Category Archives: 4 Benefits of Real Estate Investing

June 20, 2007 · 7:45 am

Depreciation And Your Rental Property

Yesterday over at my other blog on ActiveRain I authored a post titled How Are Your Current Real Estate Investments Going? To get background for this post it might be wise and go and read that post.

But the gist of the post was that if you’ve owned the same income property in Kansas City for 7 years or longer you are probably no longer maximizing your returns the way you should be. That in fact;
  1. You are no longer maximizing your leverage
  2. If you are properly bifurcating your depreciation you have already exhausted your personal property portion (with the exception of new personal property added)

Leverage was discussed there. We’ll talk about your depreciation here.

Depreciation
Bifurcate is just a $10 word for cost segregation. There are actually 4 ways you can segregate your depreciation on your investment property;
  1. Land (which of course doesn’t depreciate)
  2. Personal Property (over 5 years)
  3. Land Improvements (over 15 years)
  4. Building (over 27.5 years)
Most people are probably only utilizing #1 & #4. They are overlooking (or your accountant is) #2 & #3. But if you are maximizing your depreciation you can see that by year 7 you have already exhausted all your beginning personal property depreciation and 1/2 of your land improvements.
Why is that a big deal? Because if you have broken out your costs you will probably find that personal property depreciation accounts for between 40% – 50% of your yearly depreciation total. At least at first.
Now as you change carpet, appliances, lighting fixtures and the like you can start a new 5 year schedule on those items. But about 1/2 of your beginning depreciation number is now gone. It’s not coming back.
In addition, you are also 25% of the way through your building depreciation. That investment property that used to give you overall returns of 22%-24% is now generating overall returns of 13%-15%. And it will continue to slide down from there. No matter how much your cash flow continues to build. (Well, there might be exceptions that I haven’t seen.)
It could be that you just don’t want to change houses or there are sentimental reasons you don’t want to exchange or you are just happy with the money you have. But if you are still in the growth phase and you are looking to maximize that Retirement Worth Having, you may wish to consider sitting down with knowledgeable investment real estate agent or tax planner and figure out what to do next.

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June 7, 2007 · 7:48 am

Current State of the Kansas City Real Estate Investing Market

Here are my opinions on the current Kansas City investment market for real estate:

Buy & Holds – This market is in great shape. There are several values out there right now and many, many homes priced at a realistic market value based on their community. I’m high on duplexes and fourplexes and lukewarm on single family homes. Several apartments for sale right now have grabbed my attention, as well. I’m forecasting a 5-7 year hold period for maximum use of depreciation, appreciation and then an IRC 1031 exchange.

Rehab Properties/Flipping – This market scares me at this time. Sure, there are some good properties out there. I just haven’t seen them. Many foreclosures right now are aborted rehab situations. Not enough appreciation and housing demand to make this a lucrative enterprise at this time.

Buy, Rehab & Hold – I’m very high on this strategy. Very high. There are many a house for sale right now that are value priced but not lean enough to do buy, rehab, and sell. But if you can buy, rehab and have $12,000 of equity before you hire a property manager and put a renter in, why not?

Rental Market – In many parts of the city the rental market is extremely strong. Only a few pockets of weakness that I have seen. Most of the property managers I speak to have the same opinion. Gone are the days of long vacancies and rental incentives to get people in. Unless you are a pioneer on the outskirts of town. Then you are probably running high vacancy rates and banking on end-game appreciation. I’m not thrilled with that idea as housing growth (building) has greatly slowed.

Lease Option Market – I do very few of these. But three different real estate investors I know have successfully entered into lease option agreements with their “tenants” within the last 45 days. So there are people out there looking.

Personal Note: I read yesterday in USA Today that many real estate investors are leaving real estate and going back into stocks. Finally in the article, they distinguished between the Buy & Hold investor and the real estate speculator. They also based all of real estate’s benefits on appreciation only.

Don’t forget there are 4 Benefits to real estate investing:

  1. Cash Flow Before Taxes
  2. Principal Reduction
  3. Depreciation
  4. Appreciation

Of course, plan with your financial advisor. Diversity is the name of the game. Bawldguy did a great post about using insurance to gain the funds for real estate. Of course, out there you are paying $750,000 for the same duplexes we can get for $175,000.

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April 16, 2007 · 10:29 pm

I Have $35,000 for Rental Property – Now What?

Coming to me with $35,000 to start your real estate investment career is terrific. Let’s just see what we can do with that money.

How about we take it and split it in two? We’ll buy a couple of Waldo area homes, put 10% down, run mortgage payments (with escrows) of about $725 and we’ll get rents of about $775. Not great cash flow. In fact, pretty dead even. So why do I want to to that?
Currently your $35,000 is sitting in an IRA or CD or stock. Let’s give you the benefit of the doubt and say you are earning 8% on the money. That is a $2,800 gain for the year. Heck, I’ll take it if you don’t want it.
But now let’s look at that same $35,000 in the above scenario. Remember, there are 4 Benefits to investing in real estate (see side bar) and we are only going to talk about the appreciation factor here. Not Cash Flow Before Taxes because it’s minimal to nothing here. Not Principal Reduction even though that can really add up. Not Depreciation…trust me you’ll love me at tax time. We’re only going to discuss the Appreciation benefit.
With that $35,000 you should have leveraged yourself into about $200,000-$225,000 worth of real estate. So let us take the smaller number of $200,000. Historically, Kansas City real estate appreciates at about 5% a year. But I believe we’ll have another flatish year at 2%-3%. Again, let’s use the lower number of 2%. $200,000 x 2% means a $4,000 increase.
“Well Chris. That’s only $1,200 better than the return I was getting in the stock market.”
You are right. And couldn’t be more wrong. Remember, we are only calculating ONE of the 4 Benefits of owning residential investment property. Remember, we didn’t fully leverage your capital. And remember, we are in a flat year of real estate growth. What happens if it really takes off, again? (And quit talking to me about dips in the west and east. We didn’t get the growth they were getting so why do you think you’ll get those dips…ALL REAL ESTATE IS LOCAL!
Your thoughts?
Editor’s Note/May 26, 2008: According to the Office of Federal Housing Enterprise Oversight the Kansas City area had 2.7% appreciation in Kansas and 1.7% in Missouri.  What did I say above? 

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April 5, 2007 · 10:01 am

Investment Property Analysis Doesn’t Have To Be Complicated

People love to complicate things. Especially the gurus. After all, they do have two hours to fill when they are trying to convince you to purchase their book and tape systems. Knowing your investment property has profit potential is very important. Measuring it against every other property within a 20 mile radius, isn’t.

Again, there are 4 Benefits to investing in real estate;

  1. Cash Flow Before Taxes
  2. Principal Reduction
  3. Depreciation
  4. Appreciation

You hear about cap rates and gross rent multipliers and internal rates of return and the list goes on. But figuring your total rate of return doesn’t have to be rocket science.

Figure your 4 Benefits and their total revenue and divide that by the amount of cash you have invested. There is your return. Then you can compare property to property.

Or, you can do what I hear so many of you do. Put down as little as you can on the purchase and trust that the rents will cover the house payment along with escrows. If that works then buy it! (Not necessarily the strategy I recommend. But it beats not doing anything at all. So long as it works out…)

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March 27, 2007 · 9:15 am

Rental Property Appreciation in Kansas City

I have to confess to you here and now that I am a numbers guy…when it comes to investment property. I like to know what the returns will be, how profitable it will be (if at all) and exactly what my money will be doing here rather than there. And that, in turn, is how I counsel my investment property clients. You see, to me, owning rental property is all about the returns. And with appreciation being one of the 4 benefits to owning investment property I thought I would discuss it here.

One of the most popular questions I get is “what is the rate of appreciation for this property?” My standard answer is “I have no idea.” Keep in mind that even the most educated real estate agent on earth cannot tell you what appreciation will be. He can tell you what it was. He can give you a historical perspective. But that’s it. Anyone who tells you any differently is guessing, at best.

Here in Kansas City the average historical appreciation is right at 5% per year. The Bulls Eye, if you will. Take any 10 year period and that’s about what it will average out to. But some years it has been 10%. Some years 2%.

So when I’m figuring returns for my investor clients I will always use 5% or less. Recently, because of the flat to moderate growth we’ve been getting here in the KC area, I’ve been using 3% to 4%. I also put a big asterisk next to the number saying “Best Guess”. I want people to know I cannot forecast something like that. Heck, if two more planes tragically fly into New York high rises anytime soon I would say 4% would be a dream. (Get my point? I cannot see what will happen next month, or the month after.)

In my opinion, an investment property should make sense at 0% growth for the first year. You should know pretty accurately what your rates of return will be BEFORE you purchase and that is without appreciation.

And one last thing to keep in mind. Income property will appreciate, by in large, separately from regular housing. Emotions and demand drive housing to appreciate quicker than it should. But with rental property the demand will drive it to some degree but appreciation can be tied very closely to rent rates.

We just exited a period of time when everyone and their brother could get a loan under almost any circumstances. Rents fell slightly or in a best case scenario held steady. Rent incentives were common. But now that mortgages have gotten a little more difficult to obtain and foreclosures are up rents have firmed and are even starting to rise while housing appreciation is very flat.

It’s not an exact science. That is why it’s important to be in tune with your particular criteria. Or work with someone who is.

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March 23, 2007 · 1:46 pm

Kansas Jayhawks Move On To Elite 8 & Some Real Estate Thoughts

I’m trying to keep my mind on real estate today. But I have to be honest and let you know it keeps going back to last night’s game and forward to tomorrow’s game against UCLA. Don’t worry, however. I had a closing today. Showed a couple places. Writing an offer tonight. So I haven’t stopped working. Just have Jayhawks on the brain!

Kansas City real estate seems to be getting quite a bit of attention from around the country. I have probably had 11-13 inquiries this week by phone and email asking about our market, what places rent for, where is the best place to own? Owning rental property to help fund your retirement is a great idea. And Kansas City is one of the few metropolitan areas around the country where investment property is still “affordable”.

And don’t forget…there are 4 Benefits to owning income property in Olathe, Kansas City, Overland Park, etc.

  1. Cash Flow Before Taxes
  2. Principal Reduction
  3. Depreciation
  4. Appreciation

I spotted some great condos in Lawrence, Kansas yesterday. Priced at $73,000 they are converted apartments with new mechanicals and vinyl siding. Two bedrooms and one bath located a few minutes from the campus of the University of Kansas. Rents should be $550-$600/month. Priced at $73,000. Email me for more info.

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March 19, 2007 · 9:37 pm

Stock Market vs. Real Estate Investing

I have discussed before the 4 benefits of owning residential investment property. And today I had a little fun with a stock broker from Kansas City that was, well gloating I think would be the term, on the fall of real estate as an investment vehicle.

Really?

I know I shouldn’t do these things, but I decided to have a little fun with him. Here is some simple math;

$100,000 invested in the stock market returning 10% a year (his number) will give you a $10,000 increase in your portfolio after one year. Not too bad, actually.

$100,000 invested in real estate, however, should net you around the $20,000 in the same period of time. Is that better? Let me explain.

Take the $100,000 cash and purchase $400,000 worth of real estate (4 $100,000 houses, 1 $400,000 apartment…really doesn’t matter) with a historical appreciation rate of 5%. That leads to a $20,000 increase in property value after one year.

Now you may want to say what if houses don’t appreciate 5% this year? Good question. But if you are holding for 6-8 years, does it matter for any one year what appreciation is? Remember, historical appreciation in Kansas City is 5% on average. Some years have been 10%-12%. Other years, like last year, were -2% to +3%. Heck, my zip code was 6.6% last year.

“Wait. We’re not done here yet,” I told him. “Remember, real estate yields four benefits; cash flow before taxes, principal reduction, depreciation and appreciation. We’ve only discussed one of the benefits!”

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