Before a lynch mob is dispatched…let me clarify: I’m still a huge proponent of real estate investing!  It’s just that residential investments rarely cash flow…you have to wait to make your money at sale from appreciation.  And you can’t afford to have someone else manage the units for you in most cases.  Banks limit you on how many residential investment loans you can have…but they don’t care how many commercial loans you have active.

Take Off Your Training Wheels-

Rumor on the street is that banks are again permitting a prospective borrower to have up to 10 residential loans. Legally you

can have as many as you want of course…its just that lenders won’t underwrite loans past 10 residences. (This is a reversal from a year ago when Freddie Mac tightened up standards to permit only 4 loans.  Fannie Mae adopted the stricter rules shortly thereafter.)

Will the banks  change course again and tighten up standards anew? Rather than shout: “Hurray!” and buy more residential investment properties, I advocate a different strategy.

Convert your multiple residential property equities into a single commercial investment.

Here’s an example:  I have a friend that has 10 single family homes, nine of which are investments. He holds many of them “free and clear” while others have small balances.  He can sell off some of the homes and use a 1031 Exchange to defer taxes, converting the proceeds into equity for a commercial property downpayment.  He can also put new loans on the remaining house to add still more.  Banks are currently writing loans of up to 70 to 80% LTV on investment properties where cash is being taken out at refi.  When this is done my friend will easily be able to acquire sufficient funds ($250-350,000) to buy a commercial property like Heather Joy, currently listed at $779,000.  The advantage of Heather Joy is that he will be able to manage 8 units by going to a single address…a significant improvement in efficiency.

The next step up would be to take an even greater portion of his existing portfolio equity and purchase a larger asset like the 18-Unit South Towne. That $1,150,00 property would require approximately $350-450,000 in equity to purchase.  It has enough units that we could now afford MBO…Management By Others.  That means that my friend would transition from running all over town to manage 9 single family homes to reviewing the results created by the management company.

To take this further…if my friend’s holdings were enough that he could combine equities to add up to $1,200,000…he could purchase Los Verdes, available for $3,200,000.  That property is large enough to not only have management by others…but an on-site manager.  Contrast owning 53 units in one spot that are managed by someone else vs. running all over town to manage and maintain 9 single family homes.

Summary:  You will make more money, receive it earlier, and have fewer headaches…when you transition to Commercial Real Estate Investments.

Call Rick Bean at Rose City Commercial Real Estate for a no cost, no obligation assessment of your investment options.

Summary:  Cost Seg. is an underutilized strategy that commercial real estate investors can employ to reduce their taxes, improve their ability to fund new properties and increase their purchases.  Below I have adapted information provided me by one of the nation’s leading authorities on Cost Segmentation Studies.

As we all have enjoyed our Holiday Season, sadly the next event we face involves the perennial tax deadlines.  This year you could apply cost segregation and save considerable money. Cost Segregation is the least utilized and most cost efficient way to save tens and even hundreds of thousands of tax dollars on the commercial properties that you own, represent or manage. Unless you take action soon, you will forgo these tax deductions.

Reasons why you should learn more about Cost Segregation: Cost segregation is the spigot that taps the hidden “cash flow” in every commercial property, including apartments. Less than 10% of all commercial property owners have utilized cost segregation. The reasons vary but in general it is due to a lack of awareness and because the 1997 Supreme Court ruling requires than the cost segregation be prepared by an independent cost-engineer – not an accountant. In addition up until 2001, the cost of cost segregation services were prohibitive – this is no longer true.

Recent court rulings and changes in IRS filing procedures make this tax savings benefit fully accessible to owners of any size commercial property.

Property owners now need only file a single form accompanied by a cost seg report prepared by an independent cost engineer — no costly, formal, multi-stage appeal process is required. You can even file for a previous year’s reduction in Federal and state taxes. All these funds are “hidden cash flow” for the business owner. These monies become a new source of investment capital. In addition to these Federal tax benefits there are other significant monetary gains.

Big Dollar Returns – TRIFECTA of Cost Seg

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When investors buy any commercial real estate they are acquiring a revenue stream.  Admittedly there are a few signature buildings that are so iconic that they are a ”pride of ownership” acquisition, but most properties are valued solely for their future economic potential.  There are four primary ways in which investors benefit from their acquisitions:

1. Cash Flow

is the sum of:  Cash In - Cash Out.  The primary source of inflow cash is rent.  Pet rent, late fees, laundry and owner contributions are also part of the cash in stream.  Cash Outflows include taxes, expenses and distributions to owners.

Owner types vary widely on the importance they place on distributions:

• Residential Multifamily properties (2 to 4 units) and smaller Commercial Multifamily properties cast off little cash.  Their owners tend to focus more on equity gained at the time of disposition.
• Investors of larger properties often use cash flows (distributions) as a primary source of spendable income.  They certainly expect gains at sale, but they often will use that gain to step up in basis to acquire a larger asset in the hope of increasing the monthly cash-flow.
• The bane of all investors is the much dreaded Cash Call.  When cash out ‹ cash in to the extent that operations are impacted, the property owner(s) are forced to add cash to keep expenses current.  Because of their focus on maintaining regular, dependable distributions, the owners of larger properties tend to have lower LTV loans.  This doesn’t eliminate cash calls, but it does make operations inherently more stable, reducing the likelihood of requiring additional cash.

2. Appreciation

is Future Disposition Price - Original Acquisition Price.   A 53 unit complex that is purchased for $3.2 million is 2007 appreciates $700,000 if it is sold for $3.9 million several years down the road.

• Appreciation gains can occur from (external) market forces such as a downward trend in Cap rates, or from increases in rent relative to expenses due to high demand.
• Gains can also be “forced” by internal forces.  This occurs when we reposition a property.  Renters will pay more for upscale amenities and newer looking accommodations.  Success requires having the amortized costs of improvements be exceeded by the increased rents.  In some cases we merely seek to raise the rents on the existing renters; other times we are using the upgrades to attract a new tenant profile.

3. Loan Paydown

is determined by subtracting the initial loan amount from the remaining loan balance at any given time.  Suppose a $3,200,000 property is acquired with a roughly 65% LTV loan at 6% with a 30-year amortization.  Day one the beginning loan balance would be $2,000,000.  42 months later (3-1/2 years) the loan balance would be $1,909,649.  The loan paydown amounts to $90,351 for that period. Read more

Residential Multifamily (RM) definition:  Typically regarded as 2 to 4 units, or “doors”, with 5 units and up being considered Commercial Multifamily (CM).  Many multifamily investors start by purchasing a duplex, triplex or quad; living in one unit and renting out the balance.

Residential Multifamily Pluses and Minuses: One advantage of a plex investment strategy is that lower downpayments are permitted by banks…sometimes as low as 5-10%.  RM loans close much more quickly with fewer requirements than CM loans.  It’s easier to keep a watch on your renters when they’re next door, too.  Prices per door are lower than single family homes…an area where starter homes are $225,000 is likely to have duplexes and even triplexes for not much more.

The inherent nature of plexes is that their pluses are also a source of their weakness:  living next to your renters means they always know when you’re home.  From the renter’s perspective you are always available to discuss their maintenance problems and “wish list” of improvements they would like you to make (without compensation.) You are more likely to become “friends” rather than business associates.  It’s harder for most to enforce rent timeliness on friends.

Plexes tend to produce low Cash Flow, a reason they are eschewed by some investors.  Cash Flow is simply the monthly amount remaining from:  (All Income) – (All Expenses, including taxes, insurance and debt service).  With fewer units to amortize expenses over, plexes can’t compete with the functional efficiency of commercial complexes.  As a result, the plex investor focuses primarily on returns gained over time from appreciation.  Those gains are that are reaped at resale or refinancing of the property.  Contrast this with the investor of larger investments that expects to make a higher downpayment (20 to 40%) and recieve monthly distributions from profitable operations.  (In addition to appreciation.) Read more