© 2008 by South-Western, Cengage Learning Chapter 27 Chapter 27 Charles J. Jacobus Thomas E. Gillett

© 2008 by South-Western, Cengage Learning Georgia Real Estate An Introduction to the Profession Seventh Edition Chapter 27 Investing in Real Estate

© 2008 by South-Western, Cengage Learning Investing Benefits Investing Benefits Appreciation Increase in property value over time Mortgage reduction Rental income used to reduce loan balance

© 2008 by South-Western, Cengage Learning Investing Benefits Investing Benefits Cash Flow Annual dollars remaining after payment of rent, operating expenses & mortgages payments Positive cash flow Negative cash flow

© 2008 by South-Western, Cengage Learning Investing Benefits Investing Benefits Annual Rent Receipts $30,500 Less operating expenses 10,000 Less mortgage payments 20,000 Equal cash flow $ 500

© 2008 by South-Western, Cengage Learning Investing Benefits Investing Benefits Net spendable Amount of spendable income produced Cash-on-cash

© 2008 by South-Western, Cengage Learning Investing Benefits Investing Benefits Tax Shelter Tax deductible expense generated by investment property Interest Maintenance Insurance Property taxes Depreciation

© 2008 by South-Western, Cengage Learning Investing Benefits Investing Benefits Annual Rent Receipts $30,500 Less operating expenses 10,000 Less mortgage payments 20,000 Less depreciation 8,000 Equal cash flow $ (7,000)

© 2008 by South-Western, Cengage Learning Investing Benefits Investing Benefits Passive Investor Deduct loss against other passive investments Active Investor Up to $25,000 to offset income $100,000 adjusted gross income Eliminated at $150,000 adjusted gross income

© 2008 by South-Western, Cengage Learning Investing Benefits Investing Benefits Eligible taxpayers More than 50% services in real property trade or business More than 750 hours of service in real property trade or business

© 2008 by South-Western, Cengage Learning Investing Benefits Investing Benefits Depreciation Calculation Straight-line depreciation Building value divided by number of years Accelerated depreciation Any rate faster than straight line depreciation during the 1 st few years $275, years = $10,000 per year

© 2008 by South-Western, Cengage Learning Capital Gains Capital Gains Gain due to depreciation is “recaptured” 1031 Tax-Deferred Exchange Identify “like kind” property within 45 days Purchase complete within 180 days Qualified Intermediary

© 2008 by South-Western, Cengage Learning At-Risk Rules At-Risk Rules Write-off limited to the amount actually invested plus… Recourse financing Amount investor is obligated to repay Non-recourse financing Value of the real estate secures the debt

© 2008 by South-Western, Cengage Learning Investing in Real Estate Investing in Real Estate Installment Sales Construction-Period Expenses Rehabilitation Tax Credits Low-Income Housing Credit Watch List

© 2008 by South-Western, Cengage Learning Calculating Equity Buildup Calculating Equity Buildup Equity Market value minus all liens and charges Equity buildup Change in equity over a period of time

© 2008 by South-Western, Cengage Learning Calculating Equity Buildup Calculating Equity Buildup Equity at Time of Purchase Purchase Price Mortgage Loan Down Payment (equity) $200, ,000 $ 60,000

© 2008 by South-Western, Cengage Learning Calculating Equity Buildup Calculating Equity Buildup Equity Five Years Later Market Value Less loan balance Current equity $220, ,000 $100,000

© 2008 by South-Western, Cengage Learning Calculating Equity Buildup Calculating Equity Buildup Equity Buildup Current Equity Less beginning equity Equity buildup $100, ,000 $ 40,000

© 2008 by South-Western, Cengage Learning Leverage Leverage Impact of borrowed funds on investment return $250,000 Cash - 250,000 Cost of building 0 Leverage

© 2008 by South-Western, Cengage Learning Leverage Leverage $500,000 Cost of building - 250,000 Cash 250,000 50% Leverage $2,500,000 Cost of building - 250,000 Cash $2,250,000 90% Leverage

© 2008 by South-Western, Cengage Learning Leverage Leverage Use of leverage depends on: Amount of expected: Cash flow Tax benefits Mortgage reduction Appreciation Willingness to take risk

© 2008 by South-Western, Cengage Learning Investment Timing Point in the property’s life the investment is made Idea stage: riskiest Finished & rented: least risky Risks & expenses increase as building ages

© 2008 by South-Western, Cengage Learning Limited Partnerships General Partners Organize & operate Contribute capital Full financial liability

© 2008 by South-Western, Cengage Learning Limited Partnerships Limited Partners Provide bulk of capital Little say in day to day operations Share in profits & losses Liability limited to amount of investment

© 2008 by South-Western, Cengage Learning Limited Partnerships Before Investing in a partnership: Prospectus Describes the investment Investigate general partners

© 2008 by South-Western, Cengage Learning Effort and Courage

© 2008 by South-Western, Cengage Learning Key Terms Key Terms Cash flow Cash-on-cash Equity build-up Leverage Negative cash flow Prospectus Straight-line depreciation Tax shelter