Commercial Real Estate and Retirement Planning
Commercial Real Estate and Retirement PlanningBy [http://ezinearticles.com/?expert=Irving_Diaz]Irving Diaz
We often browse through newspapers, magazines, business journals and the internet and regardless of how much we try; ignoring the vast array of retirement planning ads is next to impossible. It seems as though the last century has given birth to more investment vehicles than any one individual will ever use in a lifetime. Everything from stocks and bonds to IRA's and mutual funds are peddled in one form or another. And the number of securities brokers and financial planners willing to help pave the way for our retirement success are anything but scarce. What amazes me though is that of the thousands of retirement planning professionals in the U.S., very few if any actually recommend real estate to be included in their clients' retirement portfolios.
Advantages
Let's begin with the advantages of owning what I believe to be the greatest investment vehicle ever created; Commercial Real Estate. I want to clarify two important points before proceeding; first, the term commercial real estate and investment real estate will be used interchangably throughout this article and second, even though our homes are a potential gold mine in terms of equity and value, and make up what is more often than not our biggest asset, it lacks one of the three characteristics that classify it as investment real estate; Cash Flow (more on this in a moment and assuming that your principal residence is a Single Family Home). For purposes of this article, I would like for everyone to create a mindset that even though our home is indeed a very valuable asset, for retirement purposes, it should be considered icing on the cake rather than our largest contributor of net worth. The theory being that should our home ever be sold, a large portion of the proceeds will eventually have to be reallocated towards the purchase or leasehold of another home. In other words, we'll still need a roof over our head and therefore the full receipts of the sale may in many cases not remain fully liquid for retirement purposes.
With that said, lets analyze the characteristics that make up investment real estate and more importantly, the investment benefits they provide. There are four characteristics to consider:
Cash Flow, Tax Shelter, Equity Build-Up, and Value Appreciation.
1.) Cash Flow. As I mentioned earlier, all of the characteristics of investment real estate are in one form or another inherent in our primary residence (our home) except for Cash Flow. Assuming that our primary residence is a Single Family Home with no add-on apartments or studios or mineral rich land, then for obvious reasons if we are the primary occupants, there is a slim possibility of receiving cash flow from an additional source such as tenants residing on the property or an energy company drilling in the back yard. In investment real estate, Cash Flow refers to the property's periodic receipt of gross income minus all of its operating expenses. Cash Flow is usually measured in annual intervals and is classified as either Pre-Tax Cash Flowor After Tax Cash Flow. The former, Pre-Tax Cash Flow; is the total cash available after paying for expenses (i.e. management fees, utilities, repairs, property taxes, insurance, etc.) and mortgage debt (i.e. principal plus interest). After-Tax Cash Flow; is the total cash remaining after deducting income tax liabilities from Pre-tax Cash Flow.
2.) Tax Shelter. Inherent in Investment Real Estate is the ability to keep more of the periodic cash flow from operations through Property Depreciation and provides a mechanism to build a tax deferred net worth via a 1031 Exchange. Both of these are mere Tax Shelter examples of how Investment Real Estate can contribute towards a solid retirement portfolio:
a. Property Depreciation. As a common practice recognized by the IRS, Property Depreciation is an accounting concept that contributes towards the deduction of taxable income by recovering the costs of investment real estate thus improving cash flow. It's important to notethat land does not depreciate; the concept only applies to the value of the improvements on the land. For example: say we had a multifamily apartment building with a total assessed value of $500k and of that totalvalue, 40% would be allocated towards the land and 60% would be allocated towards the actual building improvement. Based on this example, only 60% of the value or $300k would be allowed for depreciation. It's important to note that there are various forms of depreciation and timelines that apply to each. For reasons of simplicity, we will not get into the intricacies of each here, however, the important point to understand is that investment real estate allows for depreciation which in turn improves cash flow.
b. 1031 Exchange. Section 1031 of the IRS code allows for a seller to exchange their investment property for another like kind property without having to pay capital gains taxes on the transaction. The 1031 code in essence, does not exempt the taxes altogether but rather, defers them. These are specialized transactions which require qualified intermediaries who are well versed in the 1031 procedure. In the interest of simplicity, we will not go into an in depth discussion of a 1031 as it would require a lengthy explanation however, the important point once again is to understand that investment real estate allows for the growth of tax deferred net worth until and through retirement. Visit our section on 1031 Exchanges for more information on this topic.
3.) Equity Build-Up. While investment real estate is sometimes purchased all cash, more often than not, leverage is the tool of choice. Mortgage Debtfinancing makes up the majority of investment real estate financing in the U.S.A reduction in the mortgage debt occurs periodically, best measured annually and is covered by a portion of the gross income received from the property's operation. As the mortgage principal and interest is paid down, the property begins to build equity; the difference between its accumulating market value and any outstanding mortgage liabilities. As Equity builds on the property, this provides an opportunity to re-leverage (or re-finance) and use the newly found capital to acquire additional investment properties thus expanding the owner's real estate portfolio.
4.) Value Appreciation. The fourth and probably the most compelling reason for acquiring investment real estate is the increase in its market value through appreciation. The economic forces of supply and demand coupled with inflationary trends and property improvements contribute to an everlasting growth in property market value. Real Estate markets are local vs. regional therefore, an impact in one market may have little or no effect in another market. This can have either a positive or negative connotation depending on the type of impact. It's important to point out that historically, real estate market appreciation has averaged between 3% and 6% growth annually.
Disadvantages
There are two disadvantages inherent in investment real estate; Property Management and Lack of Liquidity. At first glance they may appear to be serious impairments but, after closer evaluation, you'll quickly realize that these two not-so-good attributes are easily remedied.
1.) Property Management. So you're concerned that acquiring commercial property will require landlord duties. Everything from broken toilets, to loud music complaints at 3AM gives you the chills, not a problem. My first suggestion would be to invest in office, retail or industrial property. The toilets may still need repairing on occasion but the stigma of residential landholding quickly disappears. Now of course, commercial tenants need TLC too, in fact they have a business image to upkeep, so they expect the landlord to maintain
a presentable property. If this is still not enough of a remedy to change your mind about investment real estate, then how about hiring a professional management firm. Remember earlier in the cash flow section when we cited the example of the various expenses associated with operating an investment property. Well in case you missed it, the budget calls for a management fee. Leave it to the pros! A management company will handle all of your complaints, maintenance, repairs, and even accounting duties. At the end of the month they will send you a statement of all income and expenses and a check for the difference, that's right your cash flow!
2.) Lack of Liquidity. This is my favorite objection. As a real estate broker I'm always faced with resistance from new investors, especially those who are securities inclined and tend to argue that in the event they find themselves in a financial bind, they can easily liquidate their stock portfolio and have cash on hand within a few days. Here is where I allow for a few seconds of silence as to allow them a moment of argumentative victory, or so they may think. I always follow up the silence with this question; Can you ask a bank to lend you money using your stock portfolio as collateral?. The answer of course is always No! Stocks are very volatile and no lender in their right mind will accept a stock portfolio as collateral in exchange for a loan. However, if you are the proud owner of commercial real estate and found yourself in a financial bind, and assuming that you have equity in your property, you can approach any financial institution and borrow funds using your property as collateral. This loan is tax free until the property is sold or if the loan is repaid then no taxes will ever be due. Another point I like to make is that if an investor neededto liquidate their stock portfolio today, then they will have to sell at whatever the market price is today. Real estate is no different. An investment real estate owner that needs to sell today can place their property on the market and accept whatever the market may be willing to pay today. Both securities and real estate portfolio owners have the option of holding their assets and selling at more favorable times. The lack of liquidity concept in real estate has been greatly misconstrued.
After absorbing the concept of commercial real estate as an investment vehiclefor retirement, it should be clear that by comparison to securities products, investment real estate holds its own. This brings me back to my initial question; Why aren't there more retirement planning professionals offering investment real estate as an option for their clients? Perhaps lack of knowledge on thesubject or lack of licensing may be two thoughts that come to mind. Real Estateis a long term investment vehicle, so the excuse that it does not fit into a long term retirement plan cannot be valid.
Irving J. Diaz is a Licensed Real Estate Broker and Managing Director of Irving J. Diaz & Associates, LLC., a commercial real estate investment firm located in Miami, FL. For questions or comments please email the author at [mailto:ijdiaz@irvingdiaz.com]ijdiaz@irvingdiaz.com or learn more about the company at http://www.irvingdiaz.com
Article Source: http://EzineArticles.com/?expert=Irving_Diaz http://EzineArticles.com/?Commercial-Real-Estate-and-Retirement-Planning&id=678605
We often browse through newspapers, magazines, business journals and the internet and regardless of how much we try; ignoring the vast array of retirement planning ads is next to impossible. It seems as though the last century has given birth to more investment vehicles than any one individual will ever use in a lifetime. Everything from stocks and bonds to IRA's and mutual funds are peddled in one form or another. And the number of securities brokers and financial planners willing to help pave the way for our retirement success are anything but scarce. What amazes me though is that of the thousands of retirement planning professionals in the U.S., very few if any actually recommend real estate to be included in their clients' retirement portfolios.
Advantages
Let's begin with the advantages of owning what I believe to be the greatest investment vehicle ever created; Commercial Real Estate. I want to clarify two important points before proceeding; first, the term commercial real estate and investment real estate will be used interchangably throughout this article and second, even though our homes are a potential gold mine in terms of equity and value, and make up what is more often than not our biggest asset, it lacks one of the three characteristics that classify it as investment real estate; Cash Flow (more on this in a moment and assuming that your principal residence is a Single Family Home). For purposes of this article, I would like for everyone to create a mindset that even though our home is indeed a very valuable asset, for retirement purposes, it should be considered icing on the cake rather than our largest contributor of net worth. The theory being that should our home ever be sold, a large portion of the proceeds will eventually have to be reallocated towards the purchase or leasehold of another home. In other words, we'll still need a roof over our head and therefore the full receipts of the sale may in many cases not remain fully liquid for retirement purposes.
With that said, lets analyze the characteristics that make up investment real estate and more importantly, the investment benefits they provide. There are four characteristics to consider:
Cash Flow, Tax Shelter, Equity Build-Up, and Value Appreciation.
1.) Cash Flow. As I mentioned earlier, all of the characteristics of investment real estate are in one form or another inherent in our primary residence (our home) except for Cash Flow. Assuming that our primary residence is a Single Family Home with no add-on apartments or studios or mineral rich land, then for obvious reasons if we are the primary occupants, there is a slim possibility of receiving cash flow from an additional source such as tenants residing on the property or an energy company drilling in the back yard. In investment real estate, Cash Flow refers to the property's periodic receipt of gross income minus all of its operating expenses. Cash Flow is usually measured in annual intervals and is classified as either Pre-Tax Cash Flowor After Tax Cash Flow. The former, Pre-Tax Cash Flow; is the total cash available after paying for expenses (i.e. management fees, utilities, repairs, property taxes, insurance, etc.) and mortgage debt (i.e. principal plus interest). After-Tax Cash Flow; is the total cash remaining after deducting income tax liabilities from Pre-tax Cash Flow.
2.) Tax Shelter. Inherent in Investment Real Estate is the ability to keep more of the periodic cash flow from operations through Property Depreciation and provides a mechanism to build a tax deferred net worth via a 1031 Exchange. Both of these are mere Tax Shelter examples of how Investment Real Estate can contribute towards a solid retirement portfolio:
a. Property Depreciation. As a common practice recognized by the IRS, Property Depreciation is an accounting concept that contributes towards the deduction of taxable income by recovering the costs of investment real estate thus improving cash flow. It's important to notethat land does not depreciate; the concept only applies to the value of the improvements on the land. For example: say we had a multifamily apartment building with a total assessed value of $500k and of that totalvalue, 40% would be allocated towards the land and 60% would be allocated towards the actual building improvement. Based on this example, only 60% of the value or $300k would be allowed for depreciation. It's important to note that there are various forms of depreciation and timelines that apply to each. For reasons of simplicity, we will not get into the intricacies of each here, however, the important point to understand is that investment real estate allows for depreciation which in turn improves cash flow.
b. 1031 Exchange. Section 1031 of the IRS code allows for a seller to exchange their investment property for another like kind property without having to pay capital gains taxes on the transaction. The 1031 code in essence, does not exempt the taxes altogether but rather, defers them. These are specialized transactions which require qualified intermediaries who are well versed in the 1031 procedure. In the interest of simplicity, we will not go into an in depth discussion of a 1031 as it would require a lengthy explanation however, the important point once again is to understand that investment real estate allows for the growth of tax deferred net worth until and through retirement. Visit our section on 1031 Exchanges for more information on this topic.
3.) Equity Build-Up. While investment real estate is sometimes purchased all cash, more often than not, leverage is the tool of choice. Mortgage Debtfinancing makes up the majority of investment real estate financing in the U.S.A reduction in the mortgage debt occurs periodically, best measured annually and is covered by a portion of the gross income received from the property's operation. As the mortgage principal and interest is paid down, the property begins to build equity; the difference between its accumulating market value and any outstanding mortgage liabilities. As Equity builds on the property, this provides an opportunity to re-leverage (or re-finance) and use the newly found capital to acquire additional investment properties thus expanding the owner's real estate portfolio.
4.) Value Appreciation. The fourth and probably the most compelling reason for acquiring investment real estate is the increase in its market value through appreciation. The economic forces of supply and demand coupled with inflationary trends and property improvements contribute to an everlasting growth in property market value. Real Estate markets are local vs. regional therefore, an impact in one market may have little or no effect in another market. This can have either a positive or negative connotation depending on the type of impact. It's important to point out that historically, real estate market appreciation has averaged between 3% and 6% growth annually.
Disadvantages
There are two disadvantages inherent in investment real estate; Property Management and Lack of Liquidity. At first glance they may appear to be serious impairments but, after closer evaluation, you'll quickly realize that these two not-so-good attributes are easily remedied.
1.) Property Management. So you're concerned that acquiring commercial property will require landlord duties. Everything from broken toilets, to loud music complaints at 3AM gives you the chills, not a problem. My first suggestion would be to invest in office, retail or industrial property. The toilets may still need repairing on occasion but the stigma of residential landholding quickly disappears. Now of course, commercial tenants need TLC too, in fact they have a business image to upkeep, so they expect the landlord to maintain
a presentable property. If this is still not enough of a remedy to change your mind about investment real estate, then how about hiring a professional management firm. Remember earlier in the cash flow section when we cited the example of the various expenses associated with operating an investment property. Well in case you missed it, the budget calls for a management fee. Leave it to the pros! A management company will handle all of your complaints, maintenance, repairs, and even accounting duties. At the end of the month they will send you a statement of all income and expenses and a check for the difference, that's right your cash flow!
2.) Lack of Liquidity. This is my favorite objection. As a real estate broker I'm always faced with resistance from new investors, especially those who are securities inclined and tend to argue that in the event they find themselves in a financial bind, they can easily liquidate their stock portfolio and have cash on hand within a few days. Here is where I allow for a few seconds of silence as to allow them a moment of argumentative victory, or so they may think. I always follow up the silence with this question; Can you ask a bank to lend you money using your stock portfolio as collateral?. The answer of course is always No! Stocks are very volatile and no lender in their right mind will accept a stock portfolio as collateral in exchange for a loan. However, if you are the proud owner of commercial real estate and found yourself in a financial bind, and assuming that you have equity in your property, you can approach any financial institution and borrow funds using your property as collateral. This loan is tax free until the property is sold or if the loan is repaid then no taxes will ever be due. Another point I like to make is that if an investor neededto liquidate their stock portfolio today, then they will have to sell at whatever the market price is today. Real estate is no different. An investment real estate owner that needs to sell today can place their property on the market and accept whatever the market may be willing to pay today. Both securities and real estate portfolio owners have the option of holding their assets and selling at more favorable times. The lack of liquidity concept in real estate has been greatly misconstrued.
After absorbing the concept of commercial real estate as an investment vehiclefor retirement, it should be clear that by comparison to securities products, investment real estate holds its own. This brings me back to my initial question; Why aren't there more retirement planning professionals offering investment real estate as an option for their clients? Perhaps lack of knowledge on thesubject or lack of licensing may be two thoughts that come to mind. Real Estateis a long term investment vehicle, so the excuse that it does not fit into a long term retirement plan cannot be valid.
Irving J. Diaz is a Licensed Real Estate Broker and Managing Director of Irving J. Diaz & Associates, LLC., a commercial real estate investment firm located in Miami, FL. For questions or comments please email the author at [mailto:ijdiaz@irvingdiaz.com]ijdiaz@irvingdiaz.com or learn more about the company at http://www.irvingdiaz.com
Article Source: http://EzineArticles.com/?expert=Irving_Diaz http://EzineArticles.com/?Commercial-Real-Estate-and-Retirement-Planning&id=678605
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