When talking to clients many times they tell me that their investment is doing very well for them. However, they are basing this on what they paid for their property, not on the equity they have built up. For instance, a recent client purchased a 10 unit apartment building almost 30 years ago for $275,000. Their Net Operating Income (NOI) for this property was about $85,000 a year. This sounds like a good return, until you take into account that they have completely depreciated the building, and the investment is now worth close to $2,400,000. This equates to about a 3.0% return on their equity.
When we took a look at their investment, and looked at it from the perspective of return on equity, it doesn’t look nearly as good as if they considered alternative investments. We worked with the client to sell it and then coordinated a 1031 exchange. A 1031 exchange is a tax vehicle that allows someone to sell a property and exchange the proceeds into another property without paying any capital gains. There are rules to this, and by being very careful we were able to locate an exchange property within the proper time frames.
By utilizing the power of leverage, we were able to increase the NOI by almost 242%. How did we do this? First off, the NOI increase was based upon a larger purchase that required leverage, so the net income would be impacted a little. We then took advantage of the hot apartment market in Los Angeles, and sold their asset for just above $2,400,000. We then took the proceeds to purchase a single tenant NNN property for just under $4,000,000. This also increased their tax basis by $1,600,000, allowing for up to $40,000 in additional annual depreciation. Even with a small mortgage, by utilizing the strength of leverage, with today’s low rates, our client was able to achieve a net income before taxes that was almost 41% higher than the net income they experienced with their previous property. After tax benefits, our client will likely achieve returns that are between 50% and 55% higher than what they received previously, this is actual cash in pocket!
Before you decide on whether your investment is giving you a good return, be sure to look at all of the aspects, including alternative investments. By doing so, you’ll be sure to maximize your return, while possibly reducing any management headaches as well!