Be Wary of Promotions Offering Deals on Recreational Home Sites
QUESTION: What do you think of buying vacant land as an investment? While on vacation recently, I saw a newspaper ad for home sites near a nice fishing lake.
The utilities and roads are already in. The price is very reasonable and with only a $2,500 cash down payment, the developer will finance the mortgage at zero interest for 10 years. What do you think of this deal?
ANSWER: Please, please, please be very cautious. If you purchase in a recreational development, you are not buying an investment. The only person who will probably make a profit is the developer. Chances of any resale profit for you are virtually nil.
I would rather be optimistic, but the truth is, most recreational land developments are not successful. The losers are the buyers who usually default. The developer re-acquires the properties to resell again. And again. And again.
I hope you get my drift. Investigate carefully. If you decide to buy, please use money you can afford to lose. Then you can be pleasantly surprised if everything turns out well.
Tax Deduction for Lost Rents Not in the Cards
Q: I own a strip shopping center in a rough part of town. Only two of my six stores are occupied. Can I claim a casualty loss tax deduction for my lost rent on the four vacant stores? Due to the high crime rate in the vicinity I can’t get any decent storekeepers to move in.
A: Sorry, but you cannot deduct your lost rent on your income tax returns. However, you can continue depreciating the vacant stores even though they are not bringing in rental income. Please consult your tax adviser for further details.
Figuring the Value of Apartment Building
Q: I recently inherited a large amount of money and would like to buy an apartment building. Several real estate agents have shown me many apartment buildings that are for sale in my town.
But I’m confused about gross multipliers. They have shown me buildings with gross multipliers ranging from 6 to 10. Which is the correct gross multiplier?
A: None of the above. Forget you ever heard those words gross multiplier.
Gross multiplier means the gross rent of a rental property is multiplied by a number to obtain the building’s asking price. For example, suppose an apartment building produces $50,000 annual gross rent. If a gross multiplier of eight is used, the asking price would be $400,000.
However, the big defect of gross multipliers is they don’t consider the building’s operating expenses and its vacancies. A better approach is to capitalize the building’s net operating income.
To illustrate, suppose an apartment building produces $20,000 annual net income. Dividing by a capitalization rate of 10% produces a $200,000 market value. But a 9% “cap rate” results in a higher $222,222 market value. The lower the cap rate investors are willing to accept, the higher the property value.
To find out the cap rate in your community, divide the net income by the recent sales prices of similar nearby apartment buildings. Your real estate agent can obtain that information for you.
How to Lose Money Fast in Real Estate
Q: Although I look forward to your upbeat columns, why don’t you warn readers they can also lose money in real estate?
About three years ago, my wife and I sold our home, used that $125,000 old folks’ tax exemption for our profits, and bought a 22-unit motel.
We worked there day and night, never taking a vacation because we couldn’t get anyone to manage it so we could take a few days off.
Unknown to us, before we bought the only nice motel in a modest-size town, Holiday Inn was planning to build a fancy big new hotel just down the interstate highway from us. When it was finished, they took almost all our business and we had to reduce our rates to keep going.
A few months ago, we were lucky to sell out at a loss of over $100,000. Please warn your readers real estate isn’t always profitable.
A: Thank you for sharing your sad experience. Longtime readers of this column know motels, hotels, boardinghouses, bed-and-breakfast inns, and other labor-intensive acquisitions are real estate-oriented businesses.
They definitely are not real estate investments, such as rental houses, apartments, shopping centers and office buildings.
I hope reading about your situation will help others from making the same mistake.
Inflation is the Real Estate Investor’s Friend
Q: I own several apartment buildings that have substantially appreciated in market value since I bought them 10 to 15 years ago. I have positive cash flows and have enjoyed thousands of dollars of income tax savings. But I am concerned that the buildings might decline in value if the inflation rate keeps rising. Do you think I should sell now?
A: Why sell--unless you have a very good reason such as a better investment opportunity or you think property values will decline due to adverse economic influences such as high unemployment?
If you are worried about inflation, remember that inflation is real estate’s friend. The market value appreciation rate on most sound, well-located properties usually outpaces the inflation rate.
In addition, don’t forget the benefits of leverage. Chances are you bought your properties with 10% to 20% cash down payments. Even if your properties appreciate in value just a few percent each year, your return on invested dollars is probably at least 20% to 30%, often more. If you know of a better investment, please let us know.
However, if you had a huge speculative profit, my advice would be different and I would recommend you sell.
Letters and comments to Robert J. Bruss, a San Francisco-area lawyer, author and real estate broker, may be sent him at P.O. Box 280038, San Francisco 94128.
