Chapter 22 Investing in RE

cash flow

--the total amount of money remaining after all expenditures have been paid. These expenses include taxes, operating costs, and maintenance. --The cash-flow produced by any given parcel of RE is determines by at least three factors: amount of rent received, operating expenses, and method of debt payment -- to keep cash flow high, an investor should attempt to keep operating expenses reasonably low.

basis

A properties cost basis determines the amount of gain to be taxed. The basis of the property is the investor's initial cost of the RE. The investor adds to the basis the cost of any physical improvements subsequent;y made to the property. Note: the amount of any depreciation clammed as a tax deduction is subtracted from the basis. The result is the property's adjusted basis.

boot

A property owner will incur tax liability on the transaction only if additional capital or property is also received; the additional capital or property, called boot is taxed. -the value of the boot is added to the basis of the property for which it is given. -use of a qualified intermediary (also known as an accommodator or a facilitator) is considered a safe harbor by the IRS and is essential for a delayed exchange.

cost recovery

An Internal Revenue Service term for depreciation.

accelerated cost recovery system

Method for claiming tax deductions for certain property purchased before 1987 in which it was possible to claim greater deductions in the early years of ownership, gradually reducing the amount deducted in each year of useful life.

real estate investment trust (REIT)

RE estate investors take advantage of the same tax benefits as do mutual fund investors. A REIT does NOT have to pay corporate income tax as long as 90% of its income is distributed to its shareholders. -to qualify as a REIT, at least 75% of the trust's income must come from real estate.

adjusted basis

The cost or other original basis of property reduced by adjustments such as depreciation allowed or allowable and increased by capital improvements and other adjustments.

syndicate

a business venture in which people pool their resources to own or develop a particular piece of property.

capital gain

defined as the difference between the adjusted basis of property and its net selling price. -the difference between the selling price and purchase price that results in a financial gain for the seller

straight-line depreciation

depreciation taken periodically in equal amounts over an asset's useful life.

real estate mortgage investment conduit (REMIC)

has complex qualification, transfer, and liquidation rules. The REMIC must satisfy the asset test, which requires that after a start-up period, almost all assets be qualified mortgages and permitted investments.

appreciation

increasing value of a property. -Two main facts that affect appreciation: inflation and intrinsic value.

inflation

is the increase in the amount of money in circulation. When more money is available, its value declines. When the value of money declines, wholesale and retail prices rise. An operation of supply and demand

pyramiding

is the process of using one property to drive the acquisition of additional properties. Two methods of pyramiding can be used; Pyramiding through sale and pyramiding through refinance. Example of pyramiding through sale: Acquire a property and the improve it for resale at a higher price. The profit is used to purchase another property. Example of pyramiding through refinance: the goal is to use the value of the original property to drive acquisition of additional properties while retaining all the properties acquired. Using the refinancing proceeds to purchase another property.

depreciation

or cost recovery, allows an investor to recover the cost of an income-producing asset through tax deductions over the asset's useful life. -cost recovery deductions may be taken only on personal property and improvements to land. Land is not depreciated because it is not considered a deteriorating asset.

exchanges

real estate investors can defer taxation of capital gains by making property exchanges. to qualify for a tax-deffered exchange, the properties involved must be like of LIKE-KIND as defined under Section 1031 of the Internal Revenue Code. -properties must be held for investment (not owner-occupied) -RE and personal property CANNOT be exchanged in a tax-deffered transaction because they are not of like kind.

liquidity

refers to how quickly an asset may be converted into cash. -RE is not highly liquid over the short term. For example a RE investor may have to sell the property at a substantially lower price then desired to bring about a quick sale. -RE requires active management, it does not guarantee profit and involves a high degree of risk.

equity buildup

results from the addition to the amount paid as down payment on property of the principal proportion of loan payments, plus an increase in property value due to appreciation. -equity buildup is like money in the investor's bank account. This accumulated equity is not realized as cash unless the property is sold, refinanced or exchanged. -equity is LOST when a property;s market value decreases, even if the property is not sold.

income property

the most prevalent form of RE investment is direct ownership. Both individuals and corporations may own RE directly and manage it as an investment income or cash flow (income). --Property held for current income as well as a potential profit upon its sale.

intrinsic value

the result of a persons individual choices and preferences for a given geographic area. For example, property located in a pleasant neighborhood near attractive business and shopping areas has a greater intrinsic value than a similar property in a more isolated location. -As a rule, the greater the intrinsic value, the more money a property commands on its sale.

leverage

the use of borrowed money to finance investment. As a rule, an investor can receive a maximum return from an initial investment by making a small down payment, paying a low interest rate, and spreading mortgage payments over as long a period as possible. -leveraging a purchase by financing it provides a return that reflects the result of market forces on the entire original purchase price but one that is measures only against the actual cash invested. - risk is directly proportionate to leverage. A high degree of leverage translates into greater risk for the investor, as well as for the lender, because of the high ratio of borrowed money to the value of the real estate.