Lance Edwards Podcast Episode 2: How to Profit with Small Apartments

Posted on Sep 19 2018 - 5:31pm by Lance Edwards
lance-newThe Five Point Checklist for Defining the Ideal Investment

On Lance Edwards recent solocast “How to Profit with Small Apartments,” he discussed a five point checklist defining the perfect investment using the easy to remember acronym IDEAL.

The I stands for ideal. An ideal means income. The ideal investment has strong cash flow, and when it comes to apartment buildings what we are looking for is a minimum of one hundred dollars per door per month cash flow. This is the net cash flow after paying all the expenses after paying the management company to run it for you, and after paying the cost of your money whether it’s conventional financing or private financing.

The D, or the second attribute of the ideal investment, is depreciation, or more specifically, the depreciation tax benefit. The IRS allows us to depreciate the value of a piece of real estate and use that depreciation to offset the income tax we pay on our job income. This depreciation is not an actual physical loss, but a paper loss that has huge tax benefits to us.

The E in IDEAL stands for equity, the third attribute of the ideal investment. In the case of small apartments, we create equity for ourselves by one of two methods. Number one. we get free equity when we buy a property at a discount. Equity is the difference between what the market value is and our purchase price. The difference between the market value and our purchase price is free equity. That just comes from negotiating. The second way that we generate equity over time in these apartment buildings is by paying down the mortgage because every month that a mortgage payment is made, which is being paid by your renters, not by you. Remember,  this is not your home. The building is paying the mortgage for you. Every month, your tenants are building your equity by paying down the balance on this mortgage. There are two ways you get equity. The first is by negotiating upfront to buy a property at a price below market value, secondly over time, as the renters pay down the mortgage for you.

The A in IDEAL is that that investment affords you appreciation, meaning its value goes up. This is yet another way to grow your equity. In apartments, there are actually two ways to achieve appreciation. One is through something called forced appreciation and the other is market appreciation. Market appreciation is something that we don’t have control of. If market forces drive the values up, that’s great news for us. Forced appreciation is different. It’s the ability to force the value of your building to go up by raising the rent and raising the occupancy – and doing it in a predictable manner.

The final attribute of an ideal investment, or the L in our acronym, is leverage. This means our ability to buy or purchase an investment using other people’s money (OPM), and that is certainly possible with apartments. I teach that you can buy apartments with 100 percent leverage, using private money that includes the seller in combination with a private investor, or multiple sellers. that can provide 100 percent of the financing. Getting that leverage is what is where your real power comes from. Add up the five attributes – Income, Depreciation, Equity, Appreciation and Leverage – and you’ll see that apartments are one of the few vehicles that make an ideal investment.

Click Here to Listen to Lance’s Podcast: How to Profit with Small Apartments

For More Information or to Listen to More of Lance’s Podcasts Go To GreenLightREInvesting.com

 

Tax Benefits of Owning Small Apartments

One of the best parts of owning small apartments is the array of incredible tax benefits they offer. On all of your cash flow off your apartments, you are going to pay the lowest rate afforded by the IRS because this is considered passive income. So apartments afford you the ability to pay the lowest tax rate on the highest income apartments. You can have an unlimited amount of income on apartment buildings and the tax rates are always the same, which is unlike say, active income from your job. With active income, the more you make, the more your tax rate goes up. Apartment buildings are fixed at a low rate. So your goal should be to create more and more passive income.

The second tax benefit of owning apartment buildings is that it will reduce the taxes on your active income now. The IRS allows us to use depreciation on our properties to offset how much tax we pay on our active income. This means that if you buy enough income producing real estate, you will not have to pay any income tax on your active income. This bears repeating: If you buy enough apartment buildings, the tax bill on your job income will be zero because of the benefit of depreciation.

The third tax benefit that you’re going to have is, with regard to your equity, short term versus long term capital gains. Here’s an example. If you own an apartment building for less than 12 months and sell it for a profit, you don’t have to pay long term capital gains. If you own if for more than a year, you’re going to pay short term capital gains, which also is the lowest tax rate there is. So you won’t be owning your buildings generally for more than 12 months, but it’s important to talk about how you would pay zero capital gains tax with apartments.

There are a couple of ways to do this. The first is tax free sales of your apartments, which is known as a 10 31 exchange. IRS Code Section 10 31 says that if we sell an apartment building and make a profit, if we use those profits to buy another piece of real estate within a six month period, we pay zero capital gains tax. You can do it over and over, as many times as you want, without limitation. In fact, when you die and pass that property on to your heirs, it resets with them. They don’t pay your taxes, either. The ability to remove Uncle Sam from the equation every time you flip a building and use it to buy another building means you can boost your net worth that much faster. In essence, the government is allowing you to take these profits. That is how you achieve a million dollar net worth within three or four moves, by trading up and taking advantage of the 10 31 exchange.

Another way you can extract your equity without paying taxes is to refinance the property and cash out. Let’s say you bought a building and you’ve raised the rents and occupancy to create forced appreciation. You can get the property reappraised at higher value put a new loan in place to refinance the building, pay off your old mortgage, put a higher mortgage in place and extract part of the equity as cash. It’s called a “re-fi” cash out, and allows you to harvest some of the equity that you’ve created through forced appreciation. That cash you take out is tax free because you’re not selling the building. You’re not triggering any kind of capital gains because you didn’t sell the building,  you’re simply harvesting your equity.

Click Here to Listen to Lance’s Podcast: How to Profit with Small Apartments

For More Information or to Listen to More of Lance’s Podcasts Go To GreenLightREInvesting.com