Snapshot Review
Real Estate Investments & Business Opportunity Brokerage Snapshot Review
INVESTMENT FUNDAMENTALS
Investment characteristics
● the greater the risk, the higher the expected return
● some investments require more investor involvement than others
● some investments are more liquid (convertible to cash) than others
Rewards
● investors seek to increase wealth through income, appreciation, leverage and tax benefits
Risks
● risks: changes in supply and demand for the investment (market risk), changes in businesses with which the investment is connected (business risk), changes in the value of money (purchasing power risk), and changes in interest rates (financial risk)
Types of investments
● among the investor’s choices are investments in money (e.g., certificates of deposit), equity (e.g., stocks), debt (e.g., bonds and mortgages), and real estate (income and non-income properties)
REAL ESTATE AS AN INVESTMENT
Risk and reward
● the real estate investor must weigh the potential risks and returns inherent in market variability, expected vs. real income, use of borrowing leverage, changes in tax treatment of capital gains and income, and the cost of capital
Illiquidity
● real estate is generally less liquid than other investment types: it takes time to market a property
Management requirements
● real estate tends to require more investor involvement than other investments do: maintenance, management, operation
TAXATION OF REAL ESTATE INVESTMENTS
Taxable income
● gross income received minus allowable expenses, deductions and exclusions
Cost recovery
● deduction of a portion of a property’s value from gross income each year over the
Gain on sale
● an excess of proceeds from sale of a property over the original cost of the property, subject to adjustments
Interest
● mortgage interest is deductible from annual gross income from a property, subject to limitations
Passive activities
● business activities in which the taxpayer does not materially participate, including interests in limited partnerships and rental activities; losses from such activities can be used to offset income from other passive activities
INVESTMENT ANALYSIS OF A RESIDENTIAL PROPERTY
Appreciation
● increase in the value of an asset over time; may be stated as a difference between the original price and current market value, or as a percentage increase over the original price; not a true measure of investment return
Deductibles
● for non-income properties, primary tax benefit is annual deduction for mortgage Section 17: Real Estate Investments & Business Brokerage 391
Tax liability
● the seller of a principle residence owes tax on any capital gain that results from the sale unless excluded; capital gain is defined as the amount realized minus the adjusted basis
Gains tax exclusion
● up to $250,000 for a single seller and $500,000 for a married couple can be excluded from gains tax every two years
INVESTMENT ANALYSIS OF AN INCOME PROPERTY
Pre-tax cash flow
● annual pre-tax cash flow is net operating income minus debt service
Tax liability
● tax liability on income from a property is based on taxable income: net operating income minus interest expense and cost recovery
After-tax cash flow
● annual after-tax cash flow is pre-tax cash flow minus tax liability
Investment performance
● a few common measures of investment performance are:
– return on investment (net operating income divided by price)
– cash-on-cash return (cash flow divided by cash invested)
– return on equity (cash flow divided by equity)
– discounted cash flow analysis
– internal rate of return
BUSINESS BROKERAGE
● sale of existing business and its real estate; opportunity and enterprise brokerage
Business brokerage vs real property brokerage
● differences – selling business includes transfer of business income, personal property assets, goodwill, and liabilities; intangible assets include franchises, copyrights, patents, going concern value (monetary value from ongoing business operations)
● similarities – real property or lease; broker licensure per FL statute
Transaction knowledge
● types of sale: asset sale and stock sale
● documents: sale contract; real estate sale contract or assignment; no-compete agreement; consulting agreement
Accounting
● income, expenses, and profit
● balance sheet: assets, liabilities, net worth
● assets: tangible and intangible
● goodwill: intangible asset–difference between price & other assets
Determining a price
● reconciliation of income, cost, and market data approaches; influenced by risk and stability of future income
Business brokerage regulation
● may need securities license; must comply with Bulk Sales law
Steps in the sale of a business
● signing broker; determining business valuation; preparing business; documentation; hiring attorney and accountant; marketing the business; securing buyer; executing purchase contract ; preparing for closing; closing transaction
