QUESTION: My wife and I own our home and want to invest in real estate. But we are undecided if we should buy rental houses or perhaps a small apartment building. We have owned our home about 10 years and it has gone up at least $50,000 in value. It is by far the best investment we ever made. But we have a friend who has invested in apartments and done quite well. Do you advise investing in houses or apartments?
ANSWER: Sound, well-located single-family houses usually appreciate in market value faster than apartment buildings. The reason is the market value of houses depend on recent sales prices of comparable neighborhood residences. However, the market value of apartments and other income properties depend on their net income, which may not rise as rapidly as market values of homes.
As an investor in single-family rental houses and as a former investor in apartment buildings and other properties, I find houses are far easier to buy, finance, manage and profitably resell than any other real estate investment.
Forget Gross Income in Buying Apartment
Q: I am interested in buying apartments for investment. Local realty agents tell me the correct gross multiplier is anywhere from seven to 10, depending on the quality of the building. Is this correct?
A: Forget you ever heard those dirty words gross income multiplier. They are used by sellers.
But smart income property buyers don't use them. The reason is gross multipliers are based on gross income and don't consider the effect of expenses. A better approach is to purchase income property on the basis of net operating income. If you can buy for 10 times net income you will probably have a good buy.
Maturity an Advantage in Selling Real Estate
Q: I was forced out of my job as senior vice president for loans with a S&L which merged with another. But, at age 66, I am not ready to retire. A friend who owns a large realty brokerage wants me to come work there as a salesman. I have already obtained my sales license. But I am unsure at my age if I should do this. I don't need the money so much as I need something to do. My friend wants me to specialize in leasing commercial real estate. Honestly now, don't you think at my advanced age I should try something else? -- Harold R.
A: No. Your "advanced age" is an advantage in real estate sales. Older real estate salespeople, both men and women, have an advantage because of their experience and trustworthiness.
With your excellent background you will have a hard time not being successful. But you have much to learn. The reason real estate is so much fun is there is always a better way. Take all the training classes you can and never stop learning.
Annuity Can Solve Inheritance Problem
Q: We own about 10 income properties, mostly apartment buildings, which we have owned for many years. They provide us with wonderful income. Our son has taken over the management and is doing an excellent job. We would like to have our son receive these properties either now or when we die.
But the difficulty is gift and inheritance tax problems. Another consideration is our daughter, whom we dearly love, married a foxy husband who has his eye on our wealth. We have provided for our daughter in our wills, but do not want her husband to get involved in our real estate. How can we solve our problem of giving our income properties to our son without incurring gift and inheritance taxes?
A: I suggest you consider deeding your income properties to your son in return for a "private annuity plan." He thereby becomes obligated to pay you a guaranteed income as long as you or your husband lives. Each payment you receive is partly tax-free and partly taxable, depending on your ages and life expectancy. Another benefit is you get your properties out of your estates so that greedy son-in-law won't get any ideas. Consult an experienced CPA or estate planning attorney to minimize the tax.
Telling Repair From Capital Improvement
Q: I own several small commercial buildings. My CPA tells me that I can deduct repair costs, but I must depreciate capital improvements over their useful life. However, I can't tell the difference. For example, last year I put in a new 200-gallon water heater, which my CPA said I could write off as a repair. But I spent about $10,000 installing new hallway carpets, which he said I must depreciate. What is the difference? Both items replaced existing components.
A: I agree it is often difficult to tell the difference between a tax-deductible repair and a depreciable capital improvement. The IRS says a repair preserves an existing component, whereas a capital improvement enhances or extends the useful life of the building.
A clear-cut example involves a roof. If you patch a leak, that is clearly a tax-deductible repair. But if you replace the entire roof, that is a capital improvement because it extends the life of your building.