Post-License Ch14 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.

Applicable Formulas:

  • 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:

  • Expansion
  • Recession
  • Contraction
  • Recovery

There are four reasons that may contribute to a specific cycle that runs contrary to the general economy:

  1. Physical
  2. Economic
  3. Governmental
  4. Social

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).

Post-License Ch14 Summary Notes

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