of ownership and the expectation that appreciation and future cash flows would make the buyer wealthy beyond their wildest dreams.  Who cared or even looked at the current operation of the property as the future would cure all ills.

Now after the bust, investors seem to be ignoring property fundamentals again.  Only this time it is to the possible detriment of their future wealth.

Solid properties are being ignored in the hopes that an investor can uncover the one needle in the proverbial haystack that is a “great deal”.  While a few investors find such a remarkable investment, most do not and in turn they miss out on many other wealth building opportunities.  If you have the resources to make an acquisition, today is as close to a once in a lifetime opportunity as you’ll likely have.

The second half of 2008 and first half of 2009 were periods of fear and paralysis.  Neither buyers nor sellers knew what to do, how to price, how to evaluate a property, or whether investments should even be made. The question on their mind was, “Was the world as we knew it going to end?” Because of the uncertainty many investors decided to hoard cash.

Now it appears we’ve moved beyond the financial Armageddon.  We know the next few years and even decade will not be easy.  National debt levels have to be addressed.  Employment levels have to improve and we have the national health care bill to digest and it’s implications for business owners, high income earners, taxpayers with unearned income and increases to capital gains tax rates.

Investor Paralysis

In this period of an unsettled but slowly improving economy, now is the time to invest in quality assets.  What prevents investors from acting are the negative headlines we continue to be bombarded with.  Recent sales of high profile assets at prices 40% to 60% less than their 2007 transacted levels seem to set the bar for large and small investors alike.  What is forgotten in this splashy headline is the fact that in 2007 when those purchases were made, the investment community reacted in a similarly astonished way.  “They paid how much for it?” was the question around the water cooler back then.

Highly visible discounted transactions impact the rest of the market as well.  If a quality property comes on the market but doesn’t reflect such an adjustment in pricing it will be deemed to be priced too high.  Then it is either ignored by much of the investment community or offers come in that are so low only a very distressed seller would be willing to consider the offer.  This behavior is a detriment to long term investors who are passing over what could be a good addition to their portfolio.

Financing

It is true that in today’s financing environment lenders are underwriting conservatively.  Instead of 20-25% down they now require 30%-40% down and also require higher debt service coverage ratios than before.  Lenders seem to prefer Multifamily over other commercial property types as evidenced by interest rates and loan terms offered.  That being said, what the lenders do have to offer are low interest rates that likely will not be available for very long.

Investors need to evaluate how the combination of these factors impacts the overall yield on the investment as well as how it impacts their ability to perform.  A knowledgeable broker would be able to assist with this type of analysis.

We expect that banks will be forced to relax some of their stringent lending practices in the near future as cash piles up.  Banks exist to lend, that is how they make money. As their balance sheets improve you will see a greater willingness and increased competition in the lending arena which will help buyers afford to bridge the gap to purchase. We are seeing this happen now in the apartment marketplace and with SBA owner user business loans.  The recovery will be slower for commercial buildings.  In the mean time those with cash will have an opportunity to purchase with all cash and no financing, expecting to refinance within two or three years and those with a 30 – 40% down payment will also be able to get into deals.

Summary

Today, instead of evaluating properties based on proforma rents or improved occupancy levels or anticipated appreciation, values should be based on how the property is currently performing. Investors should use current rents and reasonable expense levels to determine the cash on cash return.  If that is acceptable and the property meets other physical condition and geographical criteria, buy it!

When the economy recovers, this property will likely show a strong improvement in overall returns from stronger cash flow and healthy appreciation and will make you look back to 2010 and say “boy that was a smart decision”.

We encourage you to start looking at properties now.  Our seasoned team of brokers stand ready to help you.

Marvin Kau

Bluestone & Hockley Real Estate Services

The end of 2010 is bringing with it a new era of Federal tax rate changes, most of which are not favorable to those with higher incomes and/or capital gain situations.  The changes to personal income tax rates along with lost or limited deductions and credits are too numerous and complicated for me to address in this brief article.  States are also repositioning their tax structures so attention needs to be given to investors living in States with an income tax.  Your CPA and/or Tax Attorney will be able to provide solid counsel for you when it comes to these matters.  However the changes to Federal capital gains tax rates and its impact to real estate investors is significant.

Beginning in 2011 if you sell a capital asset (apartment building, shopping center, stock) that has been held longer than one year and realize a profit, the tax you pay is going up dramatically.  Those in the upper income brackets (33% & 35% rate payers) will experience as much as a 33% increase in taxes owed while those in lower tax brackets (10% and 15% rate payers) will experience a much larger increase.  For those in the upper tax brackets the tax rate will jump from 15% to 20%.  Those in the bottom tax brackets will have gone from paying 0% tax on their long-term capital gains to 10%.

Tax Brackets: Married individuals filing joint returns and surviving spouses

What is happening?

Tax cuts that were put in place in 2001 and 2003 are set to expire at the end of 2010.  While the current administration would most likely desire to keep tax rates low to help the floundering economy they also realize the budget deficit has to be addressed.  Arguments for and against raising taxes and the corresponding impact on the deficit abound but it appears the current administration is set on letting the cuts expire.  In addition to the cuts being rescinded what we don’t know today is if there will be additional taxes placed on the upper tax bracket payers.  There has also been talk in congress of a 2%-5% surcharge on capital gain tax rates depending on the taxpayer’s specific situation which makes paying attention to these changes all the more important.

What does all this mean to you as a real estate investor?  The answer of course depends on your situation and your goals.  If you are a long-term investor who will continue to hold property for years to come, either the same property or selling and using a 1031 tax deferred exchange, then this increase has little to no impact on you.

If however you are thinking that in the near future you might want or need to sell a capital asset held more than a year than this tax change is very important.  Because of the significant jump in tax rates, it may be wise to consider selling before the tax rates change.  Due to the length of time it takes to close a transaction this means you should get your property on the market now. You’ll also need to price it realistically given today’s market conditions in order for it to transact in a reasonable amount of time.

Qualified Capital Assets

If you have multiple capital assets and wonder which one to sell now,  there is one benefit of the tax rate increases – the return of the “Qualified Five-Year” tax treatment.  This translates to a capital gains tax rate of 18% on the sale of qualified capital assets held more than 5 years. So while worse than the 15% that you would pay now, it is not the full tax increase to 20% for capital assets held less than five years.  (Not all capital assets are included in this carve-out so appropriate counsel is suggested.)

Installment Sales

In addition to selling now to save on taxes, selling on an installment basis may also result in lowering your tax bill or at least spreading out the payment of tax over years.  This is important when looking at your overall tax picture as the bump in taxable income from selling an asset may also result in lost or reduced itemized deductions, lost or reduced tax credits (education tax credits for example) and may trigger the Alternative Minimum Tax.  Our brokers can help explain how installment sales work but you will need a qualified attorney and CPA to help you structure those arrangements.

Installment Sale Example (for illustration purposes only, not to be relied on for your specific situation):

Property held more than 1 year.  Net Sales Price $1,000,000.  Purchase Price was $750,000.  Debt is $0.  Assume no depreciation and the acquisition was a direct purchase and not an exchange.  Also assume the taxpayer is married filing jointly with two exemptions (self & spouse), had income from other sources of $75,000 (wages, interest etc.) and $20,000 in itemized deductions (state income taxes, property taxes, home mortgage interest, charitable contributions etc.)

We should all pay our fair share, but not a penny more

Bottom-line is taxes are going up across the board.  With that in mind it is never too early to have a discussion with your tax advisor and real estate broker to develop a plan that works for you.  Bluestone & Hockley and our brokers are ready to help you evaluate your property and work with you on a solution that is best for your situation. ■

Lease

Yawma, LLC has leased 1,218 square feet total of office space at 519 SW Park Ave in Portland, OR.  Laura Pallin of Bluestone & Hockley Real Estate Services represented the landlord.

Lease

Brandsen has renewed their lease for 3,250 square feet total of industrial space at 4040 SE Powell Blvd. in Portland, OR.  Laura Pallin of Bluestone & Hockley Real Estate Services represented the landlord.

Lease

Foursquare Church has leased 1,800 square feet total of office space at 1122 NE 122^nd Ave in Portland, OR.  Steve Morris of Bluestone & Hockley Real Estate Services represented the landlord.

Lease

EPIC Imaging has renewed their lease for 14,989 square feet of office space at Plaza 102, 121 NE 102nd Ave in Portland, OR. Tom Sjostrom of Bluestone & Hockley Real Estate Services represented the landlord.

REO SALES

July 2010 – Gross REO Sales were $3.21 million. Properties were located in Sherwood, Boring, Salem, Beaverton, and Oregon City.

We are taking a close look at the most cost effective ways to tackle this problem while also conserving natural resources. A recent national study of multifamily dwellings revealed the largest consumers of water within an apartment unit are: 1) Toilets, which make up 26.7% of the water used in an apartment. 2) Clothes washing machines located inside an apartment, which are 21.7% of the water consumption and 3) Showers, which account for 16.8%.

The following are ways to decrease your expenses and also offer more earth friendly housing.

Toilet Retrofit
Depending on the age of your property, the water used by a flushing toilet will vary:

1930-1980 construction:           5 to 7 gallons used per flush
1980’s construction:                    3.5 gallons used per flush

In 1992 a federal law passed which required all new toilets to be 1.4 gallons per flush. 

Low Flow Toilets
If a toilet at your property currently has a 5 gallon tank, the switch to a low flow toilet means a 3.5 gallon savings each time a tenant flushes. If a toilet is flushed 4 times per day, that is a savings of 49 gallons per day. On an annual basis,at a 30 unit property, this is a savings of 529,200 gallons of water per year. If you are in the City of Portland, this translates into an annual water/sewer savings of $6,325 (at the current rate). In 2010, the City anticipates a 17.9% increase.

We expect the cost to install a new low flow toilet will be approximately $250 per toilet.

For a 30 unit property, the total cost would be $7,500. Depending on your cash flow, we may suggest this retrofit be staged over time, perhaps doing a single building or series of units each month. The significant water & sewer savings would be full appreciated in the 2^nd year.

Tank Bladders and Fill Cycle Diverter
While not as effective as a complete toilet replacement, in combination these two devices will save 4 gallons per day per unit. On an annual basis, at a 30 unit property, this is a savings of 43,600 gallons of water per year. If you are in the City of Portland, this translates into an annual water savings of $693.

Clothes Washers
We will now be purchasing Sears front loading washing machines (model 47511 and/or 26-47531). This machine uses only 14.4 gallons of water compared to the model we used to buy, which used 34 gallons. Assuming the average tenant does 4 loads of laundry per week, 78.4 gallons are saved per week. That is 4,076 gallons per year.

While the machines cost $180 more, after an Energy Trust $100 rebate, you will recoup your initial investment in water expenses in 2.5 years.

On a side note, for those with common area laundry facilities, please note that properties with common area laundry rooms versus appliances in each apartment use 39% less water.

Shower Heads (and Aerators)
Like most things, these devises have improved significantly in the last few years. Shower heads are another inexpensive retrofit which can significantly reduce your water consumption and expense.

Lease

State Farm Ins. renewed their lease of 1,170 square feet of office space at 10582 SE 82^nd Ave in Milwaukie, OR.  Tom Sjostrom of Bluestone & Hockley Real Estate Services represented the landlord.

Lease

Dale Marcum, D.C., LLC renewed their lease of 1,960 square feet of office space at 12425 NE Glisan Street in Portland, OR.  Tom Sjostrom of Bluestone & Hockley Real Estate Services represented the landlord.