1. Apartment buildings produce monthly passive income, flippers get paid once at the end of the sale (although this is usually a larger check). The difference between a passive apartment investor and a flipper on January 1st is that the flipper needs to go back to work. Are you looking for another JOB?
2. The IRS gives much better tax treatment to passive investors than they do active investors such as flippers. Flippers for do more than a few deals a year are categorized as “dealer” status by the IRS and their gains are usually falls in an earned income tax bracket while, passive investors fall in the long term capital gains, thus paying less in taxes on a sale.
3. DEPRECIATION - depreciation is one of the very best things about apartment investing. Example; Back in 2003, I purchased a building for $1,000,000.00, the land value is $300,000 and the building value is $700,000. The IRS lets me depreciate the building (Improvements on tax statement) over a 27.5 year schedule. $700,000/27.5 years gives me $25,454 in depreciation per year. Let's say the building purchased for $1,000,000 produces a 12% cash on cash return (for simplicity I am neglecting principal reduction) on the 25% down payment ($250,000). This means my annual income from the property is $30,000 ($250,000*0.12). The IRS lets me depreciate the building by $25,454 each year. So after I depreciate the loss from the $30,000 income, my income shows only $4,546 per year. So I only pay taxes on the $4,546 each year, but my income is $30,000. Flippers lose out on this ability to depreciate the building because they are in and out of a deal so fast.
3. Tenants buy you the apartment building if you choose to keep it long term. How nice of them! Over a period of 25 or 30 years you can have a $1,000,000 building or larger paid for by your tenants. This is called “Mortgage Pay down.” Flippers merely get short term gains and have to continue to work to find another deal.
4. FINANCING - Flippers often need to get higher interest loans that is a very high interest rate greater than 10% plus points. If your project is delayed watch these costs rack up and eat into your profits. Why do you think there are all the lending companies hovering around like sharks at a REIA meeting? Most times they get rich off your hard work and you taking on the risk.
These loans are full recourse, meaning they have to personally guarantee the loan if anything happens to the building. Creditors will come after the individual borrower if the equity is less than the house is worth. In some cases bankruptcy can save you, but it takes you out of the game for almost a decade. Apartment investors can get institution loans for stabilized buildings that are non-recourse with very good financing rates (today's rates are 4.75% fixed for 5 years). This means if anything happens to the building, the owner just gives the bank the keys and walks away with no personal guarantee. No creditors going after the borrowers as long as no fraud was committed (bad boy clause).
The government is social engineering and incentivizing people to buy homes and apartments for the lower and middle class by subsidizing the interest rates paid. Why would you not take advantage of this?
5. Apartment investors can form groups (Google: Real Estate Syndication) to pool the down payment money for purchase, and banks expect to see this on buildings over $1,000,000. This can minimize risk to an individual and allow investors to be in multiple deals in multiple markets simultaneously. Flippers need their own cash and have to have proof of funds for the down payment for favorable financing. As a passive investor you can ride on the coattails of a more experienced investor, get part of a bigger deal with large profit margins, and not do any more other than the upfront due diligence on the investment.
6. Apartment investors can invest in other states and other countries, thereby diversifying into other markets. Flippers need to stay local to keep an eye on all the subcontractors. As the Real Estate Guys Radio guys say “Live where you want but invest where the numbers make sense.” Lane from SimplePassiveCashflow.com says that when selecting a college he went to the best one he could not because he could do laundry at his mom’s house… why should picking an investment be any different?
7. Apartment investors can avoid paying any taxes at all by selling and using a 1031 Exchange to fund another like kind apartment building. Flippers do not have this option. they sell and pay the taxes (typically in a higher bracket as they are often viewed as traders by the IRS).
8. Apartment investors can purchase a few good buildings and live indefinitely on the passive income. Sophisticated investors call these “legacy assets”. These investments solve the long term problem of paying bills and taxes. It is the closest thing to a personal ATM machine or cash cow. Flippers will need to flip a bunch of houses and then buy an apartment or two to see the same benefits.
If you don’t have the cash to invest in real estate… save up or continue flipping properties. If you have the cash and want to break the cycle of trading your time for money let's get to know each other and see what your options are by emailing me at Patherbig@gmail.com.
This blog post is meant to be informative only, I am not a CPA, Attorney, Real Estate Agent, etc. I am an apartment investor enjoying be benefits of passive cash flow from owning multi-family property.