Post-License Ch.14 Summary Notes
Advantages of Real Property Investment:
- Leverage – Using borrowed funds for real estate investment.
- Control and Use – intrinsic val
- Reasonable Returns – The yield on real estate investment has remained ahead of inflation.
- Some tax advantages
- Low interest rates on borrowed funds
Disadvantages of Real Property Investment:
- Lacks Liquidity – Refers to the time required to convert the asset to cash.
· Requires Capital to Buy, Sell and Hold
- Demands decision-making or management.
- Presents Risk – Recognizing opportunity in the marketplace is critical; but not as critical as the timing. Some investors are attracted to undeveloped land.
A residential property, even a rental, will be purchased for the intrinsic value; often with emotional attachment rather than for an income stream.
An investor will buy today to own the right to a future net income stream. The process of Capitalization is converting the net income to estimated value.
- Net Operating Income (NOI) ÷ Sales Price = Cap rate
- Before tax cash flow ÷ equity= Equity Dividend Rate
- Cash out (expenses and annual mortgage payment) ÷ Potential Gross Income = Cash Break Even Ratio
- Net Operating Income ÷ Annual Mortgage Expense = Debt Service Coverage Ratio Cash reserves are not included in the cash out requirement as the reserves are help.
A property owner is allowed to offset rental income with expenses related to the property, financing expense and depreciation.
A passive investor cannot use passive loss to offset ordinary income.
With conditions, an active investor of real property may use $25,000 worth of loss on investment property to offset ordinary income. The Adjusted Gross Income (AGI) must be no more than $100,000 per year.
Like-Kind Exchanges – One issue confronting owners of investment property is the tax consequence when a property is sold and “profit” is made.
A taxpayer who sells property and agrees to take the payments over time rather than in one lump sum may pay taxes on only the profit received.
Once a property has been placed in service, another decision to be made is the holding period.
The Real Estate Business Cycle:
There are four reasons that may contribute to a specific cycle that runs contrary to the general economy:
Strong production of goods and services (economic base) is necessary for growth. The production of all goods and services in our country is the Gross Domestic Product (GDP).