February, 2023

An economy like today’s reminds me why I favor multifamily real estate. Stocks down, then up, now heading down. Inflation untamed. Came down some but is stubbornly holding on. Fed rate bumps all done? Or wait, not all done. New expectations as of three weeks ago of three more hikes, to be 75 basis points higher in a year. And layoffs in the tens of thousands. Blood in the streets?

But tenants are paying rent, not moving, and applications exceed vacant units. No one expects 10% rent increases but expectations are for rents to remain stable, high occupancy, and low delinquency. That’s a win. A big win. There is still probably a long way until we’re out of the woods, where rates are back in the 4’s, but when we underwrote the higher rates before we bought, that’s at least one worry we don’t have.

Unemployment has a long way to go up before the market can no longer absorb these job transitions. Amazon laying off 18,000 employees is unfortunate for those who lost their jobs, but Amazon hires smart and these people will find new work. And it is 1% of their workforce of 1.6 million. The other tech giants with big layoffs are mostly in a similar situation.

What is happening? Building starts have slowed, dramatically. Houses and commercial. What that means is that in two years the shortage of available apartment housing will be acute. Oh, and rates are likely to be lower. You think cap rates have been low over the last few years?

Just wait.

Indianapolis, IN – people are moving to Indianapolis, often because of what the city is not. Being an upper Midwest city, many think of Chicago, Cleveland, Buffalo, old heavy industrial rust belt cities with tax and regulation burdens that are inhospitable for real estate investors. Indianapolis gets cold in the winter but the city and state have done an exceptional job of making it an inviting market.

Population trends prove this, rising nearly 20% over the last 20 years to 977,000. Chicago has lost nearly 1%, Cleveland 27%, and Buffalo over 5%. A city with a declining population is a tough headwind for a real estate investor.

Jobs tell a similar story. Just in the last 15 months, after the big post-pandemic jobs bumps, jobs growth has averaged 3.4%. That’s astounding, the kinds of numbers that in normal years we would see in most Texas markets. Indianapolis also landed on CBRE’s Top 10 list of markets for industrial real estate net absorption in 2022, along with powerhouses like Dallas, Chicago, Houston, Phoenix, and Atlanta.

What brings people to Indianapolis? Well, not the Indy 500, except for Memorial Day weekend, or the Colts (sorry! I’m an optimistic Seahawks fan). I remember when the Colts moved from Baltimore to Indianapolis in the middle of the night, and no one thought it was a smart move. But the Colts in Indianapolis sell out nearly every home game, something they couldn’t do in Baltimore.

The draw is a lifestyle that is closer to true Midwest hard working self-reliance and free markets than its neighboring metros. They’re open for business. There is space to build, reasonable median home price of $155,000, and a downwardly trending crime index, according to city-data.com.

Several huge businesses call Indianapolis home, but most notably is that the city is the home to one of the largest life sciences clusters in the US. This is partly due to the concentration of highly educated people in related fields. Eli Lilly, a giant in the pharmaceutical industry, headquartered in Indianapolis, and maker of insulins and Prozac, has spun off numerous successful startups in life sciences with the help of nearby universities, and they continue to attract top players in these growing fields. These are multiplier jobs – one job in these fields generates several more jobs in related service industries.

In my networking 90% of the people I talk to prefer to invest in the south. Indianapolis has most of the same charms as the south and most of the same economic benefits, but it is overlooked and has not been discovered.

That’s evidence of a true emerging market.

Protecting your Capital Gains
A friend told me about someone they knew who had a capital gain of $1M after sale of a multifamily property. Big celebration, but unfortunately in these circumstances that person was not able to plan for deferring the taxes on that gain. Have you had a real estate gain you decided to just pay taxes on?

We have a few hugely valuable options when selling properties to defer the capital gains, including 1031 exchanges, IRS 453 tax deferrals, and opportunity zone investing. But often they are not the right fit.

First, I’m not an accountant. I utilize the best accounting resources and they have saved my bacon more than once, so verify anyone’s tax saving suggestions, including mine, with your accountant.

Would you like to just pay $200,000 in taxes on a capital gain like that, rather than risk getting in trouble with the IRS? Maybe you would, but you have to keep in mind that Congress wants to encourage certain behaviors. That’s why they passed the laws that say if you behave this way, you are entitled to save or defer some taxes. It’s not cheating, it’s not unethical, it’s not a loophole. It was designed that way. The behavior they are encouraging makes good things happen, like more housing.

Here’s a simple option. Invest your proceeds in another property the same year. Get it into a deal, fast. Don’t cram into the first deal that comes along, but get to know who the best syndicators are. One of them is likely to have a good deal offering before the end of the year.

Then study their materials and confirm they intend to do cost segregation on their new acquisition this year, the same year they purchase. With cost segregation comes bonus depreciation. Cost segregation is an engineering and accounting activity that allows all of the component assets within a real estate property, including the countertops, floors, appliances, etc., to be recharacterized for depreciation purposes as potentially shorter lifespans. So instead of depreciating your property on a 27.5 year straight line schedule, you’re able to take most of the depreciation the year you purchased it. Who owns a property for 27.5 years anyway.

I see most properties who perform a cost segregation able to deliver a depreciation deduction to their investors of 60-80% of their initial investment. If it’s highly leveraged, which unfortunately most properties these days are not, the depreciation deduction could be even higher.

You take your $1M gain from the property you just sold, invest it in a property doing cost segregation, and most of your gain is sheltered by the depreciation deduction on your new property.

Special considerations? Yes, a few. First is that the Bonus Depreciation benefit is being phased out. You can only deduct 80% of that depreciation in 2023, then 60% in 2024, 40% in 2025, etc. Unless they change that law, which hopefully they will. Still, 80% of the full depreciation is pretty awesome.

And why not? You keep that $200,000 you were going to pay the IRS and you invest it again into more real estate. Your motive may be to build your personal wealth but the net effect is it adds significant tangible support to real estate values. It is only through this process of having a low-friction free market of real estate purchases and sales that new development comes into the market. Developers will not build in an area if they believe there won’t be a buyer some day who will buy it from them, at a profit to them.

Invest your time now to find several syndicators who have demonstrated they are out buying, doing well for their investors. Can’t find one? Then check with financial advisors and find companies who manage and offer Delaware Statutory Trusts. Returns are a little lower but they can get your money into a tax deferred real estate investment pretty quickly.

Anything to defer those taxes and keep your money growing.

Who We Are

Cardinal Oak Investments acquires, improves, and manages under-valued commercial apartments. We buy B and C class properties of around 100 units in the Southeast and Midwest. We look for properties whose amenities, aesthetics, and appeal have fallen into obsolescence, whose care reflects tired management, and whose location is where a stable workforce wants to live.

And we partner with like-minded investors looking for stable assets that produce good cash flow and strong appreciation.

Founded and managed by John Todderud, Cardinal Oak Investments has acquired properties on both coasts and in between creating annual double-digit returns.

For more information, schedule time with me or contact us.

Please note: Past performance is no indication of future performance.