The Benefits of Investing in Multifamily
The benefits of investing in multifamily. According to a recent Forbes, “The most striking feature in markets in the Midwest is that home prices in most of them are still below the level where local incomes say they should be. For an investor, this means two things. First, you can still find bargains in these markets. Second, demand for housing—at least until recently—has not been very strong.”
“Growth is now returning to many Midwest markets – especially those that function as regional centers – because of the expansion of jobs in the healthcare and business services sectors. As elsewhere in the country, these services are becoming more concentrated in large urban centers, creating opportunities for investors in rental housing.”
The Benefits of Investing in Multifamily
Investopedia saysthe average 20-year returns in the commercial real estate slightly outperform the S&P 500 Index, running at around 9.5%. Residential and diversified real estate investments do a bit better, averaging 10.6%. Real estate investment trusts (REITS) perform best, with an average annual return of 11.8%.
However, there are a lot of benefits to buying a multifamily property than just an average return. According to Jered Sturm at BiggerPockets.com It works like this. You put a $200k down payment on a $1M building at an 8% capitalization rate (very achievable). This leaves you with $80k net operating income ($1M x .08). When you borrowed the $800k from the bank, they lent it to you at 4% interest with a 30-year amortization. This means your year one mortgage payments equal $45,832 ($31,744 interest, $14,088 principal), leaving you with $34,168 in cash flow ($80,000 – $45,832) or a pre-tax cash on cash return of 17%.Hold On! There Are More Benefits.
I feel like I’m one of those late-night infomercial salesmen, “But wait there’s more.” So if you cash flowed $34,168, do you pay tax on $34,168? NO! Another beauty of real estate and leverage is the depreciation tax benefit. This is one the benefit the IRS has given to their buddies who are real estate investors. Even though you only put 20% of the $1M into the property, you get ALL of the depreciation benefits.
Apartment buildings are depreciated over 27.5 years, which means you get to depreciate the building’s value. The building’s value does not equal the property value because the building sits on land, and that land also has value. The IRS does not allow you to depreciate the land. A typical percentage of a property’s value that is allocated to land value is 20%, or in this example, it would be $200k. This leaves you with $800k of building value to be depreciated, so $800k/27.5 = $29,090.
What does this mean?
It means you are a friend of mine (remember Randy Newman) at the IRS. You barely pay any tax on that $34,168 cash flow you made on the building. You actually only have a taxable gain of $19,166 ($34,168 cash flow + $14,088 principal portion of your mortgage payment – $29,090 depreciation). We add back the principal amount of your mortgage payment because it is not a tax deductible expense and subtract out the deprecation we listed above.
Since you were able to put $200k down on a property, Let’s assume you’re doing pretty well financially. You’re probably in a 35% tax bracket, and the taxable gain of $19,166 would result in cutting a check for $6,708 to the IRS, leaving you with $27,460 ($34,168 – $6,708). This means your after tax return is 13.7%.
Here’s a twist.
The IRS gives you another favor. Instead of selling the multifamily and paying long term gain taxes, you can exchange the property for a like property and not pay capital gains taxes. And you can do this again and again. It is called a 1031 Exchange.We think that multi-family investing is the place to be.
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Terra Firma Property Solutions, LLC is a professional, full-service real estate solutions firm.
We buy and sell properties throughout the greater Kansas City area. We specialize in buying distressed homes, then renovating and reselling them to home buyers and landlords. Terra Firma Property Solutions: excited to be part of the economic rejuvenation of Kansas City and its surrounding areas.
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