Tag Archives: real estate

The impact of commercial real estate taxation across the 50 states

While blogging about the impact of inter-state (non-residence) taxes on real estate investments, I came across useful research on real estate taxation parameters in every state. The research demonstrates how important it is to understand the tax regime in a state you invest in, in order to predict profits.

The taxation guide is available at no cost to anyone who requests it, at Alan Blairreiadvise.com/50-state-guide by emailing admin@reiadvise.com. I spoke with its creator, Alan Blair, Managing  Partner at REI Equity Partners, which is a Connecticut-based real estate investment and advisory company focused on stable, long-term cash-flowing investments for its clients.

Highlights below include:

  1. Alan, you’ve put together a pamphlet that summarizes tax implications of operating properties in all 50 states and Washington, DC.  The research you’ve put into this is quite an accomplishment. I count 17 columns worth of taxation and customs considerations by state. What was your goal?
    Necessity was the mother of invention in putting this together. We began servicing investment clients from the US and abroad that had a nation-wide scope for acquisition criteria.  The tax information grew beyond a legal-sized piece of paper, so I went to all of the states’ websites – secretary of state, taxation, business departments – and began capturing all these parameters. It took weeks to drafts and months to complete.
    Now, this desktop reference guide helps us accurately estimate total property acquisition and disposition costs. We had a real surprise, in fact it took our breath away, when we first understood taxes and additional costs in New York, for example.

  1. How important are taxes and fees in calculating returns?
    Very important! When you compare the least favorable state for taxation of non-resident property owner income against the most favorable, it’s a difference of keeping just 87% of your profits after state taxes, versus keeping 100%, the entirety, of your profits. Some of the other taxes and fees that most investors and developers don’t think a lot about, such as mortgage tax, transfer tax, leasehold tax, can also slice significantly into returns.
    On cash flow properties, you’re interested in the spread between the cap rate and mortgage rates. As that spread begins to narrow, it’s absolutely important to sharpen your pencil and understand how much you’ll keep in the end.

  1. What is different about New York?
    Our model ranks New York as 27th out of 50 states in terms of how favorable, or in this case burdensome, the tax regime is. New York state charges 1.4% and New York City charges an additional 2.625% transfer tax upon the sale of the property. The seller bears that expense, which is above and beyond state and city income tax. New York state also levies an annual franchise tax on the asset. And, there are annual withdholdings. I haven’t even addressed capital gains taxes here.
    Let’s go further. In most states, closings can be conducted remotely.. All documents are prepared by the attorneys in advance, executed and overnighted to the title company. Once everything is in place the order is given by the lender and buyer to wire the funds to the title company who then distributes the funds to the seller. To compare, in New York, it’s customary for a closing to occur in person. The parties and lawyers appear, a representative from the title company joins, then you sign documents. To close electronically in New York, I believe you’d need to start with attorney authorizations to sign on your behalf.
  1. What other parameters do you track?
    Mortgage tax, leasehold tax, the owner’s policy premium are some of the customs levied in various states, but the amounts and expectation of whether the buyer or seller pays differs. The seller isn’t going to volunteer this information if you’re negotiating to buy a property, so you need to be aware yourself.
  1. Can an individual investor make use of this research? What about developers?
    For both groups, especially individuals, our guide is a starting point to ask the right questions. It’s an alarm bell in a sense. Then parties can use us as an advisor, or turn to their CPA or tax lawyer, to determine all the details for a particular deal.
    In terms of asking the right questions, let’s take the case of title insurance. In some states the cost is fixed and the process is fairly standard. In other situations, you would want to understand how diligently your attorney is looking after your interests by helping negotiate the title insurance cost while ensuring that your interests are adequately protected. When I recommend an investment property, the last thing I want is for all of us to be surprised about unanticipated closing costs.

  1. You’ve developed a ranking formula for the states and list the top 10 states in terms of favorable tax regime for real estate. Which states are in the top 10 and why?
    There are 5 states where you get to keep 100% of the real estate profits as a non-resident entity. There are no filings, no surprises, nothing really is required. These became our top 5; they are Florida, Nevada, South Dakota, Washington state, and Wyoming. The next five have minimal franchise/opportunity taxes are Delaware, Illinois, North Dakota, Ohio, and Texas. Compare North Dakota, which levies a 4% franchise tax against West Virginia, at the bottom of the 50 states, with a 13% tax. And franchise taxes are levied on assets and or income annually!
    Of course, taxation isn’t by any means the only criterion for selecting investment locations. It also depends on the opportunities available in the state and the deal’s terms. Texas has a lot of opportunity currently with not as many investors bidding up prices, though that window is narrowing. Illinois works for us in terms of opportunity, yet with a 1.5% franchise tax.
  1. How closely do you estimate taxes? What does your model look like?
    Property tax rates can vary based on the amount of profit, just like a marginal tax rate on income. The numbers I report in the state tax rankings are based on assumption that a property yielded $117,000 gross profit, but the underlying model adjusts for the different tax tiers.
    Institutional real estate investment firms generally use ARGUS for assessing risks and returns. It’s considered an industry standard. On the other hand, our our proprietary model focuses solely on fully-rented, existing cash-flow, retail and office commercial properties. I personally think our model is better, more insightful, for this purpose.
  1. What does your own real estate investment company focus on?
    We operate two companies. One is Real Estate Investment Advisors (REI Advisors), which represents larger investors in their search to acquire new properties. Then there’s REI Equity Management, which is the general partner in properties we own on behalf of investors. We operate both companies under the brand “REI Equity Partners”. We specialize in high-quality properties that can provide long term passive income for our investors. Often our individual investors are planning for their retirement one day. In particular, we emphasize properties such as multi-tenant retail with strong leases and tenants, and medical office space. All our investments are based on extensive financial modeling of the income potential and risk reduction considerations.

  1. Let’s consider crowdfunding for a moment, the trending model that allows a wider range of investors to get involved with real estate properties with lower minimum investment amounts than is traditional. How can they get a handle on the risks and rewards modeling for real estate?
    It can be challenging. They should start by understanding the various property classes. For example, they may have an instinctive feel for house flips, being a home owner. However development carries additional risks in terms of unexpected surprises with the land and existing property, the cost of materials, length of time to build and sell, and especially on the high-end, exposure to economic downturns.
    Compare that to high-quality commercial leases, such as multi-tenant retail. Rental properties like this are very predictable over the long term because you can read what the lease says and you can evaluate the economic strength of the tenant and the nature of the business. This type of real estate investment would be a good substitute for other types of “fixed income” investments such as bonds. Real Estate has the added benefit of not re-pricing daily with interest rate changes and valuations are not inversely related to inflation because with inflation you get rent increases, albeit with a time lag.
  1. How do you reduce risks with your commercial RE investments?
    Well-written triple net leases are key, but not every region of the country commonly see these, so you have to be selective about location. We invest in properties that are already tenanted: you know exactly who the tenant businesses are, you can read the leases, and study the traffic around the location. All the tenants in our properties are national or super-regional companies. In our last investment, the anchor tenant is Starbuck’s, and premium coffee has proven fairly resistant to changes in the economy. Starbuck’s in turn encourages traffic to, and interest in, the other spaces on the property. Other properties we have invested in are shadow-anchored by a local medical center or university or a super regional Wal-mart.

What is crowdfunding for real estate?

““I am a firm believer in the people. If given the truth, they can be depended upon to meet any [situation]. The great point is to bring them the real facts, and beer.” – Abraham Lincoln

Crowdfunding – the involvement of a broad audience in financially supporting a project – has caught on wildly in markets ranging from consumer loans, to global micro-finance, startup support and the arts. It’s now the focus of nearly a dozen crowdfund websites for real estate investing, with the primary benefit being a low dollar minimum, typically $1,000 to $10,000 to hold your very own slice of an income- and equity-generating property.

Exactly how does real estate crowdfunding work, and what are the benefits and risks? This post will give you an introduction, with future posts diving into the details including my crowdfunded deal experiences, and interviews with crowdfund CEOs, developers and legal/financial experts.

Crowdfunding Examples

Crowdfunding has become an increasingly acceptance mode of business in a variety of markets. For consumer lending, Prosper and LendingClub allow individuals to back loans for home purchase, debt consolidation, education, etc, at interest rates of 5-15% (this is after accounting for write-downs). Google is a backer of LendingClub while the huge hedge fund Blackrock invests in Prosper. This sector was on pace to fund $2bn to $3bn in loans in 2013. Elsewhere,

  • Circle Up and and Grow VC provide access to early-stage venture capital deals;
  • Mosaic funds large-scale solar panel installations in return for an interest rate backed by those projects’ profits.
  • Kickstarter and Indiegogo crowdfund projects ranging from new technology and business ideas, to charities and musical/artistic creations. Kickstarter has raised nearly $400m so far.

RE Crowdfund Sites

In real estate, crowdfunding websites I’ve researched include: FundRise, Patch of Land, PRIMARQ, RealCrowd, RealtyShares, and Realty Mogul, and I’ve invested through several of these so far. There are another half-dozen companies in beta or beyond.

This hyper-growth was kicked-off by the Jumpstart Our Business Startups (JOBS) Act, which in 2013 first allowed companies to promote their private securities offerings to accredited investors. Accredited investors have minimum income requirements in the six figures or minimum liquid assets of a million of more.  Next, rules have been proposed for unaccredited investors to participate in crowdfunding, though with limits on invested amounts. While there’s debate over whether the law properly balances ease of access to opportunities for investors and offerers, against investor protections, so far over $2bn has been raised through this process. Read more at VentureBeat.

What are the benefits for real estate investors? To begin with,

  • Far more individuals are likely to gain access to a range of RE deal opportunities, without having to know the ‘right people’.
  • Returns are attractive on paper, ranging from 8-13% on a home refurbishment loan, to 12-20% internal rate of return on a commercial/rental property. This certainly beats average bond/stock returns, and compared to non-real estate crowdfund, investments are both better rewarded on average and better secured, via the property and developer guarantees.
  • Minimum investments for accredited individuals are relatively low, range from $1000 to $10K on many sites.
  • The crowdfund sites provide much of the due diligence, easing somewhat the need for the investor to be fully versed in real estate.
  • In sum, more individuals can incorporate real estate into their financial portfolio, without having to resort to the volatility and lack of transparency in REITs.

Risks are ever-present and need to be carefully evaluated by anyone getting involved. At a high level, these include:

  • The traditional risks with real estate remain: that these are ‘living’ properties, whose profits are affected by their developers, tenants, trends in the economy, issues in the neighborhood, etc.  Your principal investment is by no means guaranteed and, in the end, you can only look to yourself and your lawyer for responsibility to be comfortable with the due diligence.
  • Your capital is locked up in a deal from 6 months to 6 years or more. You choose the types of deals to be involved with, and all else being equal, longer lockups usually target higher return rate.
  • With some crowdfund sites and deals, the site operator has a stake in the deal or facilitates distribution of interest payments. If the site were to go out of business – far from rare in the web startup world – you need to ask what happens to your investment. (In many deals, though, you strike an arrangement directly with the RE developer and have no obligations from the website itself)..
  • There are multiple parties involved in a deal, much like a traditional RE syndication.  While the developer usually is the sole operating member of the deal’s corporate structure, in a worst case all the parties may tangle in voting or legal proceedings.

With all these considerations and more, real estate crowdfunding can be attractive in a number of situations: allocating a modest portion of savings to real estate; gaining access to a diversified set of properties, geographically and by property type; and learning more about real estate investing while preparing to serve as prime lender on your own deals.

There will be much more to follow as we look at individual crowdfund sites and the risk-reward considerations. Meanwhile, I recommend the real estate community discussions at Bigger Pockets to get a flavor of investors’ thinking.