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.

Top 5 Benefits of Investing in Real Estate as Part of a Portfolio

Investing in real estate is an excellent way to diversify your portfolio with a physical asset that generates income while simultaneously acting as a hedge against inflation. Due to consistent demand, real estate values also increase over time, increasing the potential for profit even more.

Industry experts list these top 5 benefits of having investment real estate in a portfolio:

#1 Passive Income and Increasing Values

The value of real estate keeps increasing for two reasons:

  • Rental rates, particularly in the multifamily housing sector, are continuing to rise due to demand.
  • As more investors look for quality real estate opportunities, increased bidding activity results in cap rate compression and increased values.

Income-producing real estate also generates passive cash flow month after month. Passive income can be used to pay off mortgage debt sooner, build equity faster, and leverage that equity to purchase more property.

#2 Tax Laws Are Real Estate Friendly

Current tax law is extremely friendly to real estate investors. Non-cash expenses such as depreciation allow investors to reduce the amount of taxable net income. When the time is right to sell, Section 1031 exchanges can be used to defer the payment of capital gains tax by relinquishing one investment property and acquiring another like-kind property.

#3 Hedge Against Inflation

Real estate investors are protected against the short-term and long-term effects of inflation. As prices increase, rents rise, and asset values grow.

According to the Census Bureau the average rate of inflation in the U.S. is about 3.2%, and at the average rate of inflation prices double every 20 years. But commercial real estate has more than outpaced the rate of inflation. In fact, over the past 10 years, average prices for office property, shopping centers, and large apartment buildings have more than doubled, according to the Federal Reserve Bank.

#4 Using Leverage Magnifies Returns

Positive leverage can be used to magnify the returns from investment real estate. Depending on the type of project, you can borrow between 50% and 90% of the property purchase price at interest rates that are lower than the anticipated annual return on the investment. Traditional portfolio components like stocks and bonds aren’t nearly as easy to use as collateral for financing.

#5 Variety of Investment Opportunities

Real estate provides a wide variety of opportunities to investors. Popular income-producing options include single-family rental housing, multifamily property, commercial buildings like offices and shopping centers, and vacant land.

It’s also possible to realize the benefits of investing in real estate without actually buying a property:

  • REITs: real estate investment trusts, real estate mutual funds, and real estate ETFs – or exchange traded funds – allow investors to buy shares of publicly-traded real estate funds.
  • Crowdfunding: online real estate investment platforms let investors buy fractional shares of institutional-quality office buildings, retail property, and multifamily projects.
  • Real estate partnerships: joint ventures with an experienced managing partner responsible for the hands-on, day-to-day operations of the investment works with passive investment partners who contribute money instead of their time while sharing in the profits and appreciation in value that the property generates.

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.

Top FSBO Commercial Real Estate Tips

fsbo commercial real estate

FSBO commercial real estate is commercial real estate being sold by the owner.  It’s not that uncommon in the commercial real estate business.

That’s because – unlike residential real estate – most FSBO commercial real estate is owned by professional business people.  As a result, the investment group holding the real estate includes an attorney, high-net worth individual, or even real estate professionals.

Here are a few tips for buyers thinking about investing in for sale by owner commercial real estate.

Buyer Representation For FSBO Commercial Real Estate

More often that not, with FSBO commercial real estate, or any commercial real estate for that matter, a buyer is buying problems that the seller can’t handle.

That’s not necessarily a bad thing.  Sometimes commercial real estate owners don’t have enough capital to make repairs or upgrades.  Other times they lack the property management resources to find and keep great tenants.

Situations like these can be a good deal for the buyer, if the buyer has what the seller lacks.

But whatever the reason, buying FSBO commercial real estate means that you’re buying someone else’s problems.

That’s why it’s important to hire a buyer broker to represent you in a for sale by owner commercial real estate transaction.

Commercial Real Estate Due Diligence

Commercial real estate investors should always be sure to do their due diligence.  It doesn’t matter if the property is a FSBO or listed on the open market.

There’s a lot more due diligence when buying commercial real estate than when buying a residential property.  Some of the things commercial real estate buyers should always verify include:

  • Tenant leases, tenant quality, and historical rent payments
  • Current zoning and potential business restrictions
  • New competition coming to the market
  • Discover why the owner is really selling

 

Real Estate Loan Scams

real estate loan scams

Whenever a real estate market heats up, real estate loan scams also rise.

Here are three common real estate loan scams to watch out for if you’re buying – or selling – real estate.

Seller Financing

Now, seller financing in and of itself isn’t a real estate loan scam.  But, this method of buying and selling real estate can be, if you’re not careful.

For buyers, seller financing can turn into a real estate loan scam if you pay the seller directly.  To protect yourself, always go through a independent third party such as an escrow company or attorney.  They will track payments received, the loan balance, and money disbursed to the seller.

For sellers, always remember that you are the bank, since you are carrying the note.  Sneaky buyers can turn seller financing into a real estate loan scam by providing you with bad credit information or selling the property to someone else without your knowledge.

Lease Purchase

Lease purchasing – real estate can also turn into a type of loan scam if you’re not careful to have everything in writing.  Also be sure to have written in your lease purchase contract what dollar amount or percentage of payment is applied toward the purchase price of the property.

Remember, a lease purchase agreement is different from a lease purchase option.  With an option, the tenant/buyer has the option to purchase at a predetermined price, but doesn’t have to.

Interest Only Mortgage As Real Estate Loan Scams

Using an interest only mortgage to buy real estate can also end up being a real estate loan scam if you’re not careful.

With an interest only mortgage, payments by the buyer only go toward interest and not principle.

In a real estate market where prices keep rising that’s OK.  But if the market suddenly drops, buyers can quickly find themselves upside down with negative equity on the property.

How To Market A Pocket Listing

pocket listing

A pocket listing is a listing that isn’t on the multiple listing service. Pocket listings are found in both residential and FSBO commercial real estate.

Sellers and real estate agents have pocket listings for a number of reasons.  But regardless of why, pocket real estate listings can be difficult to sell.

Here are three great ways to market a pocket listing.

Get Neighbors To Market Your Pocket Listing

Everybody loves a secret, especially neighbors who know that a place is for sale.

By letting the neighbors know you have a pocket listing, you’re putting word-of-mouth advertising to work for you.  It’s also the ultimate way of putting six degrees of separation to the best possible use.

Internet Real Estate Sites

The internet is the perfect place to market pocket listings that aren’t on the MLS.

Websites like Zillow, Trulia, and even Craigslist are great places to advertise a pocket real estate listing without having to go through the trouble of putting the property on the MLS.

This is also a good technique to use when you really want to zero in on qualified, serious buyers.

Most of the real estate agents on the multiple listing service are weekend warriors.  At most they’ll do one or two transactions a year, which means you’ll quite likely end up dealing with an amateur and their buyer client.

Social Media Real Estate Marketing

Marketing your pocket listing on social media is another great way to let people in your sphere of influence know you’ve got a great off market property for sale.

Part of your circle of friends probably includes real estate agents making six figures a year.  These are the types of agents that you want to share your pocket listing with.

They’ve got the experience and the contacts to help get your pocket listing sold to the most qualified buyer.

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.

Are Traditional Real Estate Companies Bound To Fail?

traditional real estate companies

To answer this question allow us to change gears for a moment and consider what Steve Jobs had to say about Apple Computer back in 1995.

Specifically, he talked about how Apple will eventually fail.

Granted, this thought is near-blasphemy for a countless number of retail stock market investors, mutual funds, and investment gurus.

After all, the price of Apple stock recently hit an all-time high.  Warren Buffett owns nearly $45 billion of the company, and Apple accounted for an incredible 23% of the entire S&P 500’s gains in May.

How in the world could Apple possibly fail?

According to Steve Jobs, companies with a monopoly market share forget about what it means to build a great product.  There’s no difference between a good and a bad product, and no feeling in the hearts of the people who run the company about wanting to help their customers.

Other than perhaps the size of the display screen, what’s the big difference between the last several generations of iPhones . . . except for a rising price?

Eventually companies decline because of the lack of quality products and failure to adapt to the new realities of the marketplace.  Steve Job’s belief that companies must adapt or eventually die is also applicable to the real estate industry today.

Traditional real estate companies

Media as diverse as the Pew Research Center and USA Today claim that the decline in home ownership and the rise of the ‘renter class’ is due to rapidly growing home prices and an inventory shortage.  Would-be homeowners are forced to rent because they can’t find anything to buy.

But perhaps a more likely explanation for more people renting homes than buying is that consumer demand is simply changing.

As more Baby Boomers retire and sell their family homes, they are intentionally choosing to rent, or moving into assisted living or senior housing.

At the same time, the younger generation prefers to rent a home rather than own.  Factors such as the growing gig economy and 1099 employment, the lack of mobility that home ownership brings, and the rapidly growing ways to invest in real estate other than owning a home, all make home ownership much less attractive than it once was.

The traditional real estate industry still operates under a business model of new home construction and a resale market that focuses primarily on home buyers that are owner occupants.

This is in stark contrast to the changing wants and desires of the real estate consumer, and a perfect example of Steve Job’s warning to companies who focus on their own needs rather than wanting to help their customers.

Three First-Time Home Buying Tips

first time home buying tips

Here are three first-time home buying tips that will go a long way toward enjoying your new home.

These three first-time home buying tips all focus around saving money.  That’s because buying your first home will always, always, always, take more money that you might think!

Down Payment Assistance

Many first-time home buyers think that asking the seller for down payment assistance is an embarrassment.  But smart home buyers think of this as a way of using OPM or other peoples’ money.

This first-time home buying tip works especially well with sellers who have a lot of equity in their home, and with buyers who have few contingencies in their purchase contract.

Closing Cost Credits

This is similar to asking for assistance with the down payment.  It works well with sellers who don’t even have that much equity in their home.

The fees when buying a new home can really add up.  In addition to the normal buyer costs such as doing inspections, there will be fees from the home owner association, title and escrow company, attorneys, and lenders.

Individually these can be small dollar amounts compared to the purchase price of a new home.  Most sellers are quite willing to negotiate a closing cost credit with a qualified home buyer of the house for sale.

Home Updating Escrow Reserve

First-time home buyers can also ask the title company to hold money in reserve for needed repairs.

The funds come from the seller, but are held by an independent third-party – such as the escrow, title company, or an attorney – to directly pay contractor bills.

Any left over money gets returned to the seller.

Other First-Time Home Buying Tips

In addition to getting as much money back from the seller as possible – even in a seller’s market!  First-time home buyers should also:

  • Try not to underestimate the cost of repairing & rehabbing
  • Visit the neighborhood during different times of the day and week
  • Don’t be afraid to renegotiate the purchase contract if any red flags appear during the inspection period