Cost Segregation can turbo charge your commercial real estate investments financial results by accelerating the depreciation schedule.
Paul Caputo with Segregation Holding LLC provides an explanation of how it works and what the benefit is to commercial real estate investors.
Depreciation is an accounting tool that recognizes each year, a percentage of your building’s life expectancy is used up. This loss can be recognized for tax purposes as an expense against the income generated.
When you purchase a building, regardless of the age of the building, the depreciation clock starts. The standard building depreciation schedule is 27.5 years for residential and 39 years for commercial.
If you purchase a residential property, ie an apartment building, and the building is valued at $2,750,000 at acquisition, the straight line depreciation would be $100,000 each year. This amount will be deducted from your income to determine the taxable income.
A cost segregation study breaks the building into its component parts. Depending on the estimated life expectancy of each building part determines the ability to accelerate the depreciation.
When a property owner hires a cost segregation firm to do a study, the firm takes an engineering assessment of building. This process itemizes each component used to construct the building.
Instead of using straight line depreciation the building components are assigned a new depreciation schedule of 5, 7 or 27.5 years. This significantly compresses the time to depreciate the building.
For instance, if 15 percent of the building, $412,500 of the $2,750,000, is now assigned to 5 yr depreciation schedule. The difference in allowable depreciation between straight line and the accelerated schedule for these items assigned to the 5 yr schedule is:
Straight line over 27.5 years: $30,000
Accelerated over 5 years: $82,500
Additionally, when you have a cost segregation study, you can also capture the unused life of a component if you have to replace it prior to its scheduled life expectancy. So, if you have to replace a roof 5 years after you buy the building, you can recapture the 22.5 years left on the cost segregation schedule in the year you replace the roof. The new roof is capitalized at the replacement cost with the new life expectancy updated on the schedule.
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Real Estate Investor Todd Dexheimer quit teaching once his real estate investing side hustle provided more than his teacher paycheck.
His original real estate investment strategy was to own 1000 units. He jumped in fast. He bought rentals until he ran out of money. When he needed more money, he started flipping single family homes. This gave him more money needed to buy more rentals.
The flipping business grew fast. There are only so many hours in the day, and the flips consumed most of his time. In order to make money flipping, you have to sell. If he was going to grow his portfolio, he had to answer a question: was he a Flipper or a Real Estate Investor?
He had lost focus on his real estate investment strategy of 1000 units. When he looked at the return on investment comparing the flips to the rentals, there was no question on which way he needed to go. The rentals “destroyed” the flips.
This “aha” made him question how was he going to grow his portfolio.
When he looked closer, he recognized that single family rentals were difficult to scale. He realized that if he wanted to achieve his goal of 1000 units, multifamily was the answer.
The question he needed to answer was “where” to invest?
The local market Todd lives in is extremely competitive and CAP rates are compressed making it tough to find opportunities locally.
Todd took the next 18 months analyzing markets. He looked at:
Once he identified potential markets, he took action. He bought a plane ticket and toured each market. He met brokers, lenders and property managers. This helped set Todd apart from all the other out of town real estate investors.
Todd has identified the markets that fit his investment criteria, and assembled his team.
Today, he is actively adding new multifamily units through syndication.
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Listen: Pillars of Wealth
If you want to grow your wealth, grow your network.
Vinney Chopra came to America from India with $7 as an MBA student.
He worked as a full time fundraiser and he built his network over the years. His wife and he invested in some single family properties along the way. The real estate provided cash flow and appreciated significantly.
Vinney recognized that multifamily real estate was a powerful investment opportunity. More people were renting and the banks were agreeable to lend for multifamily.
Then he made the decision to get his commercial brokers license and share what he learned about real estate with his network. His network wanted to invest with him.
To date, Vinney has completed twenty-six syndications in ten years. His investors have been rewarded handsomely. Some deals have earned annual returns in excess forty percent.
Vinney recognizes that his success is due to his network.
If your real estate investment strategy includes growth, you need to grow your network.
Don’t wait, START now. Talk with everyone and let them know what you are doing. The more you share, the more practice you will get, and the enthusiasm will build as you find like minded people.
You have to have investors if you want to go after larger properties. In the beginning, you want to focus on sharing your goals. You will be surprised who is interested and who has money to invest.
Regularly call, send emails, meet and educate your network to warm them up for eventual investment with you. Plan to spend at least four months working and meeting with prospective investors. You have to get a sense of the number of potential investors and level of commitment they can invest.
Go to free REI groups & Meetups. If there is not one near you consider starting one. Don’t forget social media, join groups, ask questions and offer input to discussions.
Real estate is a team sport. You need to have many experts to put together a successful transaction.
Commercial Real Estate Brokers are critical to your success. Get to know some. Let them know what you are looking for. It will take some time to develop the relationship, but this is important. When you have a relationship with a broker, that knows exactly what you are looking for, they will share off market deals with you before making available to the public.
When you have identified a market to invest in get to know the local professionals. A property management firm is key. Interview several to make certain they are a good fit. They can also introduce you to other off market opportunities from properties they manage.
You will also need an attorney and CPA to navigate your investment. Depending on the size of property, investment and number of investors (partnership to syndication) will determine the level of professional services you will need.
An experienced mortgage broker will help you navigate financing the balance. Depending on the property, the team you have in place and size of the mortgage, will determine the loan programs available to you.
As Vinney says, build your network and “Jump into multifamily now” to get the long term rewards available to you.
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Fundraising Rules are complex sections of Regulation D that must be followed to stay out of trouble with the SEC.
Syndication is a popular real estate investment strategy for raising capital used by real estate syndicators. The legal cost to comply with the rules and regulations can be prohibitive.
Failure to follow the rules can result in being classified as a “bad actor”. A Bad Actor can be prohibited from future involvement in SEC fundraising.
Amy Wan started Bootstrap Legal, to simplify the legal process and reduce the cost for syndicators. Bootstrap utilizes technology to expedite the first draft process from client to attorney. This technology interface saves clients 10-15 hours of attorney time.
For discussion purposes, we will focus on the four most popular federal rules regarding raising money from a pool of passive investors for real estate investment. For each rule, we will look at:
** For the official SEC details, go to:
In all cases, the success of your fundraising campaign is directly correlated to the awareness you are able to bring. So, don’t forget the marketing. If you don’t bring awareness to your campaign, you will not succeed.
For more go to: https://bootstraplegal.com/
Connect with Amy on Linkedin: https://www.linkedin.com/in/amyywan/
Depending on what you are trying to achieve will determine which valuation is important. Appraisal is more art than science.
Ken Kramer is the Co-founder and Managing Director at Rushton Atlantic, LLC. Rushton provides third party appraisals, valuations, for its clients; banks, insurance companies, governments, and property owners.
Income: based on the income the asset can produce over the life left in the asset.
Fair Market/ Market: the value agreed upon by a willing buyer and seller in a particular market.
Cost/ Replacement Cost: considers how much will it cost to replace or rebuild the property, building, with a new building.
As an investor, your primary interest is the income the property can produce. Can the property generate enough income to cover its operating expenses, reserve for capital expenditures, make the mortgage payment, resulting in a profit for you?
You are likely be interested in the market value as well. Are you getting a good deal? Can you sell it for more than you bought it for?
Your lender’s perspective will be more market value oriented. A commercial property’s value is directly correlated to the net operating income; income minus operating expense. The NOI divided by the local capitalization rate (cap rate) will provide a market value.
The difference between the market value and the mortgage is lender’s margin of safety. If you fail to make the mortgage payments, the lender will take the property back through foreclosure. When this happens, the bank wants to be able to sell the property quickly, which is likely at a discount near the mortgage balance. .
The insurance company’s perspective is based on the cost to replace the building you own. The bank will require that you purchase insurance on the property to protect you and the bank from loss.
The best insurance coverage will provide replacement cost coverage. If the building is damaged or destroyed, your insurance company will compare the limit on your policy to the amount needed. Assuming there are no issues, they will pay for the building to be rebuilt, restoring your income and the asset the bank lent against.
As you can see, different parties have different valuation considerations.
The buyer, wants to know income value, and the market value.
The bank wants to know the market value.
And the insurance company wants replacement cost value.
If a buyer gets a good deal this could be based on the economic potential due to a weak operator or the opportunity to develop the property into something greater. In either case, there is no reason the acquisition price should reflect the cost to replace the property.
Likewise, market value could be driven by the location. If the ground is valuable, it could be the driving force behind the value that the bank lends against.
If the structure is small, and simple, the replacement cost could be very small in relation to the market value determined by the bank.
The insurance company is not concerned with the income nor market value. It’s promise to the insured is to replace the property.
Remember, appraisal is an art form. Values can move from year to year and Market Value does not equal Replacement Cost.
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