How The New Tax Code Benefits Commercial Real Estate Investors

The Tax Cuts and Jobs Act of 2017 (TCJA) was the most substantial tax reform legislation enacted since 1986, when the Tax Reform Act of 1986 was passed to simplify the income tax code. Changes to the tax code by the TCJA are effective for tax years after December 31, 2017.

Here’s a quick overview of how the new tax code benefits commercial real estate investors.

Original Use Requirement Removed

The original use requirement for assets that were acquired and placed in service after September 27, 2017 was removed by the TCJA. Cost segregation studies can now be performed on newly acquired property and new construction to identify the personal property assets in the building and accelerate the depreciation.

Depreciation for Qualified Improvement Property

The definition of qualified improvement property was consolidated to make it eligible for bonus depreciation. Previously, improvements needed to be in qualifying leasehold, retail, or restaurant property. The TCJA changed that to allow for all improvements to the interior of commercial rental real estate – except for inside structural framework, elevators and escalators, and building enlargements – to be classified as improvement property.

On its website the IRS details section 179 and temporary bonus expensing for certain business property and assets.

Mortgage Interest

Commercial real estate investors are now able to deduct 100% of the mortgage interest paid on their commercial properties. However, for businesses with more than $25 million in gross revenues, the net interest expense deduction is now limited to 30% of earnings (before interest, depreciation, taxes, and amortization).

Pass-Through Taxation

Pass-through entities such as real estate partnerships and LLCs will now pay a top individual tax rate of 37%, with the pass-through business income eligible for a 20% deduction. The net effect of these changes is that the top tax rate on business income could be 29.6% compared to the previous top rate of 39.6%.

Historic Preservation and Rehabilitation Tax Credit

Developers renovating certified historic structures will still receive a 20% tax credit claimed over a five-year period. On the downside, the previous 10% credit for non-certified property constructed prior to 1936 was eliminated.

Like-Kind Exchanges

No change was made to section 1031 of the tax code. Commercial real estate investors can still benefit from using like-kind tax deferred exchanges to defer the payment of capital gains tax by selling an investment property and replacing it with another.

Impact on Multifamily Investments

While the TCJA provides several tax benefits to commercial real estate investors, homeowners didn’t benefit nearly as well.

While interest on existing mortgage debt of up to $1 million can still be deducted, interest can only be deducted on new mortgages of up to $750,000 and home equity loan deductions are no longer allowed. Deductions for state and local taxes are now capped at $10,000.

The reduction and elimination of these homeowner tax deductions makes owning a home more expensive in urban centers and high-tax states such as California. Multifamily real estate investors may benefit by offering alternative options to homeownership in central business districts, and by meeting the demand for housing as residents move from expensive city centers to more affordable suburban areas.

Real estate niche analysis

real estate niche

If you’re a new agent or investor, focusing on a single real estate niche will help jump start your business. Or maybe you’ve been in the business for a while but feel like your real estate business plan needs a reboot.

Concentrating your efforts on a single real estate niche will help separate the good clients from the bad ones, and help choose the real estate investments that are right for you.

A real estate niche can be an asset class

One way of thinking about real estate niches is to look at the different types of real estate available. Real estate asset classes can be divided into four categories:

  • Residential
  • Commercial
  • Land
  • Special use

There are a lot of different types of real estate that go into each of these four asset classes. To fine-tune your real estate business plan and avoid real estate burnout, you’ll want to break down these big real estate niche asset classes into something smaller.

Small real estate niches make up bigger asset classes

The next steps is to break down the four big asset classes above into sub-classes or smaller real estate niches. Let’s use the commercial real estate asset class avoid as an example.

Some of the types of real estate and activities that fall into the commercial category are:

  • Retail
  • Office
  • Warehouse
  • Industrial
  • Single tenant or NNN
  • Apartment buildings
  • Leasing
  • Buying
  • Selling
  • Property management

You can probably think of more, but you get the idea. Now, let’s take the office real estate niche and break it down a little more.

Office real estate niches

The office real estate niche can be divided up a number of different ways:

  • Size of property – single or two levels, midsize, or high rise office building
  • By class of property – typical office building classes are A+, A, B, and C
  • By how the office building is used – medical, professional services, consumer-related services (such as banking, collections agencies, or telemarketing), and general office use
  • Location of property – central business district, suburban office markets, or mixed-use office/residential

Choosing the real estate niche that’s right for you

The types of tenants and the types of owners for each of these office niches are different.

For example, a Class A office building in a central business district will likely be owned by an institutional investor. The types of tenants in this type of building will be white collar and professional service businesses.

The demands and expectations of these property owners and tenants will be much different from the mom-and-pop bookkeeping firm renting space in a smaller office building in the suburbs.

Successfully choosing the real estate niche that’s right for you means understanding your own preferences, strengths, and weaknesses and selecting the best match that will lead to your real estate success.

How To Buy A Home In A Safe Area

buy a home in a safe area

Buyers are often surprised to find that if they want to buy a home in a safe area, they oftentimes need to do their own research.

That’s because many laws – especially in the U.S. – prohibit real estate agents from telling buyers about the safety of an area.

Here are three easy things that can help you to buy a home in a safe area.

Buy A Home In A Safe Area With Multiple Visits

Many home buyers make the mistake of only visiting the home they are buying once or twice.  And that’s usually at the same time on the same day of the week.

To make sure that you’re buying a home in a safe area it’s important to make multiple visits are different times.

Going by the house at midnight on a Saturday is a great way to find out if there are a lot of noisy parties.

Visiting in the early evening or weekday mornings is a good way to see what the neighborhood is like when people are home.  It’s also a good way to meet your potential new neighbors.

Talk To The Neighbors

Speaking of which, there’s nothing wrong with introducing yourself to your next door potential new neighbor.

In addition to making new friends, it’s also a good way to gather intelligence about the home you’re thinking about buying.

Online Research

There’s so much information on the internet today that can help you to buy a home in a safe area.

Things like crime statistics and locations of sex offenders are important.  Aerial views of the neighborhood, and the locations of schools, churches, and shopping centers are also just a few key strokes away.

 

How To Get Buyers To Pay More

get buyers to pay more

Here are three easy ways to get buyers to pay more for your property.

These tips work in both a hot real estate market and cold real estate market, and for both commercial real estate and residential properties.

First Impressions Count

Experienced negotiators understand that first impressions are lasting impressions.  Once people have made a subliminal decision, it’s very difficult to get them to change their minds.

That’s why making a positive first impression is key to get buyers to pay more for what you’re selling.

In real estate that’s also known as curb appeal.  Well kept landscaping, no litter, and if you’re selling commercial real estate no vagrants hanging around the property.

You’re going for what’s known as the ‘Wow Factor’ when prospective buyers pull up the curb.

No Deferred Maintenance

Deferred maintenance items are things that need to be fixed or repaired but haven’t been.

Items like peeling paint, a loose shingle, or a small graffiti mark on the fence can be innocent enough.

But they can also make a buyer wonder why they haven’t been taken care of – especially if you’re selling your property.  Even worse, deferred maintenance that a buyer can see will also make the buyer think about things that can’t be seen.

Take a loose roof shingle for example.

A loose shingle means that water can get into the inside of the roof, which means dampness and potential mold issues.  Which in turn means potential health issues for the occupant and unknown legal issues for the new property owner.

Get Buyers To Pay More With A Good Story

Another key to getting buyers to pay more is by having a good story to tell.

As a seller you’ll need to be honest with yourself about the problems with your property.  Look at your real estate from a potential buyer’s point of view.

This doesn’t mean you need to apologize.  But it does mean you should foresee as many potential objections or questions as possible, and know ahead of time what your answers are going to be.

A smooth, practiced response goes a long way to convincing a potential buyer that they’re making the right decision to purchase the real estate that you’re selling.

Secrets Of Running A Real Estate Business

running a real estate business

Running a real estate business that’s successful isn’t as easy as it might seem to be at first glance.

Here are a few secrets to running a real estate business.

Have A Real Estate Business Plan

It’s surprising how many businesses – both in and out of the real estate industry – don’t actually have a business plan.  Owners of business start-ups oftentimes take the ‘fly by the seat of your pants’ approach and make things up as they go along.

Running a real estate business without a detailed, long-term plan is a recipe for disaster.

Business planning pros always suggest that after putting together the profit-and-loss statement for your real estate business, you should decrease your projected revenues by 50% and double your expenses.

If you’re still cash-flow positive after this exercise, your real estate business is very likely to succeed.

Strong Administrative Support

Most people that think about running a real estate business do so because they’re good at sales.

And in real estate, the more you sell the more money you make for yourself and your new real estate brokerage.  If you’re the rain maker – the person that’s great at attracting new business and closing deals and working with lenders – that’s fantastic.

But running a real estate business also requires strong back office people and administrative support to assist with your time management.  Tasks such as answering the phone and distributing leads, making sure bills get paid on time, and paying agent sales commissions are just a few of the countless items that fall into this category.

Choose Your Real Estate Niche

Businesses they try to be all things to all people end up failing sooner rather than later.

One of the keys to running a real estate business that’s successful is to pick a niche and stick to it.

Examples of real estate business niches include residential or commercial, buying & selling or leasing, property management, and vacation rentals.

Relationship Between REITs and Rising Interest Rates

reits and rising interest rates

In today’s rising interest rate environment, many real estate investors are wondering what the relationship is between REITs and rising interest rates.

Here are three factors to consider.

Asset Quality of the REIT

Experienced real estate investors understand that not all real estate assets are created equal.  That’s why a time-tested truism is that real estate is all about location, location, location.

But in a hot market with real estate prices rapidly rising year after year, it’s easy to forget about quality and focus solely on quantity.  Sometimes traditional real estate companies do this all too often.

As interest rates continue to rise, REIT managers may have a hard time refinancing if they made the mistake of buying a low-quality asset at too high of a price.

Property Loan Refinancing Timelines

Loans on commercial investment real estate and larger multi-family property are usually made for only a few years at a time.  That’s because lenders know that volatility in the real estate market can appear at any time.

Another reason for short-term real estate loans is that lenders what to ensure that the asset is being maintained and that the real estate property management is top notch.

It’s important for both residential and commercial REIT investors to understand when each individual loan becomes due and what the prospects are for refinancing.

Real Estate Assets of the REIT

Investors concerned about REITS and rising interest rates should also investigate the quality of each individual asset that the REIT owns.  This will help to identify potential problems when the time comes to refinance.

Some items to research include:

  • Uniqueness of property
  • Competitive environment
  • Occupancy and tenant types
  • Asset class – retail, office, industrial, multi-family residential
  • Economic drivers of the market area

REITs and Rising Interest Rate – The Crowdfunding Alternative

Investors who are worried about specific REITs and rising interest rates often find that crowdfunding can be a good alternative to buying a publicly-held REIT.

That’s because crowdfunding organizations such as RealtyMogul and Fundrise raise capital for one specific asset purchase at a time.  This makes it much easier for the individual real estate investors to determine whether the real estate investment makes sense for their portfolio.

 

How To Calculate A CAP Rate

calculate a cap rate

There are two pieces of information that real estate investors need in order to calculate  a CAP rate or Capitalization Rate:

  1. NOI or net operating income of the asset
  2. Sales price or current market value of the asset

CAP rates are useful for comparing the performance of a real estate investment to similar properties in the market, to calculate what a sales price should be based on the property’s NOI, and determining what the net operating income should be based on the CAP rate of a property that’s for sale.

The CAP rate calculation can be used for residential and multifamily property, commercial investments, and even land.

Formula To Calculate A CAP Rate

The formula used in a CAP rate calculation is pretty straightforward:

CAP Rate = NOI / Sales Price

Let’s say we have a small multi family rental property investment that is generating $100,000 in net operating income each year.  The owner decides to sell and lists the apartment building for sale for $2 million.

The CAP rate is: $100,000 NOI / $2,000,000 Sales price = 5% CAP rate

Why Is A CAP Rate Used?

In addition to comparing alternative real estate investments in the same market, the CAP rate formula can also be used for calculating what a sales price should be and in determining what a property’s net operating income should be based on CAP rates for similar properties.

For example, if our apartment building above is listed for sale with an asking price of $2.5 million and market CAP rates for similar properties are 5%, then the property’s NOI should be:

$2.5 million x 5% = $125,000 per year

Based on the capitalization rate calculation the property is over priced compared to its peers.  Now, maybe there’s a good reason for this or maybe not.  That’s up to the buyer and seller to determine.

What Is A Good CAP Rate?

CAP rates for specific asset classes vary from market to market and sometimes even from neighborhood to neighborhood.

A good CAP rate for one investor will be a not so good CAP rate for another investor.  That’s one reason why it’s dangerous to call a CAP rate good or bad in and of itself.

But capitalization rates are useful for quickly comparing one real estate investment to another, and also return on investment for specific asset classes from one market to another.

How To Analyze The Cost Of A Condo

analyze the cost of a condo

Many first time buyers and even some real estate agents misunderstand how to analyze the cost of a condo.

Here are a few things to consider when analyzing the cost of buying a condominium.

Analyze The Cost Of A Condo – Balance Sheet Reserves

The financial strength of a condominium association or strata has a big impact on the actual cost of buying a rental property such as a condo.

Condo buyers make the mistake of looking only at the profit and loss statement of the association.  They almost never look at the balance sheet showing the reserve budget.

The profit and loss statement can show a positive cash flow.  But the condo association may have very little money in the bank for an unexpected common area repair.

Budget Reserves Are A Big Deal

When a condo association needs money and doesn’t have it, the condo owner gets billed for a special assessment.

While the phrase sounds innocent enough, what it really means is that the association didn’t plan properly by saving money for a rainy day.  And the owners are the ones who will have to pay.

That’s why looking at the amount of reserves are so important when a buyer wants to analyze the cost of a condo they’re thinking about purchasing.

Imagine if you’re the owner of a condo – especially if you’re a first-time home buyer – and all of a sudden you have to pay $1,000 extra per month for the next 12 months to cover your share of an un-budgeted expense.

Land Loans And Real Estate Financing

land loans

Land loans is a term that frequently comes up when selling real estate.

Despite the name, land loans aren’t just for selling land – although that’s how the term originated.

Other Names For Land Loans

Other names for land loans are deeds of trust, seller financing, or private equity loans.

The term ‘land loans’ comes from a type of seller financing – as opposed to traditional bank or lender financing.  A land loan is when the seller retains title to the ‘land’ until the loan is paid off.

Why Use Land Loans?

There are three ways that land loans are generally used to buy and sell real estate:

  1. An owner has a property that is difficult to sell.  Maybe it’s a buyers market or the seller doesn’t have the money to make repairs.
  2. A buyer can’t qualify for traditional bank or lender financing.  The buyer may have credit issues or wants to use the property for an unconventional use.
  3. A legal technique where a seller can defer payment of capital gains tax

Let’s Make A Deal

Land loans are a creative way to finance real estate.  There are no hard and fast rules to follow, so selling real estate using a land loan can be tailored to the specific needs of every buyer and a seller.

It’s always a good idea to have the sales contract in writing.  Many buyers and sellers using a land loan also like to have an independent third party handle all of the loan payments and disbursements as well.

Last but not least, a seller carrying a note with a land loan should always think of him or herself as a bank.  Especially if they decide they want to sell the deed of trust to an investor before the note becomes due.

Should You Sell Real Estate Full Time?

sell real estate full time

Many people consider giving up their day job to sell real estate full time.

Getting that first or second sale isn’t that difficult.  But what is difficult is working in the real estate business full time.

Here are a few things that will help you decide if it’s a good idea for you to sell real estate full time.

Have A Real Estate Business Plan

Putting together a realistic real estate business plan will help you decide whether or not selling real estate full time is right for you.

When putting your business plan together for your new real estate career, remember that it’s always better to be safe than sorry.

Be overly pessimistic about your projected income and expenses for the first several years.  Many business planning experts suggest that after you have what you think is a conservative business plan you should cut the revenues in half and double the expenses!

If You Sell Real Estate Full Time, Treat It Like A Business

Realize that business – just like nature – does not move in a straight line.

One very successful quarter or year doesn’t mean that the trend is your friend.  Smart real estate entrepreneurs know that there are always peaks & valleys . . . and some valleys can be deep for a very long time.

Consider Having A Real Estate Business Partner

Some people like having a business partner while others prefer to go it alone.  Having a partner or a mentor is one way to achieve a good work/life balance in real estate.

Advantages to having a business partner are the sharing of risk and having access to extra start-up capital.

If you have a real estate business partner, just be sure to clearly define the responsibilities of each person involved.  This will help to avoid conflict down the line.