Stanley Iezman & Christopher Macke of American Realty Advisors have some interesting insights on whether suburban apartment buildings will continue to be hot, in a recent article, What’s the Verdict on Urban vs. Suburban CRE Investment?
Suburban appeal is certainly increasing due to strong current property fundamentals as a result of limited construction activity. Not only is the current rent growth greater in both multifamily and office than in urban areas, but it is also above its long-term average. While this has created some major buzz in favor of suburbia, the truth is that the growth may not last.
For one thing, this shift has only occurred quite recently and the recovery period for suburban office fundamentals is much later than its urban counterparts.
In addition, the more favorable numbers for the suburbs may not be a lasting change. Multifamily rent growth in the suburbs already appears to be moderating and we are expecting to see an increased supply in the near future.
However, if property fundamentals in the suburban market continue to recover, both suburban multifamily and office supply will eventually increase, and this will have a negative impact on rent growth. Investors need to consider the long-term before taking the plunge.
Joe Fairless, joefairless.com & @joefairless, has an interesting article in the Forbes Real Estate Council, Three Ways An Owner Benefits From Selling Their Apartment Off-Market ,about the benefits to buyers and sellers of working with off-market deals. (Joe also has a highly valuable real estate podcast Invest With Joe)
For Sellers of Apartment Buildings
Below are 2 highlights from his article that really stood out as to why buyers and sellers can both benefit from off-market deals.
By selling off-market, there are no open houses or property tours scheduled with several interested parties.
There aren’t multiple question and answer sessions with prospective buyers. Random buyers and their contractors aren’t poking around the property and disturbing the tenants.
And, there are no rumors floating around about the apartment community being sold to an unknown party, which could negatively affect resident and/or vendor relationships. Instead, the owner has to deal with one buyer, which eliminates much of the hassle of listing on-market.
For Buyers of Apartment Buildings
From the buyer’s perspective, there are three ways that they will benefit by purchasing an off-market opportunity.
First, they will save money by avoiding a bidding war and the broker’s interest in finding the highest paying buyer who will close.
Second, they have more opportunities for creative financing since they’re working directly with the owner and can identify their pain points and goals for selling.
Finally, the overall closing process is faster with the broker out of the equation.
The new tax rules will have a big impact because many second-home buyers are middle-income households, not the super rich, and even a shift of a few thousand dollars can greatly affect affordability. The median buyer’s household income in 2016 was $89,900, and only 34 percent of buyers had household incomes over $100,000, according to the National Association of Realtors (NAR). Almost three-quarters used mortgage financing.
While second homeowners can still deduct the interest on new mortgages up to $750,000, experts predict that many people will no longer itemize their expenses on Schedule A. The new tax rules raise the standard deduction to $24,000 for a married couple, and this may be too high a threshold for many people to reach without being able to claim more than $10,000 in combined property and other state and local taxes.
Also, homeowners can no longer deduct interest on home equity loans. That is likely to hold back vacation home buying because many people use home equity on their main residence to purchase additional homes, said Zillow’s Terrazas.
When homeowners think about the long-term impact on their finances, the math becomes even trickier. People are looking at vacation homes as longer-term commitments than in the past, with the average buyer planning to own the home nine years compared with five years in 2015, NAR reported.
It will be interesting to see what happens in vacation home markets, especially those where you could potentially find a beach house that pays for itself.
We may see some buyers who are priced out of markets like the Jersey Shore, take advantage of a fall in prices to buy or we may begin to see some vacation home owners sell to buy better performing commercial real estate investments.
Below is some interesting information on buying a vacation/beach house that can pay for itself. The information comes from Mike Bishal an Outer Banks Real Estate Consultant.
You can contact him through his website to receive a list of the best investment homes on the Outer Banks.
Though it likely requires a sizable down payment, it seems there are some areas on the Outer Banks where investing in an income producing beach house is worthwhile.
This is in contrast to pretty much everywhere in Cape May and Atlantic Counties, where oceanfront homeowners are lucky to see a return of single-digit percentages.
Owning a beach home at the wonderful Outer Banks of North Carolina is the dream for many, and the reality for more than you may think.
Let’s call it what it is……owning a beach home is a huge decision that may be one of the largest financial moves you may make in your life.
What makes sense to you when you look into buying a beach home? Many times, it includes making memories with your family and friends. This is the emotional side of this. ALWAYS, this must make financial sense.
As an Outer Banks Real Estate Professional, I get asked the heading question above many times. My clients that lean more towards investment minded decisions always want to learn about beach rental properties that have strong rental histories that help pay expenses, and paying all of those expenses is ideal.
With the right level of work and educating process, I can provide them, they will see that many homes here can be strong real estate investments that actually pay for themselves.
You may have learned a long time ago that the numbers always tell the truth. Of course, you need to know how to apply the “numbers” into a basic spreadsheet and do the math.
Here on the Outer Banks, we have an array of levels of Beach Vacation Rental Homes. Logic tells us that the best performing homes are on the oceanfront or near the beach accesses.
What is not so obvious is how the ingredients of a home will affect performance. The numbers include rental income, property management fees, utilities, and maintenance. The ingredients specific to fine performance are simple but needed to ensure the best performance.
There is an old adage in real estate that applies to the investment side of a beach house purchase decision; “Highest and best use”. What do I mean? Well, “location, location, location” is another real estate term mostly used in commercial segments.
Overall condition and most current décor elements, as well as technology such as audio-visual experiences, mean a lot, as well. One could look at the top tier oceanfront homes on various property management sites here and see the list of amenities, as well as the look and feel throughout and imitate this on a home in their price point if the ocean front levels are beyond their ability to buy.
The best way to accomplish this may be easier than you think when the FIRST goal is to get a clear understanding of your borrowing position.
A good agent will align you with a local lender that understands the market here. You may be surprised to learn that some lending products allow you to include the rental history of a particular beach home as part of the qualification process.
This means your debt to income ratio may not be the only factor to qualify you for a beach home purchase. I call getting together with a lender the FIRST the best decision you can make in the process. It removes all guesswork and allows a focused plan to lead the process.
From there, a good agent will know how to examine the inventory and present genuinely and accurately in regards to matching your ability perfectly. Doesn’t that sound like the best approach?
My role as an agent is to LISTEN first.
When you share that finding a beach home that pays for itself is your primary goal you will get the straightforwardness you need to make a good decision. I must take this opportunity to openly share that I will keep it real with you.
There are times I hear from folks that they want their cake and want to eat it, too.
There is a level of investment property here that will cash flow positive at 20% down and that typically means the higher tiered price points. (Often homes over $1,000,000 though others can be found)
The lower to mid-level price points may need more than 20% down to be in the “black” but this 20% on a low-priced home typically is able to be handled due to the starting price point being lower than anticipated.
The focused plan you share with me, as long as it is realistic, can and will be achieved. You will be serving the process well when you stick to the numbers, understand them, and apply them to what I call the simple math that always tells the truth.
And, when we have connected you with a lender early on it means the process is not guesswork. It is a focused plan getting you where you want to be…….in an Outer Banks Beach House that can pay for itself.
Below are some insights on using rental income as part of qualifying for buying a beach house. Provided by a local Outer Banks mortgage lender.
Lenders often get this questions posed to us as buyers begin to look for property. Many buyers look at the purchase of property on the outer banks as an investment.
Yes, they want to use some personally and typically have enjoyed years of coming to the Outer Banks. However, almost all buyers do plan of renting in the summer season under property management agreements to gain rents from seasonal rentals.
For this reason, many assume lenders look at the properties the same way they do as an investment. Lenders typically first see if a buyer might qualify by not using the rental income to qualify.
This means we add up all the existing debt add the newly proposed payment and calculate a debt to income ratio not to exceed 50% for loan amounts of $424,100.
For loan amounts above this, we allow debt ratios of 45% sometimes exceeding by small amounts for well-qualified buyers.
As an easy example of how we calculate debt ratios is a buyer that has a gross monthly income of $10,000 per month or income of $120,000 per year.
This buyer can have up to $5000 per month in proposed total debt. This includes the new home payment on the Outer Banks and their existing housing expense where they live and any other debt payments they may have.
This equates to a 50% debt ratio.
Loans amounts above $424,100 are categorized as Jumbo Loans smaller loan amounts are categorized as Conventional Conforming Loans. The advantage of qualifying as a second home means you get the same rate as a primary residence at Citizens.
On our best days of late we have been as low as 3.875% as a second home. The other advantage is second homes allow for 90% loan to value.
When we see a buyer does not have the income to have the required debt ratio we can fill the gap by using rental income to offset the proposed payment.
An example of this; using the same income we used above but the proposed payments are totaling $6,250 per month making the debt ratio 62.5%. Let’s assume their existing home payment is $2,500 and they have another $750 of other debt from an automobile payment or some amount of credit card debt that shows up.
Even if they pay off their credit cards monthly we will likely count the minimum payment. Total existing debt is $3,250 and the proposed payment is $3,000 on their new beach home. Taxes and insurance make up a lot of the proposed payment.
Let’s assume of the $3,000 that $1,000 is for taxes and insurance leaving $2,000 as principal and interest. This will finance a loan amount of approximately $400,000. The assumed sales price in this example is $500,000. 20% is the best way to finance investment property.
Lenders do offer 85% and some 90% but the cost in rate and mortgage insurance will discourage most buyers from feeling like this is a fair bargain. This is one disadvantage of the investment category it is best and often requires 20% down. The second is the rate will be higher.
I used 4.50% in the assumption of a $2,000 payment to finance approximately $400,000. Our market is unique rents are not guaranteed and come in on a seasonal 3-month basis for the most part. Because of this, almost no lender will offer loan amounts above the Conventional Conforming Limit of $424,100.
However, we still need the debt ratio to be at 50% or less and so far we are still at 62.5%. We calculate seasonal rental income by using an Income & Operating Schedule prepared as part of the appraisal process. There is a fee typically of $150 to $200 added to the appraisal cost for this schedule.
Let’s assume our proposed $500,000 priced property has gross rents of $45,000 in a season. The appraiser uses 75% of the gross rents to offset expenses for the management fee, taxes, insurance (the big three expenses as I call them) and other expenses such as cable, electricity, or maintenance.
This yields a net income number to be used to offset the payment. Let’s assume the net income number is $24,750 or 55% of the gross rents of $45,000. This yields $2062.50 to make the proposed payment.
The proposed payment is approximately the same as the net monthly yield essentially offsetting the proposed payment. Even if the underwriter counted the entire $3,000 to include taxes and insurance the negative cash flow from the most conservative analysis is only $1,000.
I disagree in counting the entire proposed payment because the income and operating statement takes taxes and insurance into account as an expense and subtracted them already, however, underwriters can be hard to persuade and vary lender to lender.
Let’s assume we have the most conservative of underwriting and the negative cash flow in the eyes of underwriting is $1,000. Still, this client would qualify as the only payment added to his total debts of $3250 is $1000 making all debt $4,250 and a debt ratio of 42.5% on our example.
The actual negative cash flow is all that is used in determining total debt, not the payment itself. This is how we use rental income to offset the payment and allow someone to buy a home on the Outer Banks when otherwise they would not qualify.
Though the title may be a bit exaggerated. Depending on your circumstances and what you are looking to do, it can be possible to structure the sale of a vacation property into an almost tax-free long-term hand-off real estate investment.
Below is some additional information about using a 1031 and Delaware Statutory Trust to handle the sale of a vacation home. This real estate investing strategy definitely requires professional assistance.)
For some insight into selling a vacation home and turning it into a long-term investment, check out this article from Ian Lazarus, sjbeachhomes.com, (@ShoreHomeAgent) has an excellent article on ActiveRain, Get out of the Landlord Business Tax-Free.
Fast forward to a market that has put the real estate crash in the past, on the east coast, we have a large group of aging baby boomers who have a similar challenge as the farmers that came before them…but this time it’s highly appreciated rental property on the New Jersey and Delaware beach, or even those with high rental income oceanfront homes on the Outer Banks.
For those unfamiliar with the IRC 1031 like-kind exchange strategy, the time restrictions and other potential tax-triggering pitfalls seem far too daunting to even consider. For those well seasoned in the art of 1031 exchanges, it no longer seems like a viable strategy given their desire to start downsizing their properties, which would trigger a tax liability.
Or, they just don’t want to be a landlord anymore. Unfortunately, most owners think they have only two choices; a) bite the bullet and keep your property or b) sell and pay taxes, sometimes upwards of 50% of your sale proceeds!
If you have ever considered selling your investment property at the shore, but something has stopped you in your tracks, please consider reaching out to our team to discuss your specific situation. We can bring a team of real estate, financial planning, tax, and legal advisors to you or we are happy to work in tandem with your existing advisors. Either way, knowledge is power. And power leads to a lifetime of financial freedom.
Let me explain using a recent case I helped solve. John Walton (name changed to protect the innocent) has owned a shore home for almost 30 years. His adjusted cost basis after depreciation is almost zero.
His expected sales proceeds, after debt pay-off, was supposed to be about $2,000,000.
But, he was expecting to have to pay total taxes of $940,000! For a retired guy to generate income on his after-tax proceeds of $1,060,000 at today’s rates, he could only expect about $42,400 per year.
That’s terrible considering he was collecting net income of over $100,000 before he sold. We encouraged him to consider a 1031 exchange, but rather than finding another property to privately own, we identified two apartment complexes professionally-managed and owned within a Delaware Statutory Trust (DST for short).
And, by owning beneficial shares of this DST exactly matching his sales proceeds and with a loan-to-value ratio higher than his shore home, we deferred 100% of the taxes due. More importantly, with 100% of his proceeds invested in the DST, we were able to generate a tax-favorable income of $110,000 (5.5% yield) and eliminate all the hassles of being a landlord.
C. Grant Conness co-founder of Global Wealth Management & co-host of the “Global Wealth Radio Show” who also happens to be an Investment Adviser Representative at Global Financial Private Capital which is one of Forbes’ 2013 Top 50 Fastest Growing RIAs and an insurance professional has an excellent article:
C. Grant outlines the same concern Ian does in the above article. How to divest of a real estate investment without paying a high capital gains tax.
There are some guidelines that you have to follow. You must set up your 1031 prior to closing on the sale, and your sales proceeds go to a third party, called an accommodator or a qualified intermediary, to hold. From closing, you have 45 days to identify the property you’re going to exchange into. And then you have six months to close on the property you identified. If you do all that, you’ve accomplished a successful 1031 Exchange. But until 2004, you were still replacing one property with another — so, like it or not, you were still a working landlord.
More recently, Revenue Ruling 2004-86 determined that a Delaware Statutory Trust qualified as real estate and, as such, could serve as a replacement property solution for 1031 Exchange transactions. If you were tired of managing a property yourself, you could, instead, acquire a fractional or percentage interest in a DST, and become a part owner in a much larger real estate investment — a 300-unit apartment building, a grocery center, medical office building, etc.
So now instead of Mr. and Mrs. Smith as your tenants, calling you to come fix the garbage disposal, Walgreens or CVS is your tenant with a corporate lease. It’s a more hands-off way of owning income-producing real estate that’s especially well-suited to retirees. A dozen or so fairly large companies put together deals for investors to exchange into that are professionally managed and pretty much turnkey.
It could be an interesting option for anyone who owns a vacation home that has significantly appreciated since 2008. Especially those who are retiring or already retired. Being able to roll the money over from years of owning a home somewhere on the Jersey Shore like Ocean City, Sea Isle City, Avalon, or Stone Harbor to owning something that offers a more stable investment income that is also hands-free and doesn’t require you answering a tenant about why the air conditioning doesn’t work on 100 degree days.
With the average home prices up and down the East Coast on the rise, now may just be the time to buy a brick apartment building and not have to worry about things like hurricanes or seasonal changes in vacationing.
Gary Beasley who is the CEO/Co-Founder of Roofstock has an interesting look at owning investment properties versus investing in a REIT in a recent Forbes article, Buying Rental Property Vs. Investing In A REIT, Part I.
One of his best points I thought was the value of accruing equity when you actually invest in rental properties instead of investing in a REIT. Many REITs make excellent investments though as the offer professional management and access to large amounts of capital.
Investing Goal: Building Equity
While REIT investors can generate capital gains as the share price ideally increases over time, when you buy an investment property, you’re continuously building equity in a tangible asset. All the while, the tenant is paying your mortgage and your equity stake can increase as the value of the asset typically appreciates over the long term. Having more equity in your asset also gives you the ability to refinance over time and use the proceeds to buy additional assets and grow your portfolio.
Gary’s author bio was the first time I’ve heard of his company Roofstock.com, but it seems to have an interesting angle on offering single-family rental property investments.
Roofstock is the first online marketplace created exclusively for investing in leased single-family rental homes that generate cash flow day one. Created by investors for investors, Roofstock provides research, analytics, and insights to evaluate and purchase independently certified properties.
Elaine Misonzhnik has an excellent look into how the new tax plan, could be a boom to certain segments of the real estate industry and create a drag on others, The Tax Bill Is a Clear Boon to the CRE Industry. Will It Prove Too Much of a Good Thing?
According to a white paper produced by research firm Reis Inc., commercial property owners “are easily the biggest beneficiaries of this tax bill.” The 1031 exchange provision remains in place.
Commercial property landlords will still be entitled to a full mortgage interest deduction, in addition to benefitting from the reduced corporate tax rate of 21 percent.
The tax bill reduces the depreciation period for multifamily and commercial properties to 25 years.
Previously, the depreciation period for multifamily properties was 27.5 years and for commercial properties 39 years.
Pass-through entities such as LLCs and partnerships, commonly used in the commercial real estate industry, will benefit from a lower tax rate. Partners in such entities will now be taxed at their individual tax rate less 20 percent deduction for business expenses.
Reis predicts the new tax plan will likely be a net positive for the multifamily sector by discouraging home ownership.
Reis researchers argue the new tax bill may spur a construction boom, as it will allow businesses to immediately expense multiple types of asset purchases, including real estate.
This may be particularly true in the growing e-commerce sector, where companies might now be able to take advantage of the new expensing rules to build more of their own warehouses.
Steve Wamhoff has an interesting commentary in Forbes that says that the tax plan will be a boom for real estate investors, Real Estate Investors Will Love This Last-Minute Change to the Tax Plan.
The final bill provides a deduction for pass-through income that is supposed to benefit those business owners who create jobs. The original version of this deduction, which was in the earlier language passed by the Senate, limited it to half of the compensation paid to employees by the pass-through business.
But a provision inserted in the final bill also allows the deduction to be claimed up to a certain fraction of the company’s depreciable property—property like buildings that lose their value over time. This makes the deduction easier to claim for companies with few employees but a lot of buildings.
Guess what kind of business owns this type of property but has few employees? Real estate firms.
Looks like there is a good change there will be a number of ways to leverage real estate investing under the tax plan in 2018. In addition to real estate firms, a lot of corporations will have incentives to look at real estate investing as part of their corpoarate strategy.
We may see more companies look to invest in new headquarters, by renovating and adding overall value to older office buildings or corporate centers, as part of offering the amenities their employees will want.
Brian Milovich, Co-Founder of Calvera Partners a multifamily investment company catering to high-net-worth individuals and families, has some excellent advice in a recent article in Forbes, Three Need-To-Know Secrets Of Investing In Real Estate, which is excellent advice for anyone considering real estate investing but still hasn’t made the first step.
However, unlike stock investing, where being passive and finding low-cost mutual funds or ETFs is the best way to generate the highest returns, real estate requires you to be proactive.
You must be ardent in your desire to add real estate to your portfolio because no one else will tell you it’s a good idea.
You must learn how to evaluate a real estate transaction yourself, but you already know how to do it. And you must decide which type of real estate investment matches your personality and how you will invest to capture the unique tax advantages afforded in real estate.
Once you conclude real estate meets your need for reliable cash flow with the opportunity for appreciation, invest in it.
Matthew Rothstein has some interesting insights in Bisnow Philadelphia, Philly Multifamily’s Price Problem And 4 Other Things We Learned At The 2018 Forecast Event. It’s interesting to see how the costs of construction are driving up rents especially in the upper end of the market.
One of Philadelphia’s biggest advantages in drawing millennials — it is second in the country in terms of millennial growth, according to Longfellow Real Estate Partners Managing Director Jessica Brock — is its affordability compared to New York and Washington, D.C.
But newly built apartments in Philly are targeting rents at an average of $3.50/SF, according to JLL Research Director Lauren Gilchrist, or $3,500/month for a 1K SF apartment.
For most Philly renters, that is an astronomical figure. “You can go to tons of places in nice areas that are considerably cheaper than that, so I’m not sure who will be paying those rents besides professionals landing in Philadelphia for the first time or empty nesters coming into the city,” Gilchrist said. The lease-up numbers bear that out.
Available apartments costing $3.50/SF are about 60% occupied, according to Gilchrist, compared to 80% of apartments between $3 and $3.50/SF. Apartments that rent between $2 and $3/SF are over 90% occupied. The continuing difficulty of buying a house, even for those making a decent wage, means that millennials are likely to stay in the renting market for longer, as their wages figure to increase eventually.
Because of that, and landlords’ willingness to offer generous concessions, Gilchrist has no long-term concerns about multifamily absorption in the city.
There could be a tremendous opportunity for the owners of redevelopment projects or older apartment buildings to find creative ways to offer better incentives to those looking at the top of the rental market.