Glossary
|
||||||||||||||||||||||||||||||||||||||||||||||||
| A | B | C | D | E | F | G | H | I | J | K | L | M |
| N | O | P | Q | R | S | T | U | V | W | X | Y | Z |
Acquisition: The acquisition stage, or pre-ownership stage, in purchasing commercial properties is when you analyze the income statement, balance sheet, rent rolls, estoppel agreements, and personal records. At this pre-ownership stage, all third party reports are reviewed and we will be work with the attorney to create the L.L.C, L.P., and/or T.I.C. This stage is when we are conducting our legal due diligence process.
Actual Income: The total income the property generated in the prior twelve (12) months.
Actual Potential Income: The Actual Potential Income is the total income the property could have generated in the prior twelve (12) months had all units been 100 percent occupied and had the owner taken advantage of all other income opportunities.
Accredited Investor Requirements: Accredited Investor Requirements is net worth or a joint net worth with your spouse of more than $1,000,000 (valuing all assets at their fair market value); or an individual annual income exceeding $200,000 in each of the two most recent years or a joint income with your spouse in excess of $300,000 in each of those years and a reasonable expectation of reaching the same income level in the current
year.
The main reason the Security Exchange Commission (S.E.C.) sets forth these requirements is because they want to protect the public from losing their money. The S.E.C. wants to make sure an investor is knowledgeable about investing and that they know what they are getting into.
Even though some of our potential investors do not have these requirements, I will allow a limited number of unaccredited investors to become a part of our partnerships. I will hand select each investor so as to maintain a high caliber of quality in each partnership.
After-Tax I.R.R. (Internal Rate of Return): I.R.R. (Internal Rate of Return) simply put is the average annual yield on an investment. The After-Tax I.R.R. calculation for each year uses the initial investment amount, the series of After-Tax Cash Flows and the After-Tax Sales Proceeds in a particular year to establish an average return on investment. For example, if we were calculating an I.R.R. 5 years into the future for an investment, we would use the Initial Investment Amount, the After-Tax Cash Flows for each of the 5 years, and the After-Tax Sales Proceeds in year 5, the final year, to calculate an average After-Tax I.R.R. for the investment. The real estate model calculates an After-Tax I.R.R. in years 1 through 10 using this method. Be aware of one thing when looking at the I.R.R. calculations: If in year 5 you have a return of 15%, this means that your After-Tax Cash Flows in each year are ran forward at 15%. When calculating the Modified Internal Rate of Return (M.I.R.R.) for Future Wealth, On Target allows you to determine what the rate of return you would like to run your cash flows. The M.I.R.R. for Future Wealth, therefore, provides a more accurate return on investment in each year.
Asset Allocation: Asset Allocation is a basic investment principle whereby you keep the velocity of your money moving in and out of a particular asset in an asset class. The principle of “Velocity of Money” means that you purchase an asset, get your money back as soon as possible leaving the broker’s money in the property, maintain control of the asset, then move your money into another asset. Then get your money back again, leaving the bank’s money in the property; keep control of the asset, and then repeat the process. This principle of Asset Allocation will increase your wealth exponentially.
Balance Sheet: A Balance Sheet is an accumulation of your total assets and liabilities. Your assets would consist of:Real estate stocks, mutual funds, cash/savings, and personal property. Your liabilities would consist of: Your real estate mortgage(s), credit cards and school loans, etc. When you subtract your total liabilities from your total assets, you will get your total net worth.
C-Corporation: A C-Corporation is a separate legal entity from the people who own it. It has a life of its own. It can own assets, incur liabilities, and provide goods and services to the general public. Every C-Corporation starts out as a C-Corporation and remains as such unless it makes a subchapter – an S election. C-Corporations are often the first step in reducing taxes and protecting assets. They can additionally provide tax deductive expenses. C-Corporations offer approximately 300 deductible expenses of which you can take advantage. If you want to take your company public, you will need a C-Corporation structure to do that. The C-Corporation additionally offers the benefit of having a fiscal year end either 3/31st,6/30th, 9/30th, or 12/31st.
Cap Rate or Capitalization Rate: Cap Rate is the unleveraged return expected by the buyer of a property, expressed as a percentage of an all-cash purchase price. It is normally determined by dividing the property’s expected net operating income (before depreciation) by the purchase price. Generally, high cap rates indicate greater return to the buyer. In determining the expected net operating income from a property, a “nominal” cap rate excludes such normal but often capitalized expenses as new carpeting or draperies (e.g., in apartment units), tenant improvements, or leasing commissions; an “effective” or “economic” cap rate includes the effects of such expenditures.
 |
Cash Contribution: Cash Contribution is the money you contribute or invest into a particular real estate property. The percentage of ownership depends on how much money or cash contribution you invest into a particular property. (The more cash you contribute into a property, the more monthly cash flow you will receive and a larger percentage of ownership you will have.)
Cash Flow: With reference to a property (or group of properties), Cash Flow is the owner’s rental revenues from the property minus all property operating expenses. The term ignores depreciation and amortization expenses and income taxes, as well as interest on loans incurred to finance the property. (Sometimes it is referred to EBITDA.)
Cash-on-Cash Return:
Cash-on-Cash Return measures the return on cash invested in an income producing property. Be aware that the Cash-on-Cash Return formula only considers before-tax cash flows and does not take into account an investor’s individual income tax situation. Also, it does not consider the wealth-building potential of a property via appreciation. It is calculated by dividing the before-tax cash flow by the total amount of cash invested.
 |
Cost Segregation: You can utilize what is called “cost segregation” for added depreciation write-off’s. Cost segregation is expensive to initiate, but it can be well worth the money in certain situations. Cost segregation is implemented when you itemize all those items of property inside your property such as: Carpets, window covers, toilets, central air conditioning, forced air heating, cabinets, plumbing fixtures, light fixtures, plus all electrical wires and plumbing in the walls. Each one of these items has a useful depreciable life and can be depreciated accordingly. (Your reporter implemented this depreciable tool on each property we owned, and we have received huge tax benefits from it.)
Debt Service: The Debt Service is the loan amount on a particular property that you would own as an investment. It is the loan you owe the lender.
Debt Service Coverage Ratio (D.S.C.R.): The debt coverage ratio is a widely used benchmark which measures an income producing property’s ability to cover the monthly mortgage payments. The D.S.C.R. is calculated by dividing the net operating income (N.O.I.) by a property’s annual debt service. Annual debt service equals the annual total of all interest and principal paid for all loans on a property. A debt coverage ratio of less than 1 indicates that the income generated by a property is insufficient to cover the mortgage payments and operating expenses. (For example, a D.S.C.R. of .9
indicates a negative income.) There is only enough income available after paying operating expenses to pay 90% of the annual mortgage payments or debt service. A property with a D.S.C.R. of 1.25 generates 1.25 times as much annual income as the annual debt service on the property. In this example, the property creates 25% more income (N.O.I.) than is required to cover the annual debt service.
 |
Demographics: Demographics is the statistical data of a specific city. Statistics are used to map the number of people living in that particular city, information about schools, attractions such as sale prices, taxes, etc.
Depreciation: Depreciation is the loss in value of an asset (building(s) and land) over time due to wear and tear, physical deterioration and age. The cost of reproducing an income property can be recovered over the useful life of the asset which is determined by law. Only the building can be depreciated and not the land. Residential income property must be depreciated over a 27.5-year period using straight line depreciation. Commercial income property must be depreciated over 39 years using straight line depreciation. Straight line depreciation stipulates that an asset must be depreciated by equal amounts each year over its useful life. Depreciation is also referred to as “phantom loss” in the commercial real estate world.
Due Diligence: Due diligence is a process that the buyer conducts on a particular property that he or she is contemplating purchasing. Due diligence includes an examination of the seller’s records of total income and total expenses such as taxes, utilities, and repairs. The next step is to do a thorough physical inspection of each and every unit inside and outside.
Make sure that all income and expenses are accurate on the ProForma and other documents of record the seller gives to you. (A word to the wise: DO NOT take the owner’s or seller’s word for the numbers on the ProForma, brochures, or flyers. Verify each number carefully as to its accuracy. ProFormas are many times altered or enhanced to make the property’s performance look better than it actually is.) The next step in the due diligence process is to order all third party reports, many times required by the lender. These reports consist of a survey, an appraisal, a physical inspection by your contractor or licensed home/building inspector, a Phase I or II environmental report, and any other needed reports that pertain to that particular property.
Conducting this due diligence study is an extremely important process when considering purchasing any property. When a part or parts of this process is overlooked or skipped and a thorough study is not done, this is when you hear horror stories about the facts of what went wrong. On the other hand, after conducting a thorough due diligence study you can be assured that you have made the best decision as to either purchasing the property or not. This is called “Financial Intelligence.”
Economy of Scale: Economy of Scale specifically means bringing investors together as a team where individuals or families can purchase commercial properties and achieve more profit than as an individual, thus maximizing your profit. If a single-family investor had $100,000 to purchase a commercial property, that investor would be able to purchase one for approximately $450,000. Even in Texas there are very few, if any, commercial properties for sale at that price.
With a group of investors pooling their resources together to create a $1,000,000 down payment, the group should be able to purchase a property for approximately $4,500,000 to $5,000,000. With the theory of “Economy of Scale,” we are thus creating more income and a better vehicle for appreciation, a more desirable property to manage, and one with a lot more potential for future income.
Employee Identification Number (E.I.N.): An E.I.N. is an identification number the I.R.S. assigns to you when you are a member partner in one of our commercial projects when you exchange a rental property or use your I.R.A. retirement money as a Self-Directed I.R.A. When you exchange a property or use your I.R.A. to become an owner in a T.I.C., you will also control your own L.L.C. This E.I.N. number identifies you as a business so you can take advantage of all the tax loop holes and tax benefits the government gives us by law.
Entity Structuring: Entity Structuring is referred to as protecting your wealth (real estate owned, businesses owned, etc.) through: (1) Protecting your assets by owning investments through Limited Liability Companies (L.L.C.’s), Limited Partnerships (L.P.’s), Tenants in Common Agreement, or (T.I.C.’s), S-Corporations, C-Corporations, and Family Limited Partnership (F.L.P.’s). Specifically, by holding your assets in these types of entities, you will be able to protect your assets from lawsuits, protect yourself from unnecessary liabilities, protect yourself from privacy issues, and you will be maximizing tax shelters. The goal of proper asset protection is to minimize your risk and to grow and sustain your asset base.
Estoppel Certificate/Certification: An Estoppel Certificate is a signed statement certifying that certain statements of fact are correct as of the date of the statement and can be relied upon by a third party, including a prospective lender or purchaser. In the context of a lease, a statement by a tenant identifying that the lease is in effect and certifying that no rent has been repaid and that there are no known outstanding defaults by the landlord (except those specified). (During our due diligence process, the prospective owners ask the seller to provide these estoppel certifications on each unit in the project.)
Exchange (1031 Starker Exchange): A 1031 Starker Exchange is a wonderful benefit/gift the government has given you and me as a tax benefit (that is if you know how to do one and know the tax laws). Quite simply, when you normally sell an investment property (not your own personal residence), you could be taxed up to 40% of the profit you receive. When you use a 1031 Starker Exchange, you can postpone all of your profit on that investment and not pay any tax upon the sale. For each investment you make, you can postpone not paying any tax – literally forever! Once you know how to do one, you will start to see how the rich get wealthier and wealthier. I have used the 1031 Starker Exchange on all my rental properties in the last 15
years, exchanging one property for another and another, not paying any tax. Presently, I am slowly selling my residential properties and exchanging them for commercial properties such as office buildings, hotels, retail centers, banks, and multi-family apartment buildings, which I might add are paying lots of passive income (mostly tax-free).
Exit Strategy: Exit Strategy is a term used in real estate to establish what your future plans will be for a specific property in the future. For example, your exit strategy might be 5 years to: (1) Sell your investment property and simply cash out and pay capital gains on your profit, or (2) Sell your investment property using a 1031 Starker Exchange (defer your taxable gain in the future), and purchase another like kind property with the profit or proceeds that you made on that sale property. Whenever you purchase an investment, it is crucial to have an exit strategy. Your exit strategy may change in time, but at least you have a road map to follow for the immediate future.
Family Limited Partnerships (F.L.P’s): Simply put, Family Limited Partnerships are limited partnerships where the large majority of participants are family members. They follow the same basic rules and enjoy the benefits of a regular Limited Partner. They are powerful for asset protection purposes, and they are a great estate planning tool.
Future Potential Rent/Income: The Future Potential Rent/Income is the total income the property could generate at today’s market rents at 100 percent occupancy and taking full advantage of all other income opportunities.
Gross Rent Multiplier: The Gross Rent Multiplier (or G.R.M.) is a ratio that is used to estimate the value of income producing properties. The G.R.M. is calculated by dividing the sales price by either the monthly potential gross income or by dividing the sales price by the yearly potential gross income. When detailed financial information is available for the recent sales of similar properties in a particular area, a market G.R.M. can be used to provide a rough estimate of value.
 |
How can I minimize my risk in a Real Estate Investment?:Every investment has risk. You can even loose your hard earned dollars if you make bad choices. To minimize the risk in any investment, get help from a seasoned real estate investor to make the very best choices:
|
|
|
|
|
|
With so much riding on the professionals associated with the investment, you can rest assured you’re in good hands with Casey Oldham guiding us to the soundest investment vehicles, and me (Ed Barriskill) as your Managing Member Partner overseeing the management. I have also formed an outstanding legal and accounting team and tax strategist to assist us.
Internal Rate of Return (I.R.R.): This concept allows the real estate investor to calculate his or her investment returns, including both returns on investment and returns of investment. It is used to express the percentage rate of return of all future cash receipts, balanced against all cash contributions, so that when each receipt and each contribution is discounted to net present value, the sum is equal to zero when added together.
Landlord: (History of Land Lord): The term landlord can be traced back to Medieval Europe when the king reigned over all the land. The king would allow a select group of lords to each take control of a parcel of land in return for their contribution of money, military service, favors, and loyalty. The lord was given absolute control over his parcel of land and answered to no one except the king. This is the origin of the term landlord, the whole idea of one being the lord over your land (land lord).
Come and join the “Barriskill Investment Group” and become a landlord in 1, 2, or 3 of our partnerships to build wealth and become a landlord over your land. (Sounds impressive being a lord!)
Lazy Assets: Lazy Assets are those assets such as: Money in a savings account, money in your I.R.A., 401K, or SEP retirement account, or equity sitting in your primary residence or rental property. These assets look good on paper but are doing nothing to accelerate your wealth. By using the principle of “Asset Allocation,” an investor can accelerate his or her wealth by using those lazy assets to purchase more assets. Then by using the theory “Velocity of Money” you keep moving your profits into more assets, hence creating more wealth.
Letter of Intent: A Letter of Intent is the primary agreement stating the proposed terms for a final contract. They can be binding or nonbinding. In the commercial world of real estate, the letter of intent is a vehicle that is used at the origination of purchasing the property. Once the price is determined and the terms and conditions are agreed upon, then a purchase contract is written and signed by both buyer(s) and seller(s).
Leverage: Leverage is the use of borrowed money to increase your profits in an investment. Building wealth via real estate requires the use of leverage. Let’s assume you have $100,000 to invest and you purchase a small income property for $100,000. Income properties have been appreciating at an average of 7% per year. At the end of the first year of operation your property is worth $107,000. At the end of year 2 it is worth $114,490. Now let’s assume that you put your $100,000 down on a $500,000 income property. At the end of the first year, it is worth $535,000. At the end of the second year it is worth $572,450. By borrowing money to purchase a larger income property, you have increased your profit by $57,960 in just two years. To get the full advantage of leverage, put the minimum down on a good property which has a strong likelihood of appreciating in value. Quite simply, leverage is when you can do more with less.
Limited Liability Company (L.L.C.): Limited Liability Companies are a newer type of entity, but they have now been around long enough to be time tested. It is a separate entity for asset protection purposes. If sued, only the assets of the L.L.C. are at risk. The participants in an L.L.C. are called “members,” and unlike a Limited Partnership which is designed for the participants to be treated differently, an L.L.C.’s members are all on equal footing. This gives all members an opportunity to actively participate in the L.L.C.’s activities. It is a great vehicle in which to hold real estate and other investments.
Limited Partnership: A Limited Partnership is a type of ownership created under state law comprised of one or more general partners who manage the business and who are personally liable for the partnership debt, and one or more special or limited partners who contribute capital and share in profits but who take no part in running the business and incur no liability over and above the amount they contributed.
L.L.C, L.P., or T.I.C.: An L.L.C.
is a Limited Liability Company, and an L.P. is a Limited Partnership. Investors form L.L.C.’s and L.P.’s mainly for protection against legal liabilities. The L.L.C. manages the L.P. We as investors are the L.P. in the partnership. Another advantage to an L.L.C. is that the property does not show up on credit reports, so it will not decrease your FIKO scores when you are purchasing real estate. Simply put, these types of entities of ownership build “fire walls” around investors so as to protect the investors from sue-happy people.
L.L.C.’s have been the number one investment vehicle that we have used for maximum asset protection from sue-happy people and for maximum tax benefits. They have worked very well when an investor had all cash to invest or an investor who wanted to exchange (1031 Starker Exchange) for another property. After much research and talking to attorneys, your Managing Partner came up with a solution. We now use T.I.C., or commonly known as “Tenants In Common,” for most of our entities, which have similar tax benefits and asset protection as an L.L.C.
Loan-to-Value Ratio (L.T.V.): The Loan-to-Value, or L.T.V., is a ratio between the loan balance and the market value of a property expressed as a percentage. For example, a property with a loan balance of $400,000 and a market value of $500,000 where the buyer is putting a down payment of $100,000 has a L.T.V. of 80%. This ratio is used on both residential houses and commercial properties.
 |
Money Rules: Money rules are rules that you set for yourself that will help guide and direct you to make good decisions when you are building your wealth. Money rules are very important; and once you decide what they are, these rules become non-negotiable. Some of these money rules might consist of: Pay yourself first by putting 10% of your income into your wealth account, decide not to participate in credit and debt, create a model/criteria tactics when purchasing real estate, and stick to those rules.
Multi-Family Apartment Building (M.F.A.B.): In real estate a 1-unit to 4-unit apartment building is considered residential real estate. Five (5) units and above is considered commercial property. When you are involved in a M.F.A.B. of 150 to 250 or more units, you will be able to take advantage of the “Theory of Economy of Scale” whereas you will team up with other like investors to purchase a larger property. By working as a team, we will be able to purchase a larger property and receive more passive income. The property will appreciate in value giving each investor a larger equity share, and they will receive more depreciation. With this Theory of “Economy of Scale,” each investor will receive a larger amount of tax benefits.
Net Income: Net Income is an accounting term used to measure the profits earned by a business enterprise after all expenses are deducted from revenues.
Net Operating Income (N.O.I.): Net Operating Income is rental income and other income from a property, less all operating expenses attributable to that property. Operating expenses will include, for example, real estate taxes, insurance, utility costs, property management, and reserves for replacement (for capital improvements for the property). They do not include items such as a REIT’s corporate overhead, interest expense, capital expenditures, or property depreciation expense.
Passive Income: Passive Income is a term used in real estate that denotes the income an investor would receive after taxes, debt service, insurance, H.O.P. dues, property management fees, maintenance, and miscellaneous expenses. It is normally called “take home pay.” Passive income is the income you receive from an investment property when you receive passive income from an investment property after all other expenses are paid. When you receive passive income, you do not
pay a Social Security tax as you do on earned income or income you receive from your occupation.
Path of Growth: Path of Growth is a term or strategy used in real estate where an investor chooses a new, expanding area of a town or city to purchase a property. It is normally on the perimeter
of the town or city where new growth is taking place. This newer growth area is where you would find newer properties, freeway additions, newer businesses, shopping centers, and parks. Most businesses like to be in a newer part of town or city to optimize their business and attract customers.
ProForma: A ProForma is a spread sheet of numbers pertaining to the performance of a particular commercial property. This spread sheet is normally provided by a realtor or a person representing a partnership who is offering the property for sale. A ProForma will show you specific numbers of how the property has performed in the last 12 months and a projection of how the property will perform. The ProForma will show you total rental income such as: Rent, other income and a vacancy rate and total expenses such as: Utilities, repairs, maintenance, landscaping, trash, management, property taxes, and insurance. The ProForma will show you net operating income, debt service (loan balance), capitalization rate, and pre-tax cash flow
to the investor.
Pro Rata: Proportionally, according to the measure of interest or liability, a tenant is responsible for their own share of expenses for the maintenance and operation of the property.
Profit and Loss Statement/Income Statement: A Profit and Loss Statement (also called an Income Statement) is an accumulation
of your total income and your total expenses. Total income consists of: (1) Earned income (income received from your daily job), (2) Passive Income – Income received from your real estate properties (income minus your expenses), (3) Portfolio Income (Income from your stocks, mutual funds, and bonds.) The investor’s primary goal is to obtain more passive income from investments than expenses which equates to “Cash Flow.”
Prospectus: A Prospectus is normally a booklet or manual made up by an investment company, investor, or third party that has compiled all pertinent data pertaining to the property. Depending on the type of investment offered, it will show the investment in general, site plans, and details or a ProForma (Income, expenses, net operating income, debt service, Cap Rate, and Cash-on-Cash Returns). Most ProFormas will give you information for the past 12 months of the property’s performance.
REIT or Real Estate Investment Trust: A Real Estate Investment Trust is either a corporation or a business trust that has certain tax attributes prescribed by federal legislation, the most important of which is that the entity obtains a federal tax credit equal to dividends paid to its shareholders if certain requirements are satisfied (such as the requirement to pay out at least 90 percent of net annual income to shareholders). (Our partnerships are considered mini-REIT’s.)
Real Estate Investment Trust Act of 1960: Legislation passed by Congress and signed into law authorizing the REIT format, for the purpose of allowing individuals to pool their investments in real estate and receive the same benefits they would receive from direct ownership.
Replacement Reserve: Replacement Reserve is money taken out of the monthly income and deposited in a fund designated for replacement of the roof, parking lot, painting, and other predictable large-scale improvements. Your initial investment will include seed money for this account to minimize the deduction on your investment income and
to ensure that the needs of the properties can be met in a timely fashion. Replacement reserve funds can also be used for real estate commissions when a unit becomes vacant and improvements we decide to conduct during the ownership of the property.
Required Minimum Distribution (R.M.D.’s): Our government has encouraged us through our working years (from age 25 through 65) through various retirement programs to offset our taxes paid by programs such as traditional I.R.A.’s, 401-K programs, SEP programs, etc. The basic plan was to help individuals or families shelter income during the working years, build a retirement account, and have money to fall back on along with Social Security for retirement. The whole idea behind this plan was that at a certain age the tax payer would pay back the government the money that was sheltered all those years. By law we are free to start withdrawing our money from our selected retirement plan upon reaching age 59½. But the law also states that we MUST start pulling out money we sheltered in the form of R.M.D.’s (or Required Minimum Distribution) by age 70½. The rule is that by April 1 of the year the following that you reach 70½ years old, you must start withdrawing
a certain amount of money and pay tax on it. The R.M.D. changes each year and is determined by dividing the account balance in the I.R.A. as of December 31 of the previous year by the applicable I.R.S. life expectancy tables. The older
you get, the more you must withdraw. Your I.R.A. trustee or administrator can help you calculate your R.M.D.
It is important to note that your Roth I.R.A. is not subject to the R.M.D.’s during the participant’s lifetime, but they are subject to R.M.D.’s after the owner’s death.
As a personal note, my father-in-law is dealing with this issue as I write this Glossary. He is now 85 years old and has been required to withdraw a certain amount of money from his I.R.A. The good news is that the way the government has calculated his R.M.D., he thinks he will never pay the full amount that he owes the government.
R.O.I. (Return on Investment): “R.O.I.” or Return on Investment (a 30,000-foot viewpoint) is used by investors to establish a Return on Investment. The R.O.I. will help the investor decide if a particular property meets their money rules and if the investment is worth pursuing or not.
Formula:
 |
Roth I.R.A.: Here is a wonderful gift from our government you should take advantage of. The government knows that our Social Security program has failed and is beyond repair. In fact, our children will continue to pay into this account but will probably not be able to receive this benefit at age 62, like us Baby Boomers will be able to do. In the last 5 years or so the government has become very generous and lenient with legislation to encourage tax payers to take more control and self-direct their money for retirement. For this reason the government created the Roth I.R.A. whereas you put money into a retirement account, pay taxes on this money when putting money into the Roth account, and receive a tax deduction. As of this writing (May 2007), a person can contribute $15,000 per year up to age 50, and a person over 50 can contribute $5,000 more.
The beauty about this excellent tax vehicle is that: If you purchased a property for $500,000 and then sold it in 10 years for $1,000,000, the $500,000 gain or profit is tax-free. Normally, you would have to pay capital gains on the profit. (For simplicity, $500,000 profit x 30% tax bracket would be $150,000 capital gains paid.) Because you paid taxes on the money going into the Roth I.R.A., there would be no tax to pay on this $500,000 profit. This
is a gift from our government that you should take advantage of.
S-Corporations: An S-Corporation starts out as a C-Corporation. It is then converted by a simple filing of the appropriate form. By making this election, you are choosing to have the corporation’s income treated like the income of a partnership or sole proprietorship. The income is passed through to the shareholders of the corporation. S-Corporations have approximately 75 allowable expense deductions. They can be used as part of a multi-corporation strategy and for newer businesses. S-Corporations can flow this loss through to the individual which reduces their personal income, while losses to C-Corporations
do not pass through to the individual.
Self-Directed I.R.A.: A Self-Directed I.R.A. is a vehicle the I.R.S. approved (in 1974) for investors to use to self-direct their I.R.A. retirement money. Depending on the type of I.R.A. you hold (whether it be a Roth I.R.A., a traditional I.R.A., a 401K or Individual SEP), you most likely can use these funds (normally held in stocks or mutual funds) to purchase an array of real estate assets. (Your reporter, Ed Barriskill, has used some of his I.R.A. funds to purchase 2 Ace Hardware stores in Boise, Idaho. In the future I plan to use more of our I.R.A. money to invest in more commercial projects.
After reading the I.R.S. Code, I found that an investor can self-direct their money into assets such as: Land, commercial property, business and securities, and other various types of assets. According to the I.R.S., there are only 2 limitations: (1) You can not invest any portion of your I.R.A. money in life insurance, and (2) You cannot use your I.R.A. money to purchase collectibles like stamps, coins, antiques, metal or gems.
Simply put, being able to use your I.R.A. retirement money in the form of a Self-Directed I.R.A. to invest in a commercial property is a wonderful gift the government has given to you and me. By investing your I.R.A. in a commercial property and receiving monthly cash, this earned revenue or cash flow will go back into your I.R.A. for your retirement tax-free. The beauty is that the cash flow and appreciation you earn at the time of sale is not taxed.
Syndication Ownership: A syndication ownership example is a spread sheet showing the investor’s cash contribution by each investor, percentage of the L.P. ownership, annual distribution to the L.P., annual distribution to the L.L.C., and the Cash-on-Cash Return that each member partner will receive according to their cash contribution.
Tax Loop Holes: Tax Loop Holes refer to those legal tax deductions an investor deducts from income received from a particular investment. In commercial real estate, you would deduct those typical items such as: Investment on the loan, property tax, property management fees, fire insurance, utilities, maintenance, and depreciation on the shell of the building. You can also deduct the improvements or components inside the building, such as carpet, blinds, plumbing, and electrical fixtures and the wiring in the walls using a term called “Cost Segregation.” The structure of the entity dictates the types of loop holes that you can legally take advantage of while owning real property.
Triple Net Lease (N.N.N.): Triple Net Lease is a type of lease that requires the tenant to pay their pro rata share of all recurring maintenance and operating costs of the property, such as utilities, repairs, maintenance, property taxes, and insurance premiums. These expenses that the tenant pays are also called C.A.M. charges in commercial real estate.
Trusts: Trusts are powerful in two ways. First, they take the property outside of the reach of creditors. Secondly, they take the property outside the reach of beneficiaries with insatiable financial appetites. So, if you want to give a loved one a gift (and especially the benefit of the income it generates) but you are unsure of their ability to properly manage it, a trust may be the solution.
Type “A” Shares: Type “A” Shares in a limited partnership refers to the distribution of shares owned by the investors who have contributed cash into a particular investment. When we formed the limited partnership to build the Hilton Garden Inn at Granbury, Texas, the “A” share partners were those investors who invested cash and IRA retirement funds into the hotel. (Investors can also use their IRA retirement funds in the form of a “self-directed” IRA plan.) (The Type “A” shareholders/partners normally will receive all of their cash contribution back before the Type “B” shareholders receive a penny of profit. The Type “A” shareholders will also receive revenue from the hotel on a monthly basis and their share of the appreciation of the property when the hotel is sold.)
Type “B” Shares: Type “B” Shares in a limited partnership refers to a distribution of shares owned by (normally) the franchise, the builder, and other parties who contribute their expertise into the investment. These Type “B” shareholders/partners will not receive a penny of profit until the Type “A” shareholders/partners receive their entire contribution investment back in full.
Unrelated Business Income Tax (U.B.I.T.): The Unrelated Business Income Tax is a fairly new tax created in the last few years. Depending on your own personal situation you may or may not be subject to this new tax. Any income or profits that are related to your real estate loan may be subject to U.B.I.T. The U.B.I.T. is a tax on income and profits related
to any leveraged or financed part of your real estate transaction. For example, if you paid all cash for a property, you would not be subject to this tax. If no loan is required, this tax is not an issue; but if financing is involved, the tax is based on your net income after all expenses and deductions are taken out of the account. Your first $1,000 is not subject to this tax. (For a more detailed explanation of the U.B.I.T., contact your Certified Public Accountant.)
Wealth Account: A Wealth Account is an account whose sole purpose is to build wealth; it is not a savings account. The concept is to pay yourself first by consistently committing a portion of your earnings for investing, never taking the money out of the account except to purchase another asset. The concept of putting a portion of money into an account is also called a “Wealth Account Priority Payment,” which equates to paying yourself first. The theory behind a “Wealth Account” is to contribute money up to a pre-determined amount. The process would then be duplicated again by purchasing another asset.
What does Return on Investment (R.O.I.) mean?: The ROI is similar to Cash on Cash Return, which measures the return on cash invested in an income producing property, but includes total return: Cash invested, equity buildup on loan payment, increase of rents adding to cash flow (inflation),appreciation due to inflation pressures, higher costof building replacement bringing value up, location as a path of equity growth, and tax shelter benefits to the investor.
What does “Cash on Cash Return” mean? What Cash on Cash Return will we get on our investment as a
percentage?: Cash on Cash Return measures the return on cash invested in an income producing property. It is calculated by dividing the before-tax cash flow by the total amount of cash invested.
What is an L.L.C., L.P., or T.I.C.,and what is the benefit of setting one up for our syndication?: L.P. stands for Limited Partnership, and an L.L.C. is a Limited Liability Company. Investors form L.P.’s and L.L.C.’s mainly for protection against legal liabilities. The L.L.C. manages the L.P. We as investors are the L.P. in the partnership. Another advantage to an L.L.C. is that the property does not show up on credit reports, so it will not decrease your FICO scores when you are purchasing Real Estate.
L.L.C.’s have been the #1 investment vehicle that my investors have used for maximum asset protection from sue-happy people and for maximum tax benefits. They have worked very well when an investor had all cash to invest or an investor who wanted to exchange (1031 Starker Exchange) for another property. After much research and talking to attorneys, your Managing Member Partner came up with a solution. I found out that we could use a T.I.C., or commonly known as a “Tenants In Common,” which has similar tax benefits and asset protection as an L.L.C.
A T.I.C. is a relatively new way for investors to hold title in Commercial Real Estate. Because T.I.C.’s are a new way of holding title to Real Estate, I had to find an attorney who knew all the in’s and out’s of T.I.C.’s. We now have the right attorney and know the formula for conducting the T.I.C. partnership. This type of program will nowopen up many more possibilities for people to invest.
What is a “Cap Rate”?: The capitalization rate, or what an investor calls a “cap rate,” is a ratio used to estimate the value of income producing properties. Simply put, a cap rate is the return you expect to get from your investment.Investors, lenders, and appraisers use cap rates to estimate the purchase price or value for income producing properties. The cap rate is the Net Operating Income (NOI) divided by the sales price or value of a property, expressed as a percentage:
Example:
 |
The bottom line is the higher the cap rate, the more income you will receive after the mortgage payment is made and expenses are paid. Our target property will have approximately a 7.5% to 8% cap rate. As rents go up, income increases and the cap rate goes up.
What is “Cost Segregation”?: You can utilize what is called “cost segregation” for added depreciation write-off’s. Cost segregation is expensive, but it can be well worth the money in certain situations. Cost segregation is implemented when you itemize all those items of property inside your property such as: Carpets, window coverings, toilets, central air conditioning,forced air heating, cabinets, plumbing fixtures, light fixtures, plus all electrical wiring and plumbing in the walls. Each one of these items has a useful depreciable life and can be depreciated accordingly.
I personally have done this on my commercial property and have found it to be tremendously beneficial. On University Park Plaza, a complex of 3 office buildings, we had a feasibility study conducted for cost segregation and found out that over the next 5 years we would be able to write off or depreciate an additional $252,000 at $9,500. It was expensive up front,but by utilizing cost segregation substantial savings were provided through tax write-offs. Presently we depreciate $108,000 per year for the shell of the 3 buildings, but now we have an additional $50,200 per year that we can write off. Since the passive income we receive is mostly tax-free already, my CPA/Tax Strategist advised me that we can roll over the extra depreciation to our personal income tax. It pays to read, study, and learn how toobtain more tax advantages in this world of Commercial Real Estate.
What does “Economy of Scale” mean? How will economy of scale help us as investors?: Specifically, by bringing investors together as a team, where families can purchase commercial properties and achieve more profit than as an individual,your profit is maximized. If a single-family investor had $100,000 to purchase a commercial property, that investor would be able to purchase one for approximately $450,000. Even in Texas there are very few if any commercial properties for sale at that price.
With a group of investors pooling their resources to create a $750,000 to $1,000,000 as a down payment, we should be able to purchase a property for approximately $3,500,000 to $5,000,000. With “economy of scale,” we are thus creating more income and a better vehicle for appreciation,a more desirable property to manage, and one with a lot more potentialfor future income.
What is “Replacement Reserve” and how does it influence us as investors?: Replacement reserve is money taken out of your monthly income and deposited in a fund designated for replacement of the roof, parking lot, painting, and other predictable large-scale improvements. Your initial investment will include seed money for this account to minimize the deduction on your investment income and to ensure that the needs of the properties can be met in a timelyfashion.
What is a “Starker 1031 Exchange,” and how does it benefit me as an investor?: A 1031 Starker Exchange is a wonderful benefit/gift the government has given you and me as a tax benefit (that is if you know how to do one and know the tax laws). Quite simply, when you normally sell an investment property (not your own personal residence), you could be taxed up to 40% of the profit you receive. When you use a 1031 Starker Exchange, you can postpone all of your profit on that investment and not pay any tax upon the sale. For each investment you make, you can postpone not paying any tax – literally forever! Once you know how to do one, you will start to see how the rich get wealthier and wealthier. I have used the 1031 Starker Exchange on all my rental properties in the last 15 years, exchanging one property for another and another, not paying any tax. Presently, I am slowly selling my residential properties and exchanging them for commercial properties such as office buildings, retail centers, banks, and multi-family apartment buildings, which I might add are paying lots of passive income (mostly tax-free). For those who get involved with these investment groups, you will see that we will use the 1031 Starker Exchange to purchase bigger and bigger properties. When you are exchanging profits of $1,000,000 to $2,000,000, paying no tax, you will start to see what a huge benefit this vehicle can be, especially to your net worth. Knowledge of the tax laws is everything: It’s called “financialintelligence.”
What is a Self-Directed I.R.A.?: A Self-Directed I.R.A. is a vehicle the I.R.S. approved (in 1974) for investors to use to self-direct their I.R.A. retirement money. Depending on the type of I.R.A. you hold, either it be a Roth I.R.A., a traditional I.R.A., a 401K or Individual SEP, you most likely can use these funds(normally held in stocks or mutual funds) to purchase an array of real estate assets. (Your reporter, Ed Barriskill, has used some of his I.R.A. funds to purchase 2 Ace Hardware stores in Boise, Idaho. In the future I plan to use more of our I.R.A. money to invest in more commercial projects.)
After reading the I.R.S. Code, I found that an investor can self-direct their money into assets such as: Land, commercial property, business and securities, and other various types of assets. According to the I.R.S.,there are only 2 limitations: (1) You can not invest any portion of your I.R.A. money in life insurance, and (2) You cannot use your I.R.A. money to purchase collectibles like stamps, coins, antiques, metal or gems.
Simply put, being able to use your I.R.A. retirement money in the form of a Self-Directed I.R.A., to invest in a commercial property is a wonderful gift the government has given you and me. By investing your I.R.A. in a commercial property and receiving monthly cash, this earned revenue or cash flow will go back into your I.R.A. for your retirement tax-free. The beauty is that the cash flow and appreciation you earn at the time of sale is not taxed.
(These projections represent a mere prediction of future events based on assumption
(Also see: “Services Ed Barriskill, The Managing Member Partner, Will Provide For You, The Investor, Over the 10-Year Investment Time Period.”)s which may or may not occur and may not be relied upon to indicate the actual results which will be obtained.)
Yield: The “yield” on an investment is a simple calculation that investors use to obtain a quick overall return on an investment.
Formula:
 |
SIGN UP FOR OUR NEWSLETTER
FREE DOWNLOAD
SCHEDULE A RISK-FREE CONSULTATION
ARCHIVES
SEARCH