Seattle is one of the top ten hottest markets for retail, office, industrial, and multifamily with record high sale prices, lease rates, and low vacancy. Those pressures are continuing to push or hold capitalization rates down. Less volatile markets can provide good investors returns at capitalization rates of 8-12%……Wichita, KS.

I stopped almost all new RE investments around 1997 because the cap rates actually realized, with reasonable vacancy rates etc, were going to hell. And it is exactly because people – amateurs – were willing to make a purchase predicated on the idea that they’d make a killing in appreciation.

These people ruined much of the RE market for a long time, in lots of places. It’s just starting to get interesting again.

The truth is, Lookly Lou, that 5 years ago, your “inflows outflows” method would net you exactly no deals, as most every deal I saw was being done at breakeven or a loss, since people figured they’d make it up in appreciation.

The peak of this was those idiot “flippers” who would buy a property on credit figuring they could sell it at a gain after holding it for only a few months, hoping they wouldn’t have to make any or many payments as the deal was so underwater they couldn’t afford to hold it for long.

The market may be approaching rationality again. Maybe. Seattle hasn’t taken a drubbing yet, but the LA market is looking more interesting today.

Following Modern Portfolio Theory (MPT) and Dollar Cost Averaging (DCA), smart investors will diversify and invest on a regular schedule in several MSAs and real property types to hedge the inherent geographical economic risks. Investing in the Puget Sound has recently been characterized with high capital asset growth similar to Internet or tech stocks that pay no dividends and are probably operating in the red. (That worked well everyone in end. Not.) Investing in Wichita, KS or a similar market is characterized with a mature corporation that pays a lot of dividends from earnings and doesn’t increase in value at a fast rate. Forecasting cash flow from operations and dividends from earnings is far easier than forecasting capital asset growth which is more speculative.

Many new or inexperienced real property investors think there are some magic and secret strategy or analysis techniques. Nope. Good old fashion finance, accounting and economic fundamentals apply to every asset class including real property. The financial statements are the same. The discounted cash flow analysis is the same. IRR is IRR.

It is correct to say capital improvements are added to the cost basis of the property increasing the adjusted basis (cost basis less depreciation taken) which can lower taxable gain upon disposition of the real property asset Gain = Price – Adjusted Cost Basis. Currently, the capital gains rate is 15%. Keep in mind the component of the gain attributed to the depreciation recapture is taxed at a flat rate of 25%.

Katrina, thanks for helping to get my post and this information out to help consumers.

The tip about depreciation is also helpful. To clarify, I believe improvements are added to the amount paid for the property to determine your tax basis, so if you have a higher tax basis, you will pay taxes on a lower amount when you sell.

“It generally takes time (lots) for real estate to appreciate beyond the transaction costs of buying and selling the property and you should also factor in taxes, insurance, and costs for repairs, maintenance, and even improvements during your holding period.”

Historically, capital asset growth isn’t the main component of the yield. It is icing on the cake. Investment is about risk and the timing and the amount of the cash flows. Cash flow form operations will probably be the largest component of the investors yield. Occasionally, a property is forecasted to sell for a price equal to its acquisition cost. In essence, the asset lost value when inflation is considered. In hyper capital growth markets such as So Cal, FL, AZ, and to a small extent WA during this decade investors focused on capital asset growth or appreciation mostly because of media hype and gurus and not because of financial or economic fundamentals. And, of course, many people got burned similar to the internet bubble. Real property investment is not rocket science requiring the flavor of the month strategy. Business school fundamentals apply to real estate. Real estate is just another asset class with stocks, bonds, franchises, etc.

“However, repairs are tax deductible in the year they are made and improvements are added to your tax basis, though you won’t realize the gains from these until you sell the property.”

I am not real sure what this is supposed to mean. The taxpayer does realize a benefit from capital improvements long before the disposition of the asset. The cost of the capital improvements is added to the cost basis and depreciated over the remaining life of the real property providing a tax benefit each year. With property planning a tax loss with positive cash flow can result. Making repairs and improvements doesn’t necessarily guarantee more gain or a higher sales price upon disposition of the asset. Market fundamentals of supply and demand will determine the assets selling price. The taxpayers situation will determine any realized gain.