Age of buildings / long range plans

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Age of buildings / long range plans

Kenneth LaVoie
Rental Property Investor · Winslow, ME · Member since 2008 · 826 posts · 281 votes

Good day. With a year under my belt, I hope I can still post in the "just starting out" forum! Some days I feel like I've been doing it all my life, others feel like I'm all thumbs!

My question is about "long range" planning in regards to the age of buildings owned. I've read a few threads advising the purchase of newer units because a higher % is allocated tax wise toward the building (improvements) vs. land, so the depreciation deduction is greater. Also, and more importantly in my case, they warn that older buildings may need serious capital expenditures in the future JUST when you don't want to be hemmorhaging cash, such as the first few years of retirement.

In my area (Waterville, Maine), we have mostly buildings built between 1890 and 1940 for multi's. Now shouldn't I be ok as long as they are structurally sound, and heating systems are up to date?

Everything is cash flowing pretty well, but I want to make sure my long term strategy will work. (i.e. buy, improve, hold and rent forever and ever, amen)

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Bryan Hancock
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
16y

Don't let the depreciation tail wag your profitably dog. There are tons of areas of the country where the bulk of a valuation is attributable to land costs that are non-depreciable instead of improvements.

The key is whether or not the project makes sense WITHOUT the paper depreciation expense. Don't let your accounting team run your project or make decisions about what makes sense. Depreciation should be seen as a bonus and not as a fundamental piece of a deal when you decide if it makes sense. As your portfolio grows the incremental value of the tax shield for your first project will get smaller. If you did the project mainly for tax reasons then you will lose most of this advantage because there are plenty of paper losses in subsequent projects.

All projects make sense at some price. The key to buying older buildings is to be overly conservative with accounting for capex. Get a very good inspector and have them be pessimistic when they do your inspection. Once you have a list of older items that would be fully depreciable on a chattel appraisal build those expenses into your pro forma for the project and assume you will have to replace them in a reasonable amount of time.

If you get the right type of loan you can take a "deferred maintenance credit" for some of the capex that will need to be done soon after the closing. This limits your cash in the deal with the seller. I know many investors that gross up the sales price after they do an inspection so that they can ask for the credit at closing and give the seller the same cash or terms for their equity.

Hope that helps some...

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  • Bryan Hancock
    Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
    16y

    Don't let the depreciation tail wag your profitably dog. There are tons of areas of the country where the bulk of a valuation is attributable to land costs that are non-depreciable instead of improvements.

    The key is whether or not the project makes sense WITHOUT the paper depreciation expense. Don't let your accounting team run your project or make decisions about what makes sense. Depreciation should be seen as a bonus and not as a fundamental piece of a deal when you decide if it makes sense. As your portfolio grows the incremental value of the tax shield for your first project will get smaller. If you did the project mainly for tax reasons then you will lose most of this advantage because there are plenty of paper losses in subsequent projects.

    All projects make sense at some price. The key to buying older buildings is to be overly conservative with accounting for capex. Get a very good inspector and have them be pessimistic when they do your inspection. Once you have a list of older items that would be fully depreciable on a chattel appraisal build those expenses into your pro forma for the project and assume you will have to replace them in a reasonable amount of time.

    If you get the right type of loan you can take a "deferred maintenance credit" for some of the capex that will need to be done soon after the closing. This limits your cash in the deal with the seller. I know many investors that gross up the sales price after they do an inspection so that they can ask for the credit at closing and give the seller the same cash or terms for their equity.

    Hope that helps some...

    2Reply
  • Dale Osborn
    Mobile Home Investor · Spanaway, WA · Member since 2008 · 1k+ posts · 578 votes
    16y

    Some people use a CAP rate to determine if it is a good investment. I prefer to look at money in versus money out. Will the building pay for itself? You make your money when you buy - so use negative info about the building to negotiate a good price so you have a cushion in case you need to do some repairs!

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  • Rich Weese
    Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
    16y

    Hi Kenneth- You may be referring to me as one warning of differences between old/newer units. We've had some great PMs back and forth on same subject.
    As one who owns both types, and has used the depreciation angle for over 30 years to reduce taxes to nearly zero over that time, yes it is important. Should you buy for the loss? Of course not!
    Why not do both? I've posted about different entities owning for liability reasons and it also works in this arena. You'll have less income to cover with depreciation when you retire, but while you're creating your wealth, taxes are huge detriment.
    All my free and clear properties are newer. My leveraged properties are older. I have reasons for that... Rich

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  • Bryan Hancock
    Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
    16y

    At the risk of this turning into a political diatribe I also wanted to point out that the government can change the depreciation expense laws on buildings in the future as well. This political risk (for your project) is hedged by the fact that NAR has huge clout and lobbying machinery so it wouldn't go down without a fight.

    Again...Profitability first, taxes benefits a distant second. Later in your career you won't pay much in taxes so the paper expense won't matter very much.

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  • Rich Weese
    Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
    16y

    As someone who has actually seen the changes in RE over 40 years, I've seen a lot. Govt is always changing rules on everything, including deprec methods, tax rates etc. Never has it been retroactive as far as I know. Another reason to plan and organize now, as I'll continue to point out . Rich

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