One of the first questions we receive from potential investors interested in learning about commercial multifamily investment opportunities with 12M is “How do I make money on the deals?” In short, there are 3 core areas that make up total investor returns: cash flow, appreciation and principal pay down. In addition, the unique tax and estate planning benefits that commercial multifamily investing can provide is important to understand.
Cash Flow: At 12M, we use a direct, fractional ownership model with our investor pool. Each property we acquire sits in its own sole purpose entity and the investors on the project are classified as limited partners. In this type of deal structure, investors are eligible to receive pro rata cash distributions based off of the net income of the property. This is a huge upside to investing in commercial multifamily properties with 12M vs. traditional asset classes. We provide an investment opportunity that provides steady, quarterly cash returns to our investors while their equity in the deal continues to grow. Many investors then look to compound their overall returns by taking this cash and investing it in additional multifamily projects, a term we commonly refer to with our investor pool as “cascading up.”
Appreciation: Unlike residential real estate, which is based on the sales comparison approach model, commercial multifamily assets are valued based on the income they produce. All else being equal, if an asset’s net income increases over a given period of time, it is going to be worth more money. To provide a basic example let’s consider the following: An apartment complex brings in $500K in annual NOI (Net Operating Income) Year 1. 4 Years later this same property brings in $700K in annual NOI. If the cap rate for the submarket is 7.0, (see post “So what is a “cap rate?”, anyway) then the property has increased in value by nearly $3Million in just 3 years!
Year 1: $500,000/7%= $7,142,857
Year 4: $700,000/7%= $10,000,000
Appreciation from Year 1 to Year 4 = $2,857,142
Principal Pay Down: Most investors have personal experience owning a home at some point. A commercial multifamily loan is very similar to a home loan in that the monthly payment is broken down into 2 parts: principal and interest. As time goes on the portion of the monthly payment that is applied to the principal increases while the interest portion decreases. The big difference for the investor vs. the home owner, is that the renters in your apartment complex are making the monthly payments for you. Each principal dollar that is paid down increases your equity in the property.
Tax Benefits: To understand the tax benefits of owning commercial multifamily property, it is important to understand the concept of depreciation. Uncle Sam recognizes that the physical structures in commercial family assets only have a certain usable life and therefore allow owners of these complexes to “depreciate” the value of these buildings over time. At the time of this post, that timeline is 27.5 years and in many cases, a small portion can actually be depreciated at a much faster rate. When you are an owner in a multi-million $ complex, the annual depreciation write off is material. In addition to the depreciation, all of the interest that was paid over the year on the loan debt service (which was paid by your renters, don’t forget) is also deducted before calculating the taxable income on the business. This almost always results in a “paper loss” for you as an investor for many years into the project even though you are receiving cash distributions throughout. In fact, using a 1031 exchange, (a tool that allows investors to sell out of a property without paying capital gains on the sale) it is possible to move from investment to investment without paying any capital gains tax throughout your real estate investing career. All of this being said, I am not a tax professional and you should always consult with one when looking at any new investment opportunity. While these benefits hold true to the average investor, you may have a unique tax situation.
Estate Planning Maximization: At some point in life, we all have to start thinking about estate planning. Investing in commercial multifamily is one of the best ways you can achieve capital preservation as your estate is passed down. Thanks to a provision in the law referred to as a “step-up in basis,” an asset’s value or “basis” is readjusted for tax purposes upon inheritance. So what does this look like practically speaking? If you were to invest $500,000 into a multifamily project and 10 years later that ownership share is worth $2M when you pass away, there would be no tax assessed to the inheritor on the $1.5M gain in appreciation the property experienced over that time. In fact, it’s quite the opposite. The property’s “basis” would be readjusted to the new $2M value and the inheritor now owns $2M in real estate, free of any capital gains tax.
