Bluestone and Hockley Real Estate Services
Just yesterday I was meeting with a client, trying to help her make the right decision about the timing of the sale of her real estate investment. Her 20-unit apartment property is located close to a major shopping center and freeway arterials.
The decision regarding this property was complicated by some limited deferred maintenance; the asphalt and siding especially needed some repairs. In addition, some of the units were moldy and upon further investigation we discovered that most of the downspouts to her building were not hooked up. This forced water to leak back into the apartments.
She asked hard questions.
- Is it worth investing in the property if I am going to sell it anyway? Why not sell it “as is”?
- Will I get more money back if I make the repairs?
- How long should an investor hold a property?
- Does it make a difference if I have no more tax shelter because I have paid off the property?
- My children think that investing in real estate is too complicated. They don't want to deal with tenants and their problems. Since they don't want the investment what do I do?
- Are rents going up enough in this period of high vacancy to justify further investment, especially given the increases in property taxes, utilities and maintenance costs?
These questions are all answered if we set investment goals for ourselves. Most investors are lured by the call to real estate and the many different investment strategies, but have a hard time implementing a strategy. Additionally, nothing ever goes as planned so it can be difficult to hold to a strategy.
Most people start investing when they are in their forties and sell their investments when they are in their late sixties or early seventies. Their real estate investing is aimed at having cash flow in place for retirement, and then a gift to children or grandchildren or to charities. These time frames are extending as we see investors live longer.
I would suggest that all properties are worth maintaining. Deferred maintenance only creates extra problems when renting up or selling a property. This in turn holds the values of the property and gives you more flexibility when you are making the sell decision. This also gives you the option of attracting more quality tenants that may stay with you longer. On the other hand, you use more cash flow to achieve this.
Strategies for investing in real estate change depending on your income, your age, and the extra cash you have. They also change if you are strictly an investor or a dealer in real estate. Much depends on your time frame. Pay attention to your investments. Finally, these strategies also depend on your risk tolerance. If you run a pension fund, your risk tolerance is significantly less than if you are of the gambler mentality.
One option favored by investors is to buy low, depressed, good deal properties with some upside and then improve them to gain the upside and sell off later, possibly within a couple of years. Hopefully the profit will be enough to pay your capital gain taxes when you sell (20% federal, 9% state in Oregon *).
Another option is to buy a quality property (most likely more expensive) and hold onto it for a longer period of time, (five to ten years), refinance, and use the equity earned to buy another property.
A third option is to hold the properties you buy and pay them off over twenty to thirty years. We have clients that have paid off their properties and the second generation is shepherding the investments using the cash flow to make improvements and buying or developing new properties.
A fourth option is to buy a property and trade up every four or five years to a bigger property or properties, using a 1031 exchange. The basis carries forward, deferring the capital gains tax liabilities.
Another option is to pay cash for a property. Most investors do not do this because they want the interest write offs that Uncle Sam provides, but it is a legitimate option drawn from the annals of the recession.
Finally, investors that inherit real estate and have paid the inheritance taxes, receive the real estate at a new cost basis and start depreciating once they have received the property.
Each one of these strategies is valid and can lead to a successful real estate investment experience, but you have to pay attention to your property. The minute you take your “eye off of the ball” things happen that you don't expect.
Clearly, four things drive the strategy decisions investors make: federal, state and local taxes, the availability of cash, the availability of time and the passionate interest in real estate. The only goal we can all agree on as investors, is that it is our objective to make money with the investment, either now or in the future. There are no clear-cut answers to setting one successful strategy. What an investor needs to do is the look at each strategy and decide which is the best one.
* Current Capital Gains Taxes The maximum capital gains tax is 20 percent for assets held at least one year for taxpayers in the 28 percent and higher tax brackets. For assets held less than one year, the regular income tax rates apply. For assets acquired after January 1, 2001 and held for at least five years, the maximum tax rate will be 18 percent. Gains arising from previous depreciation deductions are taxed at ordinary rates. Gains attributable to straight-line deprecation on real property have a maximum tax rate of 25 percent. For taxpayers in the 15 percent income tax bracket, the capital gains tax rate is 10 percent for assets held at least one year. For assets held at least five years by taxpayers in the 15 percent tax bracket and sold after January 1, 2001 the tax rate is 8 percent (Information supplied by Ross Korves, Chief Economist, American Farm Bureau Federation, September 2001).