All Forum Posts by: Jered Collins

Originally posted by @Basit Siddiqi:

I am not sure I follow the logic here.

Depreciation expense is great in that it is a non-cash tax expense in the year of the deduction.
If the taxpayer is in the top bracket of 37%, he is getting a savings of 37%.
Now if he decides to sell the property and gets his with depreciation recapture, it is capped at 25%

Granted - this scenario is assuming the taxpayer is in the top bracket. The greater the bracket of the taxpayer, the greater the spread for the difference of depreciation and depreciation recapture.

 I’m in the opposite spectrum or your scenario. 

Originally posted by @Sam Grooms:

Originally posted by @Jered Collins:

@sam grooms Here is a simplified example of how the recaptured depreciation can outweigh the annual benefits of depreciation

Here is an example: Let’s say you had a house that had a house value (not land) of $100,000 when you put it into service as a rental. You’d take about $3,600 in depreciation each year. If you are in the 15% tax bracket, you’ll pay $540 less in taxes each year due to depreciation.
After five years, you sell the house for more than you paid. In calculating the taxes on the sale, you’ll take the $18,000 you’ve taken in depreciation, and pay $4,500 in recaptured depreciation taxes on the sale. (Again, this is the extremely simplified explanation of the math. It’s actually much more complicated.) You pay $4,500 in recaptured depreciation taxes even though you only benefited by $2,700 in taxes during the years you were depreciating.

Yes, if you are in a very low tax bracket, avoiding taxes at 15% to pay them at 25% might not make sense. However, if I can make a 20% annual return on my investments, well then I'd still be better off with the extra cash today, and paying it back at a higher rate in the future. 

You are correct. The more I think about this subject the more I want to test the idea of diminishing returns due to recaptured depreciation and capital gains. Basically there is a sweet spot for IRR.

@sam grooms Here is a simplified example of how the recaptured depreciation can outweigh the annual benefits of depreciation Here is an example: Let’s say you had a house that had a house value (not land) of $100,000 when you put it into service as a rental. You’d take about $3,600 in depreciation each year. If you are in the 15% tax bracket, you’ll pay $540 less in taxes each year due to depreciation. After five years, you sell the house for more than you paid. In calculating the taxes on the sale, you’ll take the $18,000 you’ve taken in depreciation, and pay $4,500 in recaptured depreciation taxes on the sale. (Again, this is the extremely simplified explanation of the math. It’s actually much more complicated.) You pay $4,500 in recaptured depreciation taxes even though you only benefited by $2,700 in taxes during the years you were depreciating.

Perhaps this subject has been discussed in depth before but I want to reinvigorate the importance of understanding the effects of recaptured depreciation and capital gains tax on sale of multifamily properties.  

I've done analysis on several multi-family dwellings around 20-30 units each. Both properties cash flowed well and had value-add opportunity. After doing a NPV comparison and IRR analysis on both properties the deals looked less appetizing upon the sale of the assets. I performed a 5 and 10 year analysis with the sale of the asset ending on year 5 and 10 accordingly. Strangely enough after year 5, I would yield a greater equity on the property after recaptured depreciation was inserted in the top line of the income statement. There are diminishing returns starting at year 4-5 on the model I built. I understand variables drive a large % of this (equity waterfalls, exit cap rates, etc.).

The point of all of this is to make people understand that if you have no intentions of 1031 exchanging or holding the asset until death you are subjecting yourself to a potentially heavy tax burden upon sale of the asset.  If fact in a lot of situations you actually pay back more tax upon the sale of the asset than the straight-line depreciation deductions all added up together. 

So for a 50x80 parking pad you are looking upwards of $80,000?!? They encrusting it in diamonds or something? That is insane.  I've seen a similar area paved for about $10k

Originally posted by @Dennis M.:

Looked like a lousy deal anyway even at 140k purchase . 

 I agree. After sleeping on the deal I reran the numbers on rent comparables for the area and I think it would be a stretch to get $2,850 gross rents.  I’m still scratching my head on how people are putting in offers this high. 

Originally posted by @Derek Tellier:

@Jered Collins

A 5-Unit is a Commercial Property to it's very difficult if not impossible to get a conventional 30 year mortgage from a bank. 
Possibly via seller financing and certainly call every local bank around to find out, do that even before you get into a property like this to see who MIGHT be willing to do a refi and what requirements they'll have. 
You'll likely find at best they'll give you 25% of value which will be based on NOI and Cap rate not on Comps.

I'm not a lender so don't take my word for any of this by any means, reach out and talk to commercial lenders or small community banks and ask them. 

Thanks for your time Derek to respond to my post. Am I reading the 25% part of your post correct? 25% LTV based on NOI and Cap Rates or 25% equity I would bring to the table? Thanks.

@Heath Ryans Yea, I’ve noticed lots of smaller multi family properties are getting swallowed up fast lately.  I have 4-6 markets that I keep my eye on and all of them are extremely difficult right now to find deals that cash flow.  I can’t imsgine how anyone would positively cash flow on this particular deal at the price I believed they are offering at. Especially, if they are out of market buyers relying on third-party property management. Crazy market. 

That’s good insight on the commercial loan market of the Tri-Cities. Thank you for your time. BTW, I’m always looking for partners in deals if you’re ever interested.

@Heath Ryans thank you for your thought out response. It appears that I might already be late to the party. Talked to the realtor tonight and there is a pending offer that came in much higher than what I offered.  

I agree with all your points. I am curious to point 6 about having difficulty getting a 30 year note?  Can you elaborate more on this topic?  Would I have better luck with a 10 year balloon payment on a 25 year amortized schedule? 

Found a 5-Plex in East Tennessee located in a college town in a popular part of town known as the historic "Tree Streets".   The house is a two story brick traditional home.  Unit mix is 3x 1Bd 1Ba, 1x 2Bd 1Ba, and 1x efficiency 1Bd 1Ba.  List price is $200,000.  

The apartments are outdated with wood paneling walls, old appliances, old fixtures, and outdated carpet.  The bathrooms need new vanities, fixtures, some units need new showers, and paint.  I'm really deliberating on how to deal with the wood paneling.  Should I just paint it, skim-coat, or remove and replace with drywall?   What's everyone's experience with wood paneling?  The outside of the house is in fair condition.  The roof will need to be replaced in the next 3-5 years most likely.  

Market Comps in the historic area of town (.5 mile radius of subject property) range from $450-$575 for 1 Bed 1 Bath.     I think with around 4-6k invested per apartment, plus 5-10k invested on the outside (30-50K renovation) I can get around $550-575 for the 1 Beds, and around $650 for the 2 bed 1 bad.  Rehabbed monthly gross rent should be around $2,850.

My goal is to only purchase properties that yield 1.5% gross rent of the purchase + rehabbed cost of the building.  To achieve my goal of 1.5% I would need to be all in at $190,000 or less.  With all this being said, with my renovation budget of 30-50k, I am considering placing an offer at 140K.  This is a 30% discount to the list price.  Does this seem logical to offer that low given the steep discount?  

Anywho, here are my numbers for the deal.

List Price = $200,000

Est. Purchase Price = $140,000

Est. Renovation Budget = $50,000

All In Costs = $190,000

I'm exploring private money and weighing the pros and cons of going this route. I ultimately would like to refinance to a fix rate 30 year conventional note after the apartments have seasoned for 6-12 months. Will Fannie Mae loans refinance 70% LTV from a previously held private money loan?

Assuming I can refinance to a 30 year fixed loan here are my numbers.

ARV = $270,000

70% LTV = $189,000

DEBT:

Debt Constant of 4.8% loan ($189,000) = 6.3%

Monthly P&I @ 6.3% = ($11,907 / 12 = $992)

EXPENSES:

Less Vacancy & Collection @ 10% = $285

Property Taxes (Monthly) = ($1,405 / 12 = $117)

Insurance (Rough Estimate) = $1,200 / 12 = $100)

CAPEX @ 12% Gross Rent = $342

Maintenance @ 12% Gross Rent = $342

Water/Sewage = $200

Lawn Care = $125

Property Management @ 10% Gross Rent = $285

TOTAL MONTHLY EXPENSES = $1,796

DEBT + EXPENSES = $2,788

Cash Flow = $62

My goal is to cash flow $100 per a door but this market is getting tougher and tougher to find deals.  My numbers are somewhat prudent and there is a high likelihood I will cashflow more than shown.  The only reason I'm considering doing this deal (with the assumption I can get it under contract for the price mentioned above) is that I might be able to pull most if not all my equity out of this deal and find another deal to do.  I do not live local in this area so I am very reluctant to manage this property myself.  I haven't figured out how to conduct tenant walk thrus and other logistical challenges that presents itself being distantly managed.  

What are everyone's thoughts?