EDIT - Adding a lot of details to this and some notes on the terms at the bottom.
My partner and I did some 5 year planning. This is what we're looking to do! This isn't meant to be a brag session. And I know its just a plan but I figured people might enjoy getting a look at whats going on in my business right now.
In 2017 we rolled our profits from our little old sweaty startup into a real estate development and we finished construction of a self storage facility in Ithaca NY. We spent $2.4M (75% financed by a local bank). We purchased an additional property in October of 2018 across the street for $400k. I own 40%. My partner owns 40%. Investors own 20%.
Its nearing stabilization ($55k in revenue in July and $12.5k in expenses for $42k in NOI) or $12,500 for each Dan and I in cashflow and $15,500 each in income. It's a great asset and it's going to be hard to part with that monthly recurring revenue.
But the plan is bigger than that so we have it listed for sale.
We got an offer for $4.9MM a few months ago but we're aiming for the $5.2MM mark. We're getting a lot of interest and have had action lately.
That sale would spit off about $880k each for my partner and I to reinvest. To differ the taxes into the future we'd do a 1031 exchange and find "like kind" assets to purchase with the income.
IF we sell it here is our plan.
--
We'd plan to bank $380k (less after taxes) each for a rainy day or a smoking opportunity in the future or just as an insurance policy. So we'd have $1MM between us to reinvest and grow our real estate holdings.
We'd locate five or six poorly managed but high potential storage facilities at a total value of about $4MM. Leverage about $1MM in cash and borrow another $3MM on the assets.
The facilities we’d target would be between 10,000-25,000 rentable sf each in secondary markets (20,000-100,000 population). Small enough properties and cities that the big dogs like Public Storage aren’t in the market to buy them and drive the cap rates down to 5-6. We’d manage them remotely (without a full time manager in an office on site) and contract with a local cleaning company to do the onsite punch list weekly.
Since we can manage them remotely while others have more overhead we could buy them at what would be an 8 or 9 cap for others but is a 11-12 cap for us.
That means NOI would be about $460k a year. $156k a year would be interest payments and $84k would be principle ($3MM at 5.25% over 20 years).
So that would be $220k a year in free cashflow and $304 in income on our $1MM investment.
We’d get to claim $145k a year in depreciation reducing our taxable income to only $159k a year on that $304k in income.
The assets would appreciate by about 5% a year which is $200k a year in equity we’d have on top of the cashflow. We think we can get it appreciating much faster with our management.
So we’re seeing about $504k in value and only paying taxes on $159k a year.
That would start the snowball. About 3 years later after raising rents pretty aggressively and achieving $550k or so in NOI we'd sell the portfolio for a 7 cap on trailing 12 month cash flows.
Sell for $7.8MM. That would turn our initial $1MM cash in investment into about $3.8 MM in 36 months.
The best part is that we'd have the ability to do another 1031 exchange to differ all of the tax on that appreciation and then buy $15.2MM worth of storage facilities at a 10 cap then generating $1.52MM a year in NOI.
But we'll take it one step at a time.
--
We also will have made a great return for our initial investors who bought in and owned 20% of our first facility so they would happily re-invest the proceeds ($1MM) into new developments with us.
They bought in on a pro-rata basis. Meaning if they put in 5% of the project costs they got 5% ownership. They took a second position to the bank. We then financed our ownership through the bank and took the debt service on ourselves.
So while we're going around buying and building our own profile we'd also build 2 more development projects in really great markets. We'd build them for about $2.5MM each, own them for 2 years during lease up, and according to our projections these buildings, similarly to Ithaca, would be worth about $5MM each.
We'd sell these to realize the appreciation again and likely use the investor money to build more and our profits to buy cash-flowing assets like the plan above.
And that’s the simplified version of the grand plan Dan and I made when he came to Athens and recorded a few episodes with me!
--
A few terms. Feel free to correct my language. While I grasp the concepts I'm still relatively new at this and I'm not a tax attorney.
The cap rate is used in valuing commercial real estate and is calculated using NOI. Net Operating Income (before interest and depreciation).
The lower the cap rate the higher the price you pay relative to NOI. A 10 cap means you are paying a price 10x NOI or you are accepting a 10% return on an annual basis on your investment. A 6 cap means you are paying a price of ~16x NOI accepting a 6% return on your initial investment. Thinking about it as the % return on investment is easier IMO.
Really safe and secure assets generally have low cap rates. Self storage has one of the lowest cap rates of them all because they have a ton of tenants all paying a low amount. It would take an act of god to lose 50% of your tenants in any given month so its safer. Cap rates in major metros are sometimes south of 5%. The industry average is around 7%. Meaning investors in big cities are willing to pay a price that would produce a 7% annual ROI.
A fast food restaurant chain with years of history and 20 locations would have a low cap rate because its safer than a single mom and pop restaurant. Assets with management companies in place (making the income passive) have lower cap rates and more value than an
Basically the more stable, low risk and passive the income is the lower the cap rate.
A single family property on the other hand has 1 tenant. If that tenant moves out you get 0 income. Thats risky and in most markets is reflected by a higher cap rate closer to 10 or even 20. A website that is one google alg change away from being crippled would be a 50 or even 100 cap. Thats why they don't use cap rates for assets like that.
Cap rates are different than your actual returns. You'll need to run your own pro formas based on your interest expenses and your financing terms. You'll also need cash on hand for principle payments as well that aren't technically expenses as far as tax liabilities go.
When buying real estate you also have to think about the advantages of the depreciation, appreciation and lower tax liability upon exit.
Depreciation means you can write off your full purchase price (even though the bank owns 75% of it) over time against your profit. If you pay $1MM for an asset and its depreciated on a 27.5 year schedule (standard for commercial assets) you get to write off about 4% of that purchase price, or 40k a year, in losses even though you didn't incur them. That significantly reduces your tax liability on a yearly basis. Note that when you sell down the road (unless you do a 1031 to differ the taxes further) you have to pay taxes on that depreciation.
Then theres the fact that in most markets you get to realize about 4% annual appreciation on your asset (averaged over time) based on the full purchase price even though the bank owns 75% of it. Basically your cash down if it was 25% will grow 16% a year just in equity and value just because you realize appreciation on the bank's portion too.
Its an amazing system if you can buy at the right price, cashflow, depreciate and realize appreciation later either when you refinance or sell the asset.
Add to all of this the capital gains tax when you finally do sell your asset. If you own it for more than 1 year before selling it instead of paying 35% like you do on your income you pay 15% on the gains you realized. Its insane!
This is why many house flippers hang on to the property for a year and a day before selling and rent it out in the meantime. Effectively reducing the income tax bracket from 35% for a high earner to 15% capital gains.
You also have the option to do a 1031 like kind exchange where you buy a similar asset with the profit from the previous sale and avoid taxes all together (pushing the liability further into the future).
This entire system is why real estate should be the end goal of all of us and why the American wealthy just keep getting richer and richer and richer.
Anyway that’s the end of the rant. I’ll keep you all posted on how it all shakes out!
My partner and I did some 5 year planning. This is what we're looking to do! This isn't meant to be a brag session. And I know its just a plan but I figured people might enjoy getting a look at whats going on in my business right now.
In 2017 we rolled our profits from our little old sweaty startup into a real estate development and we finished construction of a self storage facility in Ithaca NY. We spent $2.4M (75% financed by a local bank). We purchased an additional property in October of 2018 across the street for $400k. I own 40%. My partner owns 40%. Investors own 20%.
Its nearing stabilization ($55k in revenue in July and $12.5k in expenses for $42k in NOI) or $12,500 for each Dan and I in cashflow and $15,500 each in income. It's a great asset and it's going to be hard to part with that monthly recurring revenue.
But the plan is bigger than that so we have it listed for sale.
We got an offer for $4.9MM a few months ago but we're aiming for the $5.2MM mark. We're getting a lot of interest and have had action lately.
That sale would spit off about $880k each for my partner and I to reinvest. To differ the taxes into the future we'd do a 1031 exchange and find "like kind" assets to purchase with the income.
IF we sell it here is our plan.
--
We'd plan to bank $380k (less after taxes) each for a rainy day or a smoking opportunity in the future or just as an insurance policy. So we'd have $1MM between us to reinvest and grow our real estate holdings.
We'd locate five or six poorly managed but high potential storage facilities at a total value of about $4MM. Leverage about $1MM in cash and borrow another $3MM on the assets.
The facilities we’d target would be between 10,000-25,000 rentable sf each in secondary markets (20,000-100,000 population). Small enough properties and cities that the big dogs like Public Storage aren’t in the market to buy them and drive the cap rates down to 5-6. We’d manage them remotely (without a full time manager in an office on site) and contract with a local cleaning company to do the onsite punch list weekly.
Since we can manage them remotely while others have more overhead we could buy them at what would be an 8 or 9 cap for others but is a 11-12 cap for us.
That means NOI would be about $460k a year. $156k a year would be interest payments and $84k would be principle ($3MM at 5.25% over 20 years).
So that would be $220k a year in free cashflow and $304 in income on our $1MM investment.
We’d get to claim $145k a year in depreciation reducing our taxable income to only $159k a year on that $304k in income.
The assets would appreciate by about 5% a year which is $200k a year in equity we’d have on top of the cashflow. We think we can get it appreciating much faster with our management.
So we’re seeing about $504k in value and only paying taxes on $159k a year.
That would start the snowball. About 3 years later after raising rents pretty aggressively and achieving $550k or so in NOI we'd sell the portfolio for a 7 cap on trailing 12 month cash flows.
Sell for $7.8MM. That would turn our initial $1MM cash in investment into about $3.8 MM in 36 months.
The best part is that we'd have the ability to do another 1031 exchange to differ all of the tax on that appreciation and then buy $15.2MM worth of storage facilities at a 10 cap then generating $1.52MM a year in NOI.
But we'll take it one step at a time.
--
We also will have made a great return for our initial investors who bought in and owned 20% of our first facility so they would happily re-invest the proceeds ($1MM) into new developments with us.
They bought in on a pro-rata basis. Meaning if they put in 5% of the project costs they got 5% ownership. They took a second position to the bank. We then financed our ownership through the bank and took the debt service on ourselves.
So while we're going around buying and building our own profile we'd also build 2 more development projects in really great markets. We'd build them for about $2.5MM each, own them for 2 years during lease up, and according to our projections these buildings, similarly to Ithaca, would be worth about $5MM each.
We'd sell these to realize the appreciation again and likely use the investor money to build more and our profits to buy cash-flowing assets like the plan above.
And that’s the simplified version of the grand plan Dan and I made when he came to Athens and recorded a few episodes with me!
--
A few terms. Feel free to correct my language. While I grasp the concepts I'm still relatively new at this and I'm not a tax attorney.
The cap rate is used in valuing commercial real estate and is calculated using NOI. Net Operating Income (before interest and depreciation).
The lower the cap rate the higher the price you pay relative to NOI. A 10 cap means you are paying a price 10x NOI or you are accepting a 10% return on an annual basis on your investment. A 6 cap means you are paying a price of ~16x NOI accepting a 6% return on your initial investment. Thinking about it as the % return on investment is easier IMO.
Really safe and secure assets generally have low cap rates. Self storage has one of the lowest cap rates of them all because they have a ton of tenants all paying a low amount. It would take an act of god to lose 50% of your tenants in any given month so its safer. Cap rates in major metros are sometimes south of 5%. The industry average is around 7%. Meaning investors in big cities are willing to pay a price that would produce a 7% annual ROI.
A fast food restaurant chain with years of history and 20 locations would have a low cap rate because its safer than a single mom and pop restaurant. Assets with management companies in place (making the income passive) have lower cap rates and more value than an
Basically the more stable, low risk and passive the income is the lower the cap rate.
A single family property on the other hand has 1 tenant. If that tenant moves out you get 0 income. Thats risky and in most markets is reflected by a higher cap rate closer to 10 or even 20. A website that is one google alg change away from being crippled would be a 50 or even 100 cap. Thats why they don't use cap rates for assets like that.
Cap rates are different than your actual returns. You'll need to run your own pro formas based on your interest expenses and your financing terms. You'll also need cash on hand for principle payments as well that aren't technically expenses as far as tax liabilities go.
When buying real estate you also have to think about the advantages of the depreciation, appreciation and lower tax liability upon exit.
Depreciation means you can write off your full purchase price (even though the bank owns 75% of it) over time against your profit. If you pay $1MM for an asset and its depreciated on a 27.5 year schedule (standard for commercial assets) you get to write off about 4% of that purchase price, or 40k a year, in losses even though you didn't incur them. That significantly reduces your tax liability on a yearly basis. Note that when you sell down the road (unless you do a 1031 to differ the taxes further) you have to pay taxes on that depreciation.
Then theres the fact that in most markets you get to realize about 4% annual appreciation on your asset (averaged over time) based on the full purchase price even though the bank owns 75% of it. Basically your cash down if it was 25% will grow 16% a year just in equity and value just because you realize appreciation on the bank's portion too.
Its an amazing system if you can buy at the right price, cashflow, depreciate and realize appreciation later either when you refinance or sell the asset.
Add to all of this the capital gains tax when you finally do sell your asset. If you own it for more than 1 year before selling it instead of paying 35% like you do on your income you pay 15% on the gains you realized. Its insane!
This is why many house flippers hang on to the property for a year and a day before selling and rent it out in the meantime. Effectively reducing the income tax bracket from 35% for a high earner to 15% capital gains.
You also have the option to do a 1031 like kind exchange where you buy a similar asset with the profit from the previous sale and avoid taxes all together (pushing the liability further into the future).
This entire system is why real estate should be the end goal of all of us and why the American wealthy just keep getting richer and richer and richer.
Anyway that’s the end of the rant. I’ll keep you all posted on how it all shakes out!