The Time to Buy Real Estate by John Ebenger
Posted on May 09, 2012
By John G. Ebenger, Director of Real Estate Tax Services
For the sophisticated rental real estate buyer, the standard measurements for real estate investments include rate of return, risk, financial independence, cash flow and equity growth. For many first-time investors the primary concern is income generation or stated in the simplest of terms, cash flow.
Income can be generated from current positive cash flow, equity from appreciation and some would even say tax savings.
For tax purposes, there are generally three types of income: active, portfolio and passive. Active income can be wages, salaries or tips. Portfolio income includes interest, dividends and royalties.
Passive income varies from rental activity, limited business interests and activities in which the taxpayer does not materially participate.
The rules regarding passive losses are very complex and govern general tax savings. They require an investor to meet certain guidelines in order to receive the full benefit of the passive loss deduction.
While a passive loss results when all deductions exceed the property’s income for the year, passive losses can be used to offset passive income from one or more respective rental properties.
If you choose to invest but prefer your risk tolerance have a balance, there are many advantages to smaller rental properties. There is typically less competition for purchases and buyers usually have higher bargaining power, easier entry and better liquidity.
On the other end of the spectrum, if your finances allow for a higher risk, you could see greater benefits from larger, more complex real estate investments. When evaluating a venture, consider that the return or yield on an investment should correspond with the amount of risk associated with what will be invested. The positives behind investment real estate can only be achieved if the financial analysis and risk are properly identified prior to the purchase.
Once a buyer has determined the appropriate level of risk, the consideration now turns to the valuation of the investment property. Two methods commonly used in this practice are Gross Rent Multiplier (GRM) method and the Income Capitalization or Cap Rate method.
To ensure accurate data collection, knowing what is useful to obtain will make the process flow smoothly. Current information on a property’s income and expenses may be found in multiple locations. Requesting the property manager’s records, owner’s personal agreements and schedule E (from their 1040), along with copies of the current lease and rental notes are great steps to gain knowledge of your potential investment.
As many will tell you, the key to successful investing is a balanced portfolio. Diversification with portions of liquid savings, fixed-return investments and real estate ventures with equity growth potential can set you up for positive changes to your overall net worth.
About the Author:
John G. Ebenger CPA is a real estate tax director in the Miami office of Berkowitz Pollack Brant, an advisory and accounting firm with one of the largest real estate practices in Florida. For more information, call (305) 379-7000, visit www.bpbcpa.com or e-mail email@example.com.