By JODI SUMMERS
A lot of people entertain the fantasy that it would be great to invest in real estate. For many, the first step is becoming a landlord.
“You never want to buy a property where every month you have to feed it,” advises investment analyst Neil Binder of Bellmarc Equities.
Unless you’re offering up a big down payment, it’s a challenge to find profitable apartment buildings in the LA area right now.
Oftentimes when you read listings, it says “Pride of Ownership,” which is real estate slang meaning, “be happy you own it because you’re not making any money on it.” Sure, the phrase, “I own apartment buildings” runs trippingly off the tongue, but when it comes down to it, do you actually know how to run a profitable building? If you’re on LA’s Westside and trying to stay in the black, every dollar counts toward the bottom line. Here is an effective way to get your real estate empire organized: LLC: Set up a single-person limited-liability corporation, or LLC.
“An LLC is a blend of some of the best characteristics of corporations, partnerships and sole proprietorships. It is a separate legal entity like a corporation but it is entitled to be treated as a partnership for tax purposes and therefore carries with it the ‘low through’ or ‘transparent’tax benefits that corporations do not have,” notes the Limited Liability company Web site, www.llcweb.com. “It is very flexible and simple to run and, like a sole proprietorship, there is no statutory necessity to keep minutes, hold meetings or make resolutions which can trip up many corporation owners.”
If someone is injured on one of your properties, or if somebody decides to come after you because of the way you trimmed your hedge gave them an allergic reaction, the LLC becomes the legal target and your personal assets will be protected from liability claims.
INSPECTION AND REPAIRS: It’s good to know what you’re going to get. Please invest in a thorough inspection of your property before you buy. Here’s a story... once upon a time, there were two investors — architects with a vision, who did their own inspection on a property in Santa Monica. They were so caught up in their dream that they missed the mold issues and didn’t notice that the wood foundation had rotted out. Their little remodel went nearly $100,000 over budget. That property never made a profit for them.
Once you’ve done your inspection and you know what you’re getting into, get prices for the necessary repairs. Line up bids from several general contractors for quotes.
ACCOUNTANT: Use an experienced accountant. Regular readers know that there are powerful tax advantages to owning rental properties. Between depreciation, maintenance allowances and capital gains issues, tax benefits are abundant. Be sure to catch them all. For tax purposes, what you make in rent is generally taxable as regular income. Real estate taxes and mortgage interest on an investment property are fully tax deductible. Operating expenses such as utilities, insurance, repairs and condominium common charges also are deductible. Also nice is the fact that the federal tax code entitles rental property owners to a depreciation deduction even though housing prices usually go up over time. There are, however, numerous conditions and catches, which is why it is essential to consult a tax adviser before you invest a cent. LOAN: Are you buying one to four units? Can you get a residential loan? Check out your financing options. Borrowing to buy real estate as an investment is more expensive than borrowing to buy a home. Lenders generally think they are taking more of a risk on buildings that the owner doesn’t live in. Consequently, the interest rates they charge tend to be 0.5 percentage points or more above those for traditional home mortgages.
Additionally, borrowers are expected to have excellent credit scores to qualify for the low-est rates. Also, keep in mind the down payment is higher — some lenders may require up to 35 percent down — depending upon the property, the borrower and the loan scenario.
If the down payment is an issue, ask the seller whether he’s willing to self-finance the mortgage.As you know, with owner financing, the buyer signs a promissory note agreeing to make the mortgage payments directly to the seller. In exchange for forgoing a down payment, the seller typically gets a premium rate.
“It’s a lot faster to sell a house owner-financed than conventionally,” said landlord Juan Rodriguez.“There are also brokers who buy owner-financed notes from sellers who want their money up front.”
If you have a taxable profit on the sale of real estate, business property or personal effects, the tax law allows you to be paid in installments that may stretch out over years. The advantage is that you don’t have to report the gain on your tax return until you receive the money, so the sale won’t push you into a higher tax bracket or boost your income to a level where you lose tax benefits. The disadvantage is that you don’t get all of the money right away.
The terms of the loan or “carryback” vary, depending on the agreement between the seller and buyer. Typically, in an installment sale, the buyer puts down 20 percent to 30 percent of the sale price up front and pays the remainder in regular increments for a designated length of time, or in a lump sum at the end of the loan period. The seller collects interest on a regular basis throughout the life of the loan. As a result, he or she must pay capital gains tax on the lump sum amount in the first year, but not on the dollars still outstanding. (Jodi Summers is director of the investment division at Boardwalk Realty. For your real estate needs, , or call (310) 309-4219, or visit her Web site at www.santa-monicalandmarks.com. For information on Southern California investment properties there is a great blog at www.socalindustrialrealestateblog.com).
Originally published in the Santa Monica Daily Press print edition on September 6, 2006. Read the original PDF.