© 2008 by South-Western, Cengage Learning

Chapter 27Chapter 27

Charles J.Jacobus

Thomas E.Gillett

© 2008 by South-Western, Cengage Learning

Georgia Real Estate Georgia Real Estate An Introduction to the ProfessionAn Introduction to the Profession

Seventh EditionSeventh Edition

Chapter 27Chapter 27

Investing in Real EstateInvesting in Real Estate

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Investing BenefitsInvesting Benefits

Appreciation Increase in property value over time

Mortgage reductionRental income used to reduce

loan balance

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Investing BenefitsInvesting Benefits

Cash FlowAnnual dollars remaining after payment of rent, operating expenses & mortgages payments

Positive cash flow

Negative cash flow

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Investing BenefitsInvesting Benefits

Annual Rent Receipts $30,500

Less operating expenses 10,000

Less mortgage payments 20,000

Equal cash flow $ 500

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Investing BenefitsInvesting Benefits

Net spendableAmount of spendable income produced

Cash-on-cash

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Investing BenefitsInvesting Benefits

Tax ShelterTax deductible expense generated by investment property

Interest

Maintenance

Insurance

Property taxes

Depreciation

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Investing BenefitsInvesting 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)

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Investing BenefitsInvesting Benefits

Passive InvestorDeduct loss against other passive investments

Active InvestorUp to $25,000 to offset income

$100,000 adjusted gross income

Eliminated at $150,000 adjusted gross income

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Investing BenefitsInvesting 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

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Investing BenefitsInvesting Benefits

Depreciation CalculationStraight-line depreciation

Building value divided by number of years

Accelerated depreciationAny rate faster than straight line depreciation during the 1st few years

$275,000

27.5 years= $10,000 per year

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Capital GainsCapital Gains

Gain due to depreciation is “recaptured”

1031 Tax-Deferred ExchangeIdentify “like kind” property within 45 days

Purchase complete within 180 days

Qualified Intermediary

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At-Risk RulesAt-Risk Rules

Write-off limited to the amount actually invested plus…

Recourse financingAmount investor is

obligated to repay

Non-recourse financing Value of the real estate secures the

debt

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Investing in Real EstateInvesting in Real Estate

Installment Sales

Construction-Period Expenses

Rehabilitation Tax Credits

Low-Income Housing Credit

Watch List

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Calculating Equity BuildupCalculating Equity Buildup

Equity Market value minus all liens and charges

Equity buildupChange in equity over a period of time

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Calculating Equity BuildupCalculating Equity Buildup

Equity at Time of Purchase

Purchase Price

Mortgage Loan

Down Payment

(equity)

$200,000

- 140,000

$ 60,000

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Calculating Equity BuildupCalculating Equity Buildup

Equity Five Years Later

Market Value

Less loan balance

Current equity

$220,000

- 120,000

$100,000

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Calculating Equity BuildupCalculating Equity Buildup

Equity Buildup

Current Equity

Less beginning equity

Equity buildup

$100,000

- 60,000

$ 40,000

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LeverageLeverage

Impact of borrowed funds on investment return

$250,000 Cash

- 250,000 Cost of building

0 Leverage

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LeverageLeverage

$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

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LeverageLeverage

Use of leverage depends on:

Amount of expected: Cash flow Tax benefits Mortgage reduction Appreciation

Willingness to take risk

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Investment TimingInvestment Timing

Point in the property’s life

the investment is made

Idea stage: riskiest

Finished & rented: least riskyRisks & expenses increase as building ages

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Limited PartnershipsLimited Partnerships

General PartnersOrganize & operate

Contribute capital

Full financial liability

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Limited PartnershipsLimited Partnerships

Limited PartnersProvide bulk of capital

Little say in day to day operations

Share in profits & losses

Liability limited to amount

of investment

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Limited PartnershipsLimited Partnerships

Before Investing in a partnership:

ProspectusDescribes the investment

Investigate

general

partners

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Effort and CourageEffort and Courage

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Key TermsKey Terms

Cash flow

Cash-on-cash

Equity build-up

Leverage

Negative cash flow

Prospectus

Straight-line depreciation

Tax shelter