Where Should I put my Real Estate

Investment Dollars?

Tax Deferred Trading Strategy: We have all heard security investment advisors talk about the "magic of compound interest". The equivalent of that in real estate investment is "swap till you drop". This refers to continually trading up (swap), deferring all capital gains taxes, until you drop (pass on your legacy to your heirs which resets the estate's basis). The 1031 code allows you to get into larger and larger assets and enables you to build wealth pretty quickly.

The TYPICAL progression up the food chain usually starts with a duplex, then a four-plex and eight-plex. You get your depreciation out and then work your way up to a 40-unit complex. This strategy, though, is for the tireless who enjoy the management of tenant issues, maintenance, building improvements, broken water heaters and leaky toilets.

A Case for TIC Commercial Investments: What I much prefer is to trade out of residential units and into a professionally managed, institutional-quality, income-producing commercial property.

IRS guidelines issued in March of 2002 opened the door for modest-sized investors to participate in the purchase of large commercial buildings by confirming "Tenants-in-Common (TIC) ownership" as an option for 1031 exchanges. What this means is that rental property can be traded, via a tax-defered-1031-exchange, into an undivided, fractional interest in an existing piece of commercial property like an office building. There are now very large companies that provide property management, and specialize in high-quality, commercial exchange properties for use in 1031 Tenants-in-Common (TIC) real estate transactions. They lease back the property, pay taxes, insurance, debt service, and deal with the subtenants. The TIC owners only have to deal with one master lessee, who assumes the basic responsibility for the building and provides monthly rent payments to the TIC owners, which increases over time.

CASH FLOW & APPRECIATION EXAMPLE:

Cash Flow: Typically, assured income is about 6.5% on cash invested, which is after all expenses, including debt service on property leveraged up to 50%. What does that mean? let's take a typical bay area rental home owned and rented the last 20 years:

• Net $1,000,000 from 1031 exchange sale

• Roll it into $2,000,000 interest in office building with 50% loan to value

• Net income stream is $65,000/year and increases over life of lease (6.5% on $1,000,000)

• $65,000 income after all expenses, instead of the typical $20k to $30k/yr net from a $1,000,000 rental home

• But now you own a $2,000,000 share of a high quality commercial building

Appreciation: Although the leases on these properties are for 20 years, most sell (are re-spun) in 5 to 7 years. Here's why.

• Say the property appreciates 5% per year

• In 6 years the property appreciates 34% (5% compounded over 6 Years)

• Your $2,000,000 share appreciates to $2,680,000 (134% times $2,000,000)

• The owners decide to sell (typically requires 70% agreement)

• You 1031 exchange your $1,680,000 ($1 million plus 680,000 profit) into another property

• You roll-over into the same type of TIC transaction

• Value of your TIC share is $3,360,000, your 6.5% on cash now gives you a cash flow of $109,200/year

• AND, you have already collected $390,000 in cash over the past 6 years.

The discussion here has been somewhat simplified. You do need a professional to guide you through the process. Please give me a call if you would like to discuss your particular circumstance.

Bill Hoolhorst

Office:  (650) 366-0376

Cell:  (650) 888-5089

 Bill@Hoolhorst.com