Sound, Well-Located Home Gives Buyer Clear Advantage Over Units

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.

Your new water heater replaced an existing component and did not either enhance your building or extend its useful life. Therefore, it is a repair. However, if you replaced a 100-gallon water heater with a 200-gallon water heater, that is a capital improvement.

As for your new hallway carpets, they not only extended the life of the property but probably enhanced its value.

Single-Family Rental Better Than a Duplex

Q: I own property which has an old wonderful house on it. The lot has been rezoned and now I am allowed two homes on the property. Each house is permited 2,200 square feet of living space per floor, with two floors allowed. This house is paid for and I have excellent credit. What is the best method of financing something like this? What would you do in the same situation? This house has sentimental value. I get $1,350 per month rent for the old house as is. The lot size is 200 feet by 60 feet. I have such potential here and am scared to death to make a move and have it be a mistake, as I hate to lose money. I am truly conservative. Your help will be appreciated.

A: Be careful. Your house may be worth more as a single-family home than as a two-family duplex. Before you do anything, check out recent sales prices of nearby duplexes. Then investigate what it would cost to build an additional unit on your property. I'll be surprised if you can make enough profit to make adding an extra unit worthwhile.

If you plan to keep the property as a rental, it will almost surely make absolutely no sense to build an additional unit because the modest rent attainable won't justify the construction cost. Just because a property is zoned for two units doesn't mean that is a higher and better use than a single-family home. Also, please be aware single-family houses have much stronger buyer demand than do duplexes and other rental properties.

New Owners Have to Honor Existing Lease

Q: My husband and I recently bought our first apartment building. We moved into the manager's apartment and everything is going quite well except for one old tenant. The previous owner liked this woman and gave her a five-year lease, which has two years remaining at only $250 per month rent.

When the realty agent showed us the rent schedule, we knew this tenant's rent was low but we presumed she was on a month-to-month tenancy like all the other tenants. We recently gave all the tenants rent raises, which they were expecting since we quickly painted the building during our first month of ownership. How can we get out of the old lady's very low $250 per month lease?

A: I regret to report that you are the "stuckee." New owners must honor existing apartment leases. Shame on the realty agent for not informing you of that one long lease. However, if you didn't ask, it is arguable that the agent and the seller had any duty to tell you.

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