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TRANSCRIPT
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Investing in Real Estate
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Chapter 24
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In This Chapter
You will be introduced to the benefits and dangers of investing. Cash flow, tax shelters, loss limitations, capital gain, tax law changes, equity buildup, and leverage are just a few of the topics covered.
Benefits of Investing
Appreciation – increase in property value over time.
Mortgage reduction – the decline of the mortgage balance as payments are made.
Cash flow – money left each year after paying property operating expenses and debt service.
Tax shelter – tax deductible expenses generated by an investment property.
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Rent receipts for the year $30,500Less operating expenses $10,000Less mortgage loan payments $20,000
Equals cash flow $ 500
Cash Flow Picture
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Rent receipts for the year $30,500Less operating expenses $10,000Less interest on loan $19,500Less Depreciation $ 8,000
Equals taxable income ($ 7,000)*
*In accounting language, parentheses indicate a negative or minus amount.
Taxable Loss
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Tax Shelter Tax deductible expense generated by an
investment. Loss limitation – active investor can deduct
up to $25,000 of losses to offset other income.
Straight-line depreciation. Residential 27.5 years Commercial 39 years Recapture rate of 25%
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Capital Gains & Investing
Held longer than 1 year = Long Term Capital Gain
Maximum tax rate of 20% Asset held for 5 years qualifies for 18% At-risk rules Installment sales Rehabilitation Tax Credits Low-income housing credit
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Equity at Time of Purchase Equity 5 Years Later
Purchase price $200,000 Market value $220,000Mortgage loan -140,000 Less loan balance -120,000Down payment $ 60,000 Equals current equity $100,000
Equity Build-Up
Current equity $100,000Less beginning equity -60,000
Equals equity build-up $ 40,000
(equity)
Calculating Equity Build-up
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Leverage
The ability to use borrowed funds to purchase investment property.
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Purchase Price $100,000Cash Down $20,000Loan $80,000Leverage 80%
• Investor only needs $20,000 to control $100,000 property
Property Selection Vacant land Houses & Condominiums Small Apartment Buildings Medium-size & Larger Apartment Buildings Office Buildings Other property types
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APPRAISER’S VIEWPOINT INVESTOR’S VIEWPOINT
The appraiser solves for value. The investor solves for return.
Value = Net IncomeReturn
Return = Net IncomePrice
Comparative Appraisal and Investment Objectives
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Developing a Personal Investment Strategy Risk Taking Debt Repayment Valuing an Investment Ownership Property Management Disclosure Laws
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Lifetime Income and Consumption Patterns
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Investment Considerations
Risk Taking Debt Repayment Valuing an Investment
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Limited Partnerships
Property Purchase Methods Property Management Financial Liability Investment Diversification Service Fees Pitfalls
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Disclosure Laws
Prospectus Blue-Sky Laws
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EFFORT AND COURAGE There is no “get rich quick” formula, so don’t
expect one. If you have a good, informed investment
strategy & the courage to take the risks, the rewards are certainly attainable.
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Key Terms Cash Flow Cash-on-cash Downside risk Equity build-up Investment strategy
Leverage Negative cash flow Prospectus Straight-line
depreciation Tax shelter
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