In simple terms, this process, executed with the help of a mediator, allows you to avoid paying capital gains tax (for now) when you sell a commercial property.  The catch?  You have to put your profits into the purchase of another (bigger) property within a certain period of time.

Want more details?  Read on!

How Can A 1031 Tax Deferred Exchange Work For You?

A tax deferred exchange is a simple method that a property owner employs in a property trade without having to pay the federal tax on the transaction. Generally in an ordinary sale transaction, the property owner is taxed on any gain he or she realizes by the sale of the property. But in exchange, this tax is deferred until some future time when the acquired property is sold. Authorized by the Section 1031 of the Internal Revenue Code, these tax rules are sometimes referred to as 1031 exchange rules. The transaction however must carefully meet the section 1031 rule set and must be structured in such a way that the transaction is in fact an exchange of one property for another and it is not a taxable property sale.

When you look at it, the tax deferred exchange is actually an investment strategy that people are often not aware of. One of the misconceptions on the 1031 exchange rules is that an exchange requires 2 parties who want each other’s properties. However, in reality though, such two-party swaps rarely occur. Today, this exchange can be accomplished by involving four principal parties that include the exchanger, the seller of the replacement property, the buyer of the relinquished property and an intermediary. These parties often do not even know each other and may be located in different states. Furthermore, the exchange properties do not have to close at the same time. As long as the 180-day deadline has not been met, the exchange is considered legal and thus tax-free.

You Need To Know And Understand The 1031 Tax Deferred Exchange Rules Before You Sell Your First Property

It is clear that 1031 exchange rules have the advantage of shielding the exchanger from incurring immediate tax liability. Upon the death of the taxpayer, the deferred tax is forgiven and the taxpayer’s estate never has to repay the ‘loan’. A tax deferred exchange nevertheless carries the disadvantage of additional fees for entering into the agreement. These costs could be attorney’s fees, accounting fees, intermediary and accommodation titleholder’s fees. The taxpayer is also not allowed to use the net proceeds from the property disposition other than in real property re-investment.

1031 exchange rules offer a taxpayer the benefits of tax deferment. However, this should not be the only reason to enter into a deferred exchange. Business decisions like the need to consolidate investments, increase cash flow, relocate a business investment, obtain greater real property appreciation and eliminate management problems should play the dominant role. When all of the above factors are considered, one may be in a better position to engage or disengage from a tax deferred exchange.

For More Information

If you need more information on 1031 Tax Exchangers, drop us a line and we will let you know who we recommend.  We can also help put you in touch with an agent if you are looking to sell or buy a property.

Just let us know how we can help – and best of luck with your first 1031 exchange!

Fannie Mae Lending Criteria - this one is a slam dunk!

Greetings….

Two blog posts in one week…..just amazing!

Well…not really.

Anyway….

Got a great question from Steve in Colorado regarding lenders and lending criteria.  My friend Terry Painter from the Business Loan Store provided us an answer……

Rob,

I know some investors try to stay away from flat-roof apartment buildings (vs pitched).  In
general I’d prefer pitched but might consider flat especially if new roof or
other big benefit.  However I also heard (not sure if correct) that Fannie
Mae does not fund flat-roofed apartments.  If this is true this could make it a definite
typical “requirement”.  Any comments?

Also,  any comments on what lenders look for regarding unit mix % ratio (this is the % of one bedrooms, two bedrooms, studios, etc) to look out for (with desire for higher mix of two bedrooms vs. one)?

Steve,

Fannie Mae does fund Apartment complexes with flat roofs. But, we (Business Loan Store) are funding
several with flat roofs now.  If any roof has less than 5 years useful life left this will be a problem.   Without question flat roofs do not last anywhere near as long as pitched roofs and are more expensive to maintain.

As for unit mix, preferable unit mix is based on the sub market the property is located.
For example, if there are a lot of students, one bedrooms and studios are often  preferred. Otherwise in most locations, more 2 bedrooms are
preferred.  Usually one bedrooms and studios get the highest rent per SF.
So in locations that have very low vacancy, studios and one bedrooms could bring in the highest
income.

Terry Painter, President
Business Loan Store
104 Monterey Drive
Medford, OR  97504
Mortgage Banker

Office  541-326-0570
Fax     888-404-7089
Cell     541-840-3078

learn anything new?

Until next time…..rob

Jefferson Memorial was purchased on a Wrap.....okay okay...that is not true

Greetings from Washington D.C. (actually…not anymore…but when I wrote this…that’s where  I was…as if you cared).  Still my favorite metropolis (other than Cedar Crest, NM…of course).

Anyway….

With all that is happening with our economy, specifically, lenders not lending.  Creative financing (owner financing) is showing up a lot more.  Great for us…the investors.

In most cases, many of the “owner financing” deals have an existing mortgage in place.  So…for a seller to sell his/her asset with seller financing, the seller may choose to sell via a Wrap Mortgage.  What in the world is a Wrap Mortgage, a.k.a, a Wrap-Around Mortgage?

I have seen many definitions for a “Wrap Mortgage.”  But for us, the investors, a “wrap” is basically taking the existing asset’s mortgage and wrapping it (hence the word “wrap”) with a brand new mortgage.  In other words, a new legal document is created that refers to the existing mortgage (first position) but with the wrap mortgage now making the new owner liable.  The beauty here is, the new owner is only liable to the seller.  The “Seller” is still liable to the original lender.

****Note….A “true” Wrap is NOT an assumption….at least what I am defining here as a Wrap.

There is a lot more to this but the above is the general idea.

Many investors and sellers get a little jumpy when they find out there is a “Due on Sale” clause in the original mortgage when selling an asset creatively.  A “Due On Sale Clause” is simply where the lender can call a loan due if certain points of the mortgage are compromised i.e., a “wrap mortgage.”

Have I ever experienced a lender initiate a “Due On Sale” clause? No.  Have I heard of other investors have to deal with a lender exercising the “Due On Sale” clause?  Yes…but only in a residential investment he or she bought on a wrap.  But….that was the only one.  Even in that instance, the lender worked with the investor on refinancing the asset.  Go figure!

I have yet to experience or hear of it on a commercial deal specifically due to a “wrap mortgage” transaction.  That is not to say that it does not happen.  But my question is, will a lender excercise the Due on Sale clause on a performing note?  I doubt it….but none-the-less it is a possible downside.

Just a few more thoughts regarding a Wrap:

1) the terms of first-position mortgage may or may not be reflected in the Wrap.  Usually, the terms are negotiable with the first-position mortgage being the base line.

2) Legal instruments are used to put the Wrap in place, i.e., REC (Real Estate Contract).  Usually, in a commercial transaction, the documents are a little more sophisticated (uhh…hmm…more complicated since attorneys are involved).

3) In some cases, an escrow company or attorney is used for the ongoing management of the transaction.  In other words, a third party is usually used to make sure payments are collected from the new owner and payments are made to the first-position lender.  This protects both parties.

Of course, there is a lot more detail involved but overall….I love buying assets with owner financing and a Wrap is a great tool.

Until next time…..rob

Residual Income....that sounds sooo good!

Greetings from The Pit @ the Univesity of New Mexico.  Watching my boys play at Steve Alford’s basketball camp.  Good times and good people.  Today’s topic is one close to my heart because it has been my passion for most of my life.  Not specifically residual income…but the lifestyle residual income provides.  I hope you enjoy.

Residual Income

Most people who invest in commercial real estate are focused on generating profit (cash flow). One way investors generate profit is though residual earnings, which make up the net income an investment can earn over the minimum rate of return. Residuals are a source of passive income that generates income without requiring continuous active participation. Artists and intellectual property owners also generate residuals through royalty income.

Why Should I Focus on Residuals When It Just Seems Like a Small Amount Every Month?
If you spend all of your time working on the tasks that require the most effort for the littlest reward, at best you will only get the littlest reward. Instead, it would be better to spend a minimal amount of time on achieving the maximum reward (i.e. increasing residual earnings). If you are not creatively inclined or unable to invent something requiring a patent, real estate investment is a relatively easy way to begin earning residual income.

How Does This Work?
For example, let’s say you spend 40 hours a week at a job making $25 per hour or $52,000 per year. Theoretically, you are working every minute of every hour to earn $25 per hour. Now, let’s say you invest in an apartment building for $75,000. The building has four units that each rent for $400 per month, for a total of $1,600. If the mortgage on the building is $600 per month and the property management company is $100 per month and the remaining expenses are $100 per month, that means you earn $800 a month or $9,600 a year for spending at most 30 minutes a month writing a few checks. If you spent 15 minutes a month handling the apartment building, that equates to three hours or work a year, which would mean that you earn $3,200 per hour.

I can’t live on $9,600 a year. I Still Need My Job. Now What?
The explanation behind the above example applies to multiple buildings also. Let’s examine the same idea only with five properties. Following the same logic and using the same numbers, you would take home $48,000 a year, which means you earned $16,000 per hour.

Just because you earn residuals, doesn’t mean that you need to give up your job. Residuals allow you to have regular income of a potentially sizeable nature without a lot of work. They can provide you with financial security as well as legal rights to income that can be passed to your children or heirs. Take the time to think about residuals and other passive income streams. With a clear understanding of where your money comes from and how much work you must put in to earn that money, you too can begin to work smarter.

Until next time…..rob

How Did You Calculate Your Cap Rate? LOL!!!

Greetings from the metropolis of Cedar Crest, NM!

It has been a while since I have personally posted on www.TheRealWealthBlog.com. I have been going through a funk of sorts and trying to figure out what direction to go. I have been a commercial real estate coach for a while and thinking it is time to go on my own….but not really sure how to do that.  So….as I try to figure it out…let me tell you about Capitalization rates (CAP Rate)….Yawn…

Why CAP rates? Well….after going through this last deal (500 unit apartment complex in Texas that went down the tubes), sellers, buyers…brokers and agents have their own definition of a cap rate. SO….I thought I would set the record straight….or possibly screw it up even more. To explain Capitalization Rates, Emily Cressey, with the use of a white board, gives a great visual of the definition of a Cap Rate.

Before I begin on setting the record straight, I do want to let you know that my next post will be on how I put together the deal than was not to be. I will show you the contract, the analysis, the third party firms I used, even how that dadgum deal blew up.  It was actually a great learning experience….again.  I hope you will get a lot out of my experience.  That is what we are here for.

Anyway…..

Capitalization Rate (CAP Rate)

Cap Rate: “Cap rate” means “Capitalization Rate” – it is actually a percentage rate of return that you would get from the INCOME of the property if you were to buy it ALL CASH with no leverage.

Here’s the formula: Cap Rate = NOI/Price

For example, if you bought a million dollar building with no loan and the NOI was $80,000 a year, that building would be an “8-cap” (Cap Rate = $80,000 / $1 Million = 8%)

If the same building had an NOI of $90,000, it would have a 9-cap as its capitalization rate.

Understanding the formula behind the terminology makes things a lot easier to understand.

***One key thing to remember is when the seller/agent/broker gives you the financials of a property and tell you what the Cap Rate is, find out how they calculated the Cap Rate.  Do your own math.  Sellers/agents/brokers tend to play with the expenses and tend to remove some expenses into capital expenses which tend to boost the NOI of the property.  Catagories such as maintenance, reserves, property management, etc., tend to “sneak” out of general expenses giving you a false NOI.

Emily’s video explaining Capitalization Rate