Creating a Real Estate Investment Plan

Two Common Investment Strategies

Many real estate investors adopt one of two common strategies – the dynamic or the planned. Both offer success but one tends to deliver higher profit in the longer term. New investors are often assume that "It's a numbers game – win some, lose some" or "If it's a good price buy it, if it isn't the right "buy-and-hold" property, you can always sell it." This can be profitable but often not as profitable as the less dynamic forward-planned approach.

Have a Clear End Goal and Know the Trends

The foundation for forward-planning is to set an ultimate End Goal, clarify a process, and build a trusted team. By basing all decisions on the End Goal, every investment opportunity can be tested, the process followed, and results delivered by the team.

Current and future market trends support the decision to invest in, or to pass on, a particular investment property. Each market – local and general - is affected by economic forces, current and possible future mortgage interest rates, age-range of potential buyers and tenants moving into or out of the area, and overall affordability, to take some examples.

Fix-and-flip or buy-and-hold decisions are affected by these trends in slightly different ways. Keeping your eye on the "market trends ball" and the End Goal enables the right "buy it," "hold it" or "pass it by" decision to be made.

An End Goal of $X,000 in pure equity, $Y,000 in monthly income, etc. means an investor will know when to buy-and-flip or buy-and-hold or hold-then-sell. Getting it right demands making decisions several transactions in advance. How many transactions is guided by the market and the End Goal.

An Example of Forward-Planning

A neighborhood shows signs of improvement – infrastructure, greater retail and other commercial investment, etc. – and has some repossessed properties or older, unimproved properties for sale. An investor can buy and renovate two, then rent them out. As more potential tenants move into the neighborhood and new investors who want to buy appear, one or both investments could be sold – with good sitting tenants in place. This enables a bigger investment in, say, a multi-family property that will both provide high rental income, lower management costs, higher profitability, and faster equity growth.

The monthly rental profit from that multi-family property will enable, say, a fix-and-flip investment to generate future profit and thus enable another buy-and-hold investment in a year's time. In this way, the investor builds both equity and monthly profit.

Each decision takes both current market trends and the End Goal into account rather than treating each investment separately as part of the "numbers game."

Final Comment

Long term, maximum success for investors means integrating goal, process and teamwork – and making current decisions that support future decisions.

Investing Options Including Via 1031 Exchange

Expand Your Options

In a previous blog we explained the basics of buying and selling investment properties via a 1031 Tax Deferred Exchange. In this one we discuss how, by using a 1031 Exchange, investors can expand their options.

Many people who are new to real estate investment define the meaning of "like-kind" too narrowly. They also assume there is only one "route" – sell and buy (relinquish and acquire) in a simultaneous transaction. Let us begin with what the IRS means by "like-kind" and then look at the three routes investors have available.

"Like-Kind" Property

The IRS defines the term rather vaguely. Like-kind property is real estate held for trade, business or investment. Investors who have a desire to improve the world may, for example, want to buy low quality residential property, renovate it and sell it, then use the profit to repeat the process. Others want to buy, renovate, and rent the property out to tenants. At some point, they will sell that property and use the proceeds to buy more expensive property and, again, repeat the process.

Some investors inherit property. It may be a relative's home or some farmland, just to take two examples. Some investors may have owned a commercial business such as storage units, parking lots, a small manufacturing plant, or a retail store for example. The IRS allows any of them to be "exchanged" for "fix-and-flip" or "fix-and-rent out" residential property. The residences can be single- or multi-family.

This means an investor's options for what can be "exchanged" expands quite considerably, thus deferring all capital gains tax (CGT) due, to roll into the new investment.

The Three 1031 Exchange Routes

1. One or more properties may be relinquished and other property(ies) acquired in a simultaneous transaction. But that is not the only route.
2. A deferred exchange transaction is one where properties are sold to new owners, but the proceeds are held by the qualified intermediary (QI) for the next step. The investor then has 45 days to name potential new investments. This window enables a thorough search for ideal replacement properties. The investor then has another 135 days to sign contracts and close on the replacements, making 180 days in all. Such flexibility expands the options.
3. A reverse exchange transaction is one where an investor "acquires" new property but does not "relinquish" currently-owned property for a maximum of 180 days. A QI will explain and manage the process. What matters is this process enables the right replacement property to be acquired at the right time and existing properties are sold later, when ready, willing, and able buyers are found.

The Takeaway

When investors understand the flexibility that the IRS has built into 1031 Exchanges, they are able to defer CGT,  maximize profitable sales and purchases, and complete everything in a time frame and sequence that delivers the greatest benefit.

What is a 1031 Tax Deferred Exchange?

Who Should Understand the 1031 Tax Deferred Exchange?

Investors who either flip properties or who decide to sell one or more of their current rental properties to invest in new ones should understand the 1031 Exchange rule. It is also known as a Starker Exchange or a Tax Deferred Exchange.

What is a 1031 Exchange?

It is a transaction covered by Section 1031 of the IRS Tax Code. It allows real estate investors to "exchange" (buy and sell) real estate without paying out capital gains tax (CGT) on the sale. The CGT is used to purchase the new property or properties. The CGT only becomes payable if a property is then sold without the proceeds being reinvested or is invested in a non-qualifying purchase.

Can Any Property Be "Exchanged" to defer CGT?

No. The transactions must all fall within parameters set out in the Tax Code and the approved steps must be followed. By working with a title agent or real estate attorney who is approved to handle 1031 Exchanges, known as a Qualified Intermediary (QI), the process becomes straightforward.

How Does a 1031 Exchange Work?

Like this:

• All properties must be in the USA or an American Territory.
• The purchased property(ies) must be of an equal or greater value than the sold property(ies).
• All properties must be what the IRS calls "like-kind." They must all be either raw land or improved real estate. Zoning and types (residential, commercial, industrial) are unimportant. So, for example, an investor can sell commercially-zoned raw land and buy a multi-family residential building. What matters is all properties must be for investment or business purposes.
• Since the 2017 Tax Cuts and Jobs Act, equipment, trucks, patents, etc. sold or bought with the real estate are no longer considered "like-kind."
• The term "sell" is replaced with "relinquish" and "buy" becomes "acquire." The QI will only use those terms on official paperwork.
• When one or more properties are relinquished, the QI holds the proceeds in an approved account. If it is released to the seller, the IRS considers it a regular sale and any CGT becomes due. When the acquired properties change hands, the QI releases those proceeds to complete the transaction. Technically, therefore, properties were exchanged and not bought and sold.
• There are time limits on a 1031 Exchange which must be adhered to. Properties must be exchanged within a total time frame of 180 days.
• In a "reverse exchange" new properties may be acquired before current properties are relinquished. We do not have the space to go into those details here, but a QI or an experienced Realtor will explain them.

Final Comment

When investors understand the 1031 Exchange process, they defer CGT giving them more liquid capital to reinvest. The 180 day flexibility built into the process enables investors to complete either side of the transaction to suit their own plans or the market cycle.

How to Recession-Proof Your Investment Portfolio

Recessions are a fact of life for investors, but they can still do a lot of damage. Successful investors survive and even thrive during the rough patches because they know how to plan for recessions and keep their portfolio in good shape.

Is a Recession Coming?

Investors are likely to have to deal with a recession during the next twelve months. The state of the bond yield curve indicates a strong risk, and there are also political factors to consider. That is not a guarantee of a recession, but the odds are high enough that it makes sense to start planning for it. Fortunately, there are a few things that most investors can do to reduce their risks.

Avoid Volatile Investments

Some investments lose more value during a recession than others. It can be wise to sell those investments while their price is still high and invest the proceeds into other investments that are less likely to lose value. Every market is unique, but luxury vacation homes, second homes, and other expensive luxury properties are very risky during recessions. Rental properties aimed at the average person and buildings in areas with a low supply of new buildings are much safer.

Plan in Advance

People make stupid decisions when they panic, such as selling their investments are their value plummets. Human instincts simply did not develop to deal with complex markets. The best way to avoid dangerous impulses is to plan ahead. Smart investors know that the may need to tweak the plan as they go, but they should only do so after careful thought.

Aim for Income

Rental properties and others that generate cash are a good choice during recessions. Their value may drop, but their previous income provides insulation from the losses. The added income also makes it easier to invest in new properties when their prices are low from the recession. Those new investments will often regain their value when the recession ends, which can turn the recession into an opportunity for investors who have the cash to make use of it.

Increase Value vs. Improvements to Sell Your Home Faster

When the time comes to make improvements to your rental property, you want to be sure that you're choosing the right improvements. Is your goal to increase the value of your home so that you can increase the selling price, or are you hoping to increase the odds that your home will sell quickly and effectively? Knowing the difference between the two can help you make the right choice about home improvements before you put your home on the market.

Question #1: Is the improvement appropriate for your area?

Take a look at the area around your home. Adding an extra bedroom, for example, can help add square footage and value to your home. It can also make it easier to sell the home if you live in an area dominated by families and you have a small, one or two-bedroom home. On the other hand, adding on an extra room or two might not add value in an area filled with seniors or young families with only a single child. Take a look at property values in the area, too: you don't want to substantially exceed the value of other homes around yours. 

Question #2: Does the improvement genuinely add value?

Fixing up things that are wrong with the house, including updating outdated appliances, can add both substantial value and substantial sellability to your home. On the other hand, some improvements are more a matter of personal preference than value. Upgraded utilities, for example, probably won't add value to your home. If your roof is on its last legs, you might be able to increase sellability by fixing it, but you might not improve its overall value. Carefully consider the benefits of each one before making changes to your home. Improvements that genuinely add value may include:

• Kitchen remodels
• Energy-efficient appliances
• Creating versatile spaces within the home
• Adding a deck

Make sure, before you get started, to calculate the cost of the changes versus the additional selling price you can expect to bring in. It may surprise you what additions, including a swimming pool, might actually cost more than you can make on them.

Question #3: What to buyers really want in your area?

Take a careful look at what buyers are looking for when they buy in your area. Improvements that add sellability might include things like:

• Improving curb appeal
• Updating appliances
• Adding a fresh coat of paint to make the house look its best
• Upgrading the bathroom

Take a look at the market and see what sells. Consider talking with a realtor to discover more about what potential buyers are really looking for. When you know what buyers are looking for, you can add those attributes to your home--and often, that can go a long way toward selling your house quickly and effectively. 

Are you putting your house on the market? Before you sell, consider these key elements of how to upgrade your home--and how to potentially improve your selling price.