Roth&Co’s latest video series: Real Estate Right Now.

Presented by Alan Botwinick and Ben Spielman, co-chairs of the Roth&Co Real Estate Department, this series covers the latest real estate trends and opportunities and how you can make the most of them. This episode discusses more critical valuation metrics used to calculate the potential of an investment property.

Watch our short video:

In our last video we talked about three useful tools to help calculate the potential of an investment property: GRM (Gross Rent Multiplier), PPU (Price Per Unit) and Cap Rate (Capitalization Rate). Moving forward, here are additional metrics that can help an investor dig even deeper.

IRR

The Internal Rate of Return (IRR) is a metric used in financial analysis to estimate the profitability of a potential investment. It represents the annual rate of return on your investment, over the life of that investment. The higher the IRR, the healthier the return.

The IRR is calculated by computing the net present value of the investment. The Net Present Value (NPV) is the amount that the investment is worth in today’s money. To successfully analyze the data, future values must be considered against today’s values. Why? Because today’s money is more valuable than the value of the same money later on. This is also known as the time value of money.

When we calculate the IRR, we solve for “a rate”, so that the Net Present Value of the cash outflows and inflows  is  zero. That “rate” is the IRR. We achieve this by plugging in different interest rates into our IRR formula until we figure out which interest rate delivers an NPV closest to zero. Computing the Internal Rate of Return may require estimating the NPV for several different interest rates. The formulas are complex, but Microsoft Excel offers powerful functions for computing internal return of return, as do many financial calculators.

Simplified, here is how it works:

If you invest $10,000 in year one and receive an $800 return annually through Year 5, then exit the investment for $15,000, you would calculate the IRR as follows:

This scenario yields an IRR of 18%.

Here’s a similar scenario that yields a different result:

This scenario yields an IRR of 15%

Which scenario provides a better return? Looking at the bottom line is deceptive. By calculating the IRR for both investments, you would see that the IRR on the second investment, 15%, is a nice return. However, the first investment, with an 18% IRR, would be a better use of your money.

CoC Return

The Cash-on-Cash Return tells the investor how much cash the investment will yield relative to the cash invested. It measures the annual return the investor made on a property after satisfying all debt service and operating costs. This is a helpful analytic for many real estate investors who commonly leverage investments by taking out mortgages to reduce their cash outlay. The metric is the most helpful when liquidity during the investment period is important to the investor. One of the most important reasons to invest in rental properties is cash flow, and Cash-on-Cash return measures just that. Put simply, Cash-on-Cash return measures the annual return the investor made on the property after satisfying all debt service and operating costs.

Here is a simple CoC Return example:

Let’s say you buy a multifamily property for $200,000, putting down a $40,000 deposit, and assuming a $160,000 mortgage. Your gross rents are $30,000 monthly, with $20,000 of operating expenses. Additionally, you have $9,000 monthly debt service payment comprised of $7,000 interest and $2,000 principal. Because principal payments are not an expense, Net income is $3,000 annually.

However, when calculating Cash-on-Cash, you consider the debt service as well, bringing your return to $1,000 monthly, or $12,000 annually.

Comparing your investment’s yearly net income of $12,000 to the $40,000 down payment, you have a Cash-on-Cash annual return of 30%. While there is no specific rule of thumb for what constitutes a good return rate, the general consensus amongst investors is that a projected Cash-on-Cash return between 8% to 12% implies a worthwhile investment.

Financial metrics are important and useful tools that can help an investor make smart, informed decisions. Whereas any one metric may have limitations, by considering a combination of metrics commonly used for comparing, in addition to tracking performance or value, an investor can target a strategy and analyze risk in a potential investment opportunity.

This material has been prepared for informational purposes only, and is not intended to provide, nor should it be relied upon for legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.

On Monday, December 20th, Roth&Co and Korsinsky & Klein hosted a webinar detailing important employment laws, including discrimination laws, leave laws and social media policies. It was presented by Avi Lew, Esq., partner at Korsinsky & Klein, and moderated by Chaya Salamon, Director of Human Resources at Roth&Co. Below is a detailed recap of the webinar. You can also watch the full video recap here.

Federal, State and City Employment Discrimination Laws

Avi’s comprehensive overview of diverse federal, state and city employment laws illustrated how complex and illusive they are and how they impact every employer. Whether yours is a small or large business, as an employer, you need to be educated, knowledgeable, and have access to competent legal support when it comes to employee related laws.

The primary federal employment discrimination laws which were discussed include: Title VII of the Civil Rights Act; the Americans with Disabilities Act; the Age Discrimination in Employment Act; the Equal Pay Act; the Fair Labor Standards Act; the Family and Medical Leave Act; and the Older Workers Benefit Protection Act.

These laws prohibit employers from discriminating against employees on the basis of – among other factors – color, race, religion, gender, age, national origin, marital status and disability. The list is long and constantly expanding, as is the definition of ‘employee.’ Title VII of the Civil Rights Act of 1964 has expanded to include discrimination by gender identity and now defines even independent contractors as ’employees.’

Employee Handbooks

Providing an employee handbook to your employees is no longer optional – it is required by law. An employee handbook is a vital resource in an employee claim of discrimination or harassment. An employee handbook protects the employer from liability and educates employees about the business’ policies and procedures.

An employee handbook is not a document you want to write yourself; using the wrong language can inadvertently violate a law or create a contract with the employee. Don’t include policies that your business doesn’t actually adhere to, and consider including provisions that address restrictive covenants, alternative dispute resolution terms and cyber-security obligations.

It is vital to document that your employees actually read and received your business’ employee handbook, which will be helpful to you in the event of future employee claims against you. Reviewing and updating your company’s employee handbook annually is necessary to ensure that you have policies and procedures in place before an issue arises.

Social Media Policies

Do you use social media sites to screen applicants? Have you ever rejected a potential employee because of something you found online? The National Labor Relations Act protects the rights of employees when it comes to certain work-related conversations conducted on social media, such as Facebook and Twitter.

This is a very grey area of the law and employers are advised to protect themselves by developing a clear policy that serves the company’s legitimate business interests without compromising the rights of its employees. It is important for the company to regularly review handbooks for potential violations and encourage management training.

Reasonable Accommodation

This is an important term that effects both employers and employees. It is usually unlawful to refuse to provide reasonable accommodation to someone with disabilities or to someone who claims hardship due to his religious belief. In order to avoid a charge of discrimination, an employer must be able prove that making accommodations to such an employee would fundamentally alter the nature of the business or cause it an undue burden. An undue burden is defined as a significant difficulty or expense.

Discrimination laws aren’t limited to federal law. For example, the NYC Human Rights law is one of the most powerful anti-discrimination laws in the country – even stronger than federal law. If you employ four or more employees (which includes independent contractors), this law applies to you.

The threshold for making a claim of discrimination under this law is very low and makes it easy for an employee to sue. Under the NYC Human Rights law, litigation is easily triggered and often becomes prolonged and expensive.

Small and Large Companies

Employment laws apply to small and large companies and it is the employer’s responsibility to be aware of its business’ obligations. Here are a few examples:

• Title VII discrimination laws apply to employers with 15 or more employees.

• The federal Fair Labor Standards Act sets standards for wages and overtime pay. It applies to all employers, regardless of how many employees they have.

• The ADA (American with Disabilities Act) and the Pregnancy Discrimination Act guards against discrimination for the disabled and for pregnant employees. It applies to businesses with 15 or more employees.

• The Age Discrimination and Employment Act (ADEA) protects seniors and applies to employers with over 20 employees.

• The Family and Medical Leave Act of 1993 (FMLA) is a federal law requiring covered employers to provide employees with job-protected, unpaid leave for qualified medical and family reasons. Both the FMLA and the Affordable Care Act apply to employers with over 50 employees.

• The NYC Paid Safe and Sick Leave Law provides employees with mandated sick leave time and requires that New York City employers provide up to 40 hours of paid leave each calendar year (or up to 56 hours if the company has 100 employees or more).

• The Stop Sexual Harassment in NYC Act requires all employers located in New York City with 15 or more employees to conduct an annual anti-sexual harassment training for all employees, supervisors and managers.

Employers have a responsibility to safeguard and protect both their businesses and their employees. When a business delays addressing an employment issue, it will most likely intensify, resulting in prolonged and expensive litigation that will damage the business and erode its work environment. Conversely, when an employment issue is addressed promptly and at its source, it can be remediated much more easily, avoiding costly violations, penalties and litigation. Employers must be vigilant in creating and documenting clear policies, abide by those policies and educate management to report issues promptly. Lastly, employers must be mindful of the constant changes in employment law that can impact their business, their employees and their bottom line.

This material has been prepared for informational purposes only, and is not intended to provide, nor should it be relied upon for legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.

Roth&Co’s latest video series: Real Estate Right Now.

Presented by Alan Botwinick and Ben Spielman, co-chairs of the Roth&Co Real Estate Department, this series covers the latest real estate trends and opportunities and how you can make the most of them. This episode discusses critical valuation metrics used to calculate the potential of an investment property.

Watch our short video:

Investing in real estate can be profitable, rewarding and successful. At the same time, the real estate investment industry is also demanding, competitive and very often, risky. Success requires a combination of knowledge, organization and determination, and while this article may not be able to supply some of those requirements, it will help increase your knowledge about how to initially assess a real estate investment. Here are three useful tools to help calculate the potential of an investment property:

o Gross Rent Multiplier (GRM)
o Price Per Unit (PPU)
o Capitalization Rate (Cap Rate)

Gross Rent Multiplier (GRM)
When an investor considers buying a commercial or rental property, he’ll need to know how long it will take to earn back his investment. The GRM is a simple calculation that tells us how many years of rent it will take to pay off the cost of an investment purchase. The GRM formula compares a property’s fair market value (the price of the property) to its gross rental income.

Gross Rent Multiplier = Purchase Price / Gross Annual Rental Income

The result of the calculation represents how many years it will take for the investor to recoup the money he spent on the purchase of the property. The lower the gross rent multiplier, the sooner the investor can expect to get his money back.

Calculating an investment property’s GRM is not complex and will result in a useful metric, but in practicality, it does not consider operating costs such as the debt service coverage, the property’s maintenance expenses, taxes, local property values and other important factors that strongly impact the profitability of an investment
Experienced investors use the GRM metric to make quick assessments of their opportunities, and to quickly weed through their options. A high GRM may serve as a red flag, directing the investor to look elsewhere and spend more time analyzing more optimal options.

Price Per Unit (PPU)
Another tool in the investment arsenal is the PPU, or Price Per Unit. This calculates just that – the price per door on your investment property. The calculation is simple:

Price Per Unit = Purchase Price / Number of Units

In other words, the PPU is the amount the seller is asking per unit in the building. The PPU can provide a broad view of the market and can give you a good idea of how one property compares to another. The downside of the calculation is that it does not determine the ROI or Return on Investment. PPU does not take any other features of the property into consideration, so its usefulness is limited.

Capitalization Rate (Cap Rate)
The Cap Rate is a realistic tool that considers an investment’s operating expenses and income, and then calculates its potential rate of return (as opposed to the GRM, which looks only at gross income). The higher the Cap Rate, the better it is for the investor. Why is it realistic? Because the Cap Rate estimates how profitable an income property will be, relative to its purchase price, including its operational expenses in the computation.

Capitalization Rate = Net Operating Income / Purchase Price

Like any other calculation, the Cap Rate will only be as accurate as the numbers applied. If a potential investor under- or overestimates the property’s operational costs or other factors, the calculated Cap Rate won’t be accurate.

There is no one-size-fits-all calculation that will direct an investor to real estate heaven. However, utilizing basic tools like the GRM, PPU and Cap Rate will give an investor a broad view of the investment’s potential. Using these tools to jumpstart the due diligence process can help the investor determine whether further research into the investment is warranted and what a property’s potential for profit may be.

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This material has been prepared for informational purposes only, and is not intended to provide, nor should it be relied upon for legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.

Roth&Co’s latest video series: Real Estate Right Now. Presented by Alan Botwinick and Ben Spielman, co-chairs of the Roth&Co Real Estate Department, will cover the latest real estate trends and opportunities and how you can make the most of them. This episode discusses real estate professionals.

Watch our quick 1-minute video:

REAL ESTATE PROFESSIONALS IN DETAIL:

Qualifying as a real estate professional potentially allows a taxpayer to deduct 100% of all real estate losses against ordinary income. It also helps the taxpayer avoid the 3.8% Section 1411 net investment income tax on qualifying rental property income.

For many real estate businesspeople, especially those who own several rental properties, acquiring Real Estate Professional status can create thousands of dollars in tax deductions resulting in a zero tax liability at the end of the year.

How does one qualify as a Real Estate Professional?

Under the IRS’s Section 469(c)(7)(B), one can qualify as a real estate professional if two conditions are met:

• The taxpayer must prove that he or she spends more time “materially participating” in real estate activities than in non-real estate activities.
• The taxpayer must spend at least 750 hours per year “materially participating” in real estate activities

Material Participation

The IRS wants to know that the taxpayer is active in real estate activity and is not a passive investor. A taxpayer can try to establish material participation by satisfying any one of the seven tests provided in IRS Publication 925. The taxpayer may elect to aggregate all of his or her interests in rental real estate to establish material participation.

Passive or Non-Passive Income?

 According to the IRS, non-passive income is money that you actually work for. It’s generally reported as W-2 or 1099 wages. Passive income is the money you earn without any particular labor, like interest, dividends…and rental income.

IRS Code Section 469 defines all rental activities, regardless of the taxpayer’s level of participation, as passive activity; and the taxpayer may only offset losses from a passive activity against income from a passive activity.

However, Section 469(c)(7) was later added to the law to avoid unfair treatment to those actually participating in the  business of renting, selling or developing real estate. This provision provides an exception for ‘qualifying real estate professionals’ and allows them to treat rental activities as non-passive.

So, the rental activity of a taxpayer who qualifies as a real estate professional under Section 469(c)(7) is not presumed to be passive and will be treated as non-passive if the taxpayer materially participates in the activity.

Bottom line? As a qualified real estate professional, one can deduct of rental losses against his or her non-passive income.

Qualifying as a real estate professional can also be advantageous to taxpayers with rental income. A net investment income tax imposed in Section 1411 levies an additional 3.8% surtax on, among other matters of investment income, all passive income of a taxpayer. A taxpayer who qualifies as a real estate professional with rental income may choose to represent that rental income as non-passive and may be able to avoid this 3.8% surtax.

Does your business activity define you as a Qualified Real Estate Professional? Contact us for advice on how to take advantage of this significant status and how to minimize your real estate tax burden.

Click here to sign up for important industry updates.

This material has been prepared for informational purposes only, and is not intended to provide, nor should it be relied upon for legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.

As we approach the holidays and the end of the year, many people may want to make gifts of cash or stock to their loved ones. By properly using the annual exclusion, gifts to family members and loved ones can reduce the size of your taxable estate, within generous limits, without triggering any estate or gift tax. The exclusion amount for 2021 is $15,000.

The exclusion covers gifts you make to each recipient each year. Therefore, a taxpayer with three children can transfer $45,000 to the children every year free of federal gift taxes. If the only gifts made during a year are excluded in this fashion, there’s no need to file a federal gift tax return. If annual gifts exceed $15,000, the exclusion covers the first $15,000 per recipient, and only the excess is taxable. In addition, even taxable gifts may result in no gift tax liability thanks to the unified credit (discussed below).

Note: This discussion isn’t relevant to gifts made to a spouse because these gifts are free of gift tax under separate marital deduction rules.

Gift-splitting by married taxpayers

If you’re married, a gift made during a year can be treated as split between you and your spouse, even if the cash or gift property is actually given by only one of you. Thus, by gift-splitting, up to $30,000 a year can be transferred to each recipient by a married couple because of their two annual exclusions. For example, a married couple with three married children can transfer a total of $180,000 each year to their children and to the children’s spouses ($30,000 for each of six recipients).

If gift-splitting is involved, both spouses must consent to it. Consent should be indicated on the gift tax return (or returns) that the spouses file. The IRS prefers that both spouses indicate their consent on each return filed. Because more than $15,000 is being transferred by a spouse, a gift tax return (or returns) will have to be filed, even if the $30,000 exclusion covers total gifts. We can prepare a gift tax return (or returns) for you, if more than $15,000 is being given to a single individual in any year.)

“Unified” credit for taxable gifts

Even gifts that aren’t covered by the exclusion, and that are thus taxable, may not result in a tax liability. This is because a tax credit wipes out the federal gift tax liability on the first taxable gifts that you make in your lifetime, up to $11.7 million for 2021. However, to the extent you use this credit against a gift tax liability, it reduces (or eliminates) the credit available for use against the federal estate tax at your death.

Be aware that gifts made directly to a financial institution to pay for tuition or to a health care provider to pay for medical expenses on behalf of someone else do not count towards the exclusion. For example, you can pay $20,000 to your grandson’s college for his tuition this year, plus still give him up to $15,000 as a gift.

Annual gifts help reduce the taxable value of your estate. There have been proposals in Washington to reduce the estate and gift tax exemption amount, as well as make other changes to the estate tax laws. Making large tax-free gifts may be one way to recognize and address this potential threat. It could help insulate you against any later reduction in the unified federal estate and gift tax exemption.