Chapter 17 - Investments and Business Opportunity Brokerage (2%) Flashcards
Section 17.1: REAL ESTATE INVESTMENT ANALYSIS
:::STATE EXAM CONTENT AREA: XVII.A: REAL ESTATE AS AN INVESTMENT:::
Investment Analysis, Advantages, and ** Disadvantages
Investment Analysis
Most important consideration:
Economic soundness
Land use controls
Zoning
Deed restrictions
Permitting requirements
Economic force
Population growth
Foreign capital
Impact of taxation
Advantages
Income
Equity build up
Appreciation in value
Tax benefits
Positive leverage
Prestige
** Disadvantages
** Illiquidity
** Immobility
** Expense/overhead
** Additional expertise from
– Real estate brokers
– Tax accountants
– Attorney’s etc.
Section 17.2: TYPES OF INVESTMENT PROPERTIES
:::STATE EXAM CONTENT AREA: XVII.A: REAL ESTATE AS AN INVESTMENT:::
Types of Investment Properties
Agricultural
Business Opportunities
Commercial
Industrial
Office
Residential
Condominiums
Villas
Single family homes
Apartment complexesSection 17.2: TYPES OF INVESTMENT PROPERTIES
:::STATE EXAM CONTENT AREA: XVII.A: REAL ESTATE AS AN INVESTMENT:::
Real Estate Investment Trust (REIT)
Individuals pooling their resources for
investment
Professionally managed portfolio
Real property
– Office buildings, apartment
complexes, retail centers
Mortgages secured by real property
Similar to mutual fundSection 17.3: REAL ESTATE TERMINOLOGY
:::STATE EXAM CONTENT AREA: XVII.A: REAL ESTATE AS AN INVESTMENT:::
** Terminology
BASIS (or COST BASIS) - original value of an asset for tax purposes
ADJUSTED BASIS = COST BASIS + INCREASES (cost of improvements) - DECREASES (IRS allowed reductions)
EQUITY - The initial down payment creates equity. Additional equity is created through principal reduction and appreciation
LIQUIDITY - asset’s ability to be easily converted through the act of buying or selling w/o causing a significant movement in the price and w/ min loss of value
Tax shelter An investment that shields income from taxation Positive Cash Flow as property appreciates is ideal Tax shelter obtained by deducting interest and depreciation - especially depreciation - from net operating income
Capital Gains and Losses
Amount Realized = SALE PRICE - COSTS OF SALE
** Capital gain = AMOUNT REALIZED - ADJUSTED BASIS
** Sold for more than paid
** Taxed in the year earned
** Capital Loss
** Sold for less than paid
** Loss may be carried forward to future
years (passive income)
Section 17.3: REAL ESTATE TERMINOLOGY
:::STATE EXAM CONTENT AREA: XVII.C: ASSESSMENT OF RISKS:::
/* Static vs. Dynamic Risks
- ** 1) Dynamic risk
- ** Associated with general market conditions
- ** Can not be shifted to an insurer
-
/** 2) Static risk
- /** Can be transferred to an insurer
- /** E.g. fire, theft or vandalism
*** Dynamic Risks: Business Financial Inflationary (or purchasing power) Interest rate Liquidity Market
Section 17.3: REAL ESTATE TERMINOLOGY
:::STATE EXAM CONTENT AREA: XVII.D: LEVERAGE:::
*** Leverage
** Use of borrowed funds, or OPM - other
people’s money; (AKA “trading on the
equity”)
** Positive leverage
– rate of return greater than interest
rate (increased return by borrowing)
*** Negative leverage –
– rate of return less than interest rate
Section 17.4: EVALUATING INVESTMENT PROPERTIES
:::STATE EXAM CONTENT AREA: XVII.B: ANALYZING INVESTMENT PROPERTIES:::
** Reconstructed Operating Statement
** The effect of financing and taxation on the investment (last 4 new acronyms - apply to investor, not the property)
PGI Potential Gross Income -V&C Vacancies & Loss Collections -------- EGI Effective Gross Income -OE Operating Expenses (FE, VE, R) ------- NOI Net Operating Income -ADS Annual Debt Service ------- BTCF Before Tax Cash Flow (or Cash Throw Off - CTO) -TX Taxes ------- ATCF After Tax Cash Flow
** Operating Expenses
Fixed Expenses
Property Taxes
Hazard Insurance
Variable Expenses
Maintenance
Utilities
Management fees
Reserve for Replacements
Noncash expense
Use in the future to replace worn out
components
** NOTE: ANNUAL DEBT SERVICE (MORTGAGE PAYMENTS) IS NOT CONSIDERED AN OPERATING EXPENSE
Section 17.4: EVALUATING INVESTMENT PROPERTIES
:::STATE EXAM CONTENT AREA: XVII.B: ANALYZING INVESTMENT PROPERTIES:::
** Operating Expense Ratio and Loan-to-Value Ratio
** Operating expense ratio =
Operating Expenses / Effective Gross Income
NOTE: Provides for comparison with similar properties
Loan-To-Value ratio =
Loan/Value
NOTE: Shows the % of value the lender agrees to lend
Section 17.4: EVALUATING INVESTMENT PROPERTIES
:::STATE EXAM CONTENT AREA: XVII.B: ANALYZING INVESTMENT PROPERTIES:::
/* Calculating Profit on Investment
/* Made/Paid = Profit or loss %
Example: An investor paid $300,000 for a parcel
of land and sold it for $200,000. What
was the percentage of profit or loss?
Made/Paid = ($100,000) loss/$300,000 = 33% loss
Section 17.4: EVALUATING INVESTMENT PROPERTIES
:::STATE EXAM CONTENT AREA: XVII.B: ANALYZING INVESTMENT PROPERTIES:::
Rate of Return (ROR) and Equity dividend Ratio (EDR)
Rate of Return (ROR) =
Net operating income (NOI) / Investment value
Equity dividend ratio (EDR) =
Cash throw off (CTO) / Original Equity
Section 17.5: IMPACT OF FEDERAL TAXATION
:::STATE EXAM CONTENT AREA: XVII.B: ANALYZING INVESTMENT PROPERTIES:::
** Depreciation as a tax deduction
** Deductions from Gross Income
** Depreciation - allows investor to
recover cost of improvements
** Land (Site) does not depreciate
** Deduction, but not expense
** Not appraisal depreciation
** Straight-line method
** Recovery Periods
** Residential - 27.5 years
** Non-residential - 39 years
EXAMPLE: A residential rental property sells
for $225,000; closing costs were $17,000 and
the land represents 20% of the value.
What is the annual straight line depreciation
allowance?
$225,000 + 17,000 = $242,000 Total acquisition cost
$242,000 X 80% = $193,600 Basis for depreciation
$193,600 ÷ 27.5 = $7,040 Annual cost recovery
Section 17.5: IMPACT OF FEDERAL TAXATION
:::STATE EXAM CONTENT AREA: XVII.B: ANALYZING INVESTMENT PROPERTIES:::
Capital Gains Tax
Short term
Property held for 12 months or less
Taxed at taxpayer’s ordinary tax rate
Long term
Property held for more than 12 months
15% tax rate
20% tax rate
– Single > $400,000 annual income
– Married, joint return > $450,000
Section 17.5: IMPACT OF FEDERAL TAXATION
:::STATE EXAM CONTENT AREA: XVII.B: ANALYZING INVESTMENT PROPERTIES:::
Income Classification
Three categories of income
Active : salary, tips and commissions
Passive : income from activity in which investor does not
actively participate, including any rental activity - even if
investor actually participates
Portfolio : dividends, interest,and capital gains
Section 17.5: IMPACT OF FEDERAL TAXATION
:::STATE EXAM CONTENT AREA: XVII.B: ANALYZING INVESTMENT PROPERTIES:::
1031 Tax Deferred Exchange and Installment sale
There are two methods an investor can use when a property is sold to reduce or defer the amount of tax due on the transaction:
1) 1031 Tax Deferred Exchange
Like Kind Exchange
Investment real estate for investment
real estate
Tax deferred
Boot
Any unlike property received in
exchange
Taxable now
e.g. cash
2) Installment sale
Gain
Received over a number of years
Percentage received is taxable that year
Reduces tax due in any year
Section 17.6: BUSINESS BROKERAGE AND OPPORTUNITY BROKERAGE
:::STATE EXAM CONTENT AREA: XVII.E: BUSINESS BROKERAGE:::
Business Brokerage
Analyze financial statements
Reconstructed operating statements
Balance sheets
Income statements
Business brokers
Sale, purchase or lease of a business
Must hold real estate license
Business Enterprises
Transactions over $200,000
Business Opportunities
Transactions under $200,000
Sales frequently involve
Shares of stock
Limited partnership interests
Securities
Be careful
May violate securities laws
Requires separate license
