All Forum Posts by: Denise Evans

@Giovanni Isaksen, I NEVER recommend new or small investors buy on an IRR analysis. New or small investors should buy on a buy-and-hold analysis or a flip quickly analysis. For those of you who do not know what an IRR is, it is a tool that analyzes a property's value based on ALL cash coming in and going out over a period of time, usually 5 years. It anticipates selling the property at the end of the holding period.

So, you start with the purchase price and related expenses. That is money going out.  Over the years, revenues come in and expenses go out. Sometimes there is a capital expenditure anticipated, such as a new roof or rehab or something. That is money going out. At the end of 5 years, you sell the property for some amount of money you THINK it will be worth in 5 years (AH...there's the rub...) which is more money coming in. Closing costs and sales costs are money going out.  Next, you "discount" all of those cash flows to present value. You say to yourself, "If I can anticipate getting $300,000 sales price for this property at the end of 5 years, what amount of money would I need today that if I invested it at x% interest compounded monthly, would grow to $300,000 by the end of five years?"  Picking the correct interest rate--the "discount rate"-- is another educated guess.  The number you calculate is called the "present value" of the future income or expense. You do the same discounting for all cash inflows and outflows.  You then add all the revenue present values and subtract all the expense present values. That gives you one final number which is the supposed value of the property today. If you can buy it more cheaply than that value, you will presumably make money. 

The problem is, unless you are incredibly sophisticated, your buying decision is based on a guess about what the property will be worth in 5 years (which is probably based on a reasonable assumption about NOI and a guess about cap rates) and a guess about the best discount rate to use. If either guess is wrong, your model is worthless. If you want a better explanation of this, you might want to check out @Frank Gallinelli website, RealData, or his book on Amazon, What Every Real Estate Investor Needs to Know About Cash Flows.

Many unwary buyers buy on an IRR and convince themselves that negative cash flows after purchase are okay, because of the huge payoff upon sale in 5 years. Or, they convince themselves that paying a higher price than recent sales warrant, is justified because of the huge payoff upon sale in 5 years. Five years out is too far a "look-ahead" for the average investor to evaluate if the numbers are realistic or not.

My rule of thumb--if I have to talk myself into an investment, it's best to not buy.

@Giovanni Isaksen, I stand by my assertion that the seller is buying tomorrow's cash flow based on responsible and realistic growth assumptions.  Yes, I know many sellers prepare pro formas that assume huge rent increases and expense decreases and cap rate decreases that will occur after "somebody" renovates the property. Those pro formas should be ignored. But, if the market is stable and my annual numbers show solid 5% per year increases in rents and an average of 3% per year expense increases, then I think the pro form should reflect that. And, I will sell on that pro forma.  And, @Frank Gallinelli, I agree that for a new lease up, you should show month-by-month financials and pro forma.

Hi Lydia, I live in Chilton County. Clanton is the county seat. Wetumpka is in Elmore County. I don't know much about that market, but I might be able to direct you to somebody reputable.

I'm sorry, @Shannon Keating, I don't know a thing about Oklahoma. Good luck!

With reference to title vs. lien, Alabama is a title state but with non-judicial foreclosure. Lender gets title after the foreclosure auction.  Former owner has 12 month redemption rights in some circumstances, six months in others.

@Brandon Hall, excellent advice.  I'm afraid I've had very bad experiences with accountants who refused to have discussions with me, but basically took the parents' line, "Because I said so, that's why."  It colors my judgment sometimes, and I should not have been so flippant with my comments. Thank you for taking the time to add your insights and comments. If my accountant or lawyer can give me a reasoned explanation to why they want to do or not do something, then that's terrific. If I disagree, then it's a matter of "Who is willing to take the risk of a bad decision in an iffy area?"  If I want to take the risk, but the accountant is unwilling to sign off on the tax return, then we should part ways.  On the other hand, I am appalled at the number of gurus who advise bogusing up a business plan, and as long as the paper in the file is okay, the taxpayer is okay. As if the IRS is populated by gullible idiots. If you are flipping as an incidental activity to support your investments, then I think you should get investment tax treatment.  If you are a flipper, BE A FLIPPER.  There are many tax advantages available to flippers that are not available to investors.  Many reported decisions on this topic are people who WANTED to be characterized as selling properties in the ordinary course of business, rather than mere investors.  Perhaps you could start a thread on tax advantages available to flippers but not investors. I'm sure there would be a lot of interest in that.

@Bill Walston, my bad for not being clear.  I see I posted at 6:21 in the evening. Note to self:  "Remember, you are a morning person who usually rises at 5am, and not at the top of your form in the evenings. DO NOT POST after 3pm!"  That probably explains why I started looking for legal precedent on this issue and then gave up and was satisfied with a nudge in the right direction!  I'll see if I can find some more definite guidelines to share with everyone. It's often not the IRS we have to convince, but our own accountants. :)

@Bill Walston, I was not saying that was the decision of Byram, I said to take a look at it.  It is the beginning point of research on this topic.  I am comfortable with the advice I gave, and have no need to spend hours on the legal research finding the support.  If someone else wants to do that, I gave them a starting place.  No, the decision is not relevant to the typical wholesaler. It is relevant to the original question, which related to a desire to engage in some flips to generate capital for long term capital gains. That is defensible as investment income, not ordinary income.  And, while you are correct that only 7 flips were at issue, the  history of 22 sales was a factor in the analysis.

@Marcus Perkins Sr  The former owner can redeem at any time during the 3 years after you take possession of the property, even if you have a tax deed.  Some experts believe that if you have 3 years of possession starting with the tax certificate, then the former owner does not get an additional 3 years. Some experts believe the former owner gets at least 6 years from the tax sale, no matter what. Please send me an email off-post, and I'll send you my phone number so we can discuss. It is very fact-specific. 

If you've been cleaning and fixing up the property, you are entitled to the VALUE of these "preservation improvements."

If you have access to Federal Court reporters, you might want to read the case of Byram v. Commissioner, 705 F.2d 1418 (5th Cir. 1983) for a decision that 22 flips in 3 years were, nevertheless, investment properties.