A way to Survive!!! Why Apartment Buildings should be in your financial plan!!!

The interest rates are going up and the value of real estate will be going into a valley soon.  It happened before and we survived it and it will happen again.  I am 72 years old and I’ve seen it before and, GOD willing, I’ll see it again.  But there is one way to get through it.  You can’t panic when it happens, you have to start planning NOW!!!

If you bought a single-family home as an investment when the market was favorable, then you have a nice asset today.  But what happens if we go into a recession and your tenant loses his job.  If you have one house and it is empty, you have 100% vacancy.  That’s not good.

And, while all this is going on the stock market is taking a dive and your net worth is going down the toilet.  Dividends that you used to rely on to live and eat may be gone because your investments are not doing good and they can’t afford to declare and pay a dividend.

The way to make it through a recession or a fall in real estate prices is not to panic and own a multifamily dwelling.  But assuming that you do not now own real estate you have to start out like this.  If you have some capital then purchase as many single-family homes as you can first.  Leverage your investments because putting a lot down on one house is wrong but putting something down on three homes makes more sense.  Like I said before, if you own one investment home and it is empty, then you have a 100% vacancy factor and instead of making money you are losing money every month.  But if you have three single family homes, then if one house is vacant, your vacancy factor is thirty-three percent and the two remaining rented units will pay for the one vacancy.  Don’t put all your eggs in one basket!!!

Then, after the market turns around and there is real appreciation you should sell the houses and buy one multifamily apartment building.  Your ratio of land to units goes down and it turns out to be cheaper to have one apartment building instead of three or four houses.  Management is also easier as all the units are in one place and are not miles apart.  Either you or a management company can manage the property, keep the rents up and take care of the maintenance that is needed.

Here is the point where I can go into a discussion of the tax law and Section 1031 exchanges but I will save that for another blog.  By the way, I am probably the only realtor in the State of California with over fifty years as a practicing Certified Public Accountant.  An asset that can help you with tax planning and maximizing your profits and reduce your taxes.  And I work with a team of estate planners who can show how to pass the assets in your estate through to your heirs with a great tax benefit.

But let’s get back to protecting our assets and growing your estate.  I read an article recently that said that the better off middle class are renting luxury apartments.  Why do you ask? With housing prices where they are and interest rates rising even the well-to-do, those earning about $150,000 per year cannot qualify for mortgages and the payments on the house.  And you have to add property taxes that, in Los Angeles County, start at 1.25% and go up from there.  Then, in newer developments, there is Mello Roos.  This is like an additional tax to pay the cities back for the streets, sewers and other infrastructure.  They add it on to your real estate taxes and it is NOT deductible on your tax return.  That might bring your tax rate to about 2% per year.

Let’s say you buy a house for $600,000 with a combined tax and Mello Roos rate of 2%, you have to add $1,000 a month to your mortgage payment.  And to round things out you have to pay homeowners insurance.  And if something breaks you don’t just call maintenance from your apartment complex, you have to find someone to fix it and pay for it, and the landscaping costs more money.  So, houses are expensive.  Yes, you have appreciation and ownership, but nothing is guaranteed.  

And, under the new tax law you can only deduct $10,000 in total State and Local Income Taxes.  If you live in California and own a home where your real estate taxes are $1,000 per month you already are losing deductions.  When you add State Income Tax and Sales Tax you are losing deductions left and right.  Your real estate taxes and mortgage interest used to reduce your income tax obligation making your house “pay for itself”.  But that's gone now.  And, don’t even let me get started with mortgages over $750,000 and refinancing but not using the money for home improvements.  You can’t deduct home mortgage interest on mortgages over $750,000 and, if you refinance, you must use the money to improve your property or else it is not deductible.

But if you own an apartment building you are charging rent to offset those expenses, there is no limitation on Real Estate Taxes and Mortgage Interest.  So, you can deduct all expenses against your rental income and then you can deduct DEPRECIATION!  I was an Associate Professor of accounting at California State University Los Angeles for six and a half years.  By definition, depreciation is the systematic allocation of cost of a fixed or non-monetary asset over the period of benefit.  In English that means that you get to reduce your taxable income every year for 41 years by taking a percentage of the cost of the building (not land) against your income thereby reducing your taxes without paying one penny.  By taking depreciation as a deduction you can end up with a loss on your tax return on your rental property to offset other income like wages, interest, dividends, etc. in the early years.  So, your tax is less tax which results in paying the government less or getting back a larger refund.

Now you must be asking yourself, why is he telling me all this?  We are headed for a recession.  Nine out of ten people in the know will tell you that.  When interest rates rise and people cannot afford to buy houses, jobs are lost.  When interest rates rise people cannot afford to buy cars, jobs are lost.  So, investing in apartment buildings is a smart idea.  Also, as rents go up and land values go up the value of your investment goes up and you can always pull out tax free cash by refinancing the property to use to purchase other real estate or personal items.

I’ve seen families get together and invest their money this way.  I’ve seen young men, in their late thirties, amass a lot of equity and money investing this way.  It is a great hedge against inflation and it is one of the best strategies in a recession.  

Now, how do you get started?  When I started out in Real Estate I bought and sold single family residences for my clients.  Then I was presented with the opportunity to sell a piece of land in Sherman Oaks.  I sold a 20,000 square foot piece of property that was originally valued at $2 million for $4.6 million and I sold it to a developer.  We are going to put a fifty plus unit apartment building on the property and sell it for over $30 million.  Having been an accountant for over fifty years I have associated myself with some wonderful professionals.  I work with business attorneys, estate and trust attorneys, loan officers, building designers, building developers, financial planners, etc.  We would arrive at a budget based on your particular financial situation, set up the correct company structure for your project to protect your assets as well as take advantage of all of the applicable tax laws, plan the development, choose the right developer, get financing, build the building and either sell it or hold it.  We would hire a management company to rent out the units and manage the building.

Once we get a certificate of occupancy from the city we would rent the units and manage the building and run it as a business for one year and one day.  You see, if you sell the building right away you have what is known as “ordinary income” and it is taxed at close to 40%.  If you hold on to the property for one year and one day then sell the building you get a “long term capital gain” and pay taxes on the gain at only 20% Federal and some State tax.  Also, during the year that you hold the building and rent out the units you are either making cash flow or reducing your expenses.

Certified Financial Planners would want you to invest with them.  They would invest your money in various funds and investments.  You have a chance of making a decent return on your investment or, on the other hand, you can lose your investment.  In the stock market or other such investments some of your individual investments can go down to pennies or go bankrupt.  In Real Estate, and especially Apartment Buildings, that’s never going to happen.  And, even though it takes some time, you can sell an Apartment Building and cash out any time you want or you can refinance the property and pull-out tax-free cash as I said before.

Lastly, when you own an apartment building or any other real estate and you pass away, the property goes to your heirs at Fair Market Value.  Your heirs can sell the property and realize NO GAIN and pay NO TAXES on the difference between what you paid for the property 40 years ago the present market value.  And that’s been around for a very long time and it’s not going to change any time soon.  How do you think the rich people save taxes?  This is one way!!!

For more information and an education please contact me to help plan your future and your family’s future.  My name is PAUL LEVINE and my telephone number is (818) 298 – 4000.  I am a realtor and associated with Crown Real Estate & Funding, Inc.  We have a full staff of expert Brokers and Realtors to create the team to help you build wealth and cash flow which equals financial security.  Remember, no one has the background I do and I am the team leader.  I’ve told you about the resources I have, the builders, attorneys, tax experience, etc. that no one else has.  We consider each project a challenge and we want to see if we could be more creative each time we get an assignment.  Of course, we are here to meet YOUR needs so we listen to you very carefully so we can help you define and reach your needs, wants and desires.  Most people care about what they want to say to you, to sell themselves to you.  We listen to you because you are the most important person in our lives.  I am UNIQUE and I will work very hard for you!!!