Which investment is wiser?

General Real Estate Investing
1

I own a two-unit apartment building that is worth $500,000. I am currently generating $23,000.00 in net rental income as the building is paid off.

My options are as follows:

1.) Sell the building for $500,000 and put down 25% ($500,000) on a $2,000,000 triple net lease commercial investment with an 8.5% cap rate. Under this scenario with a ten year lease, I will be generating net rental income between $34,000 and $35,000 per year for ten years. In addition, the pre-tax equity on the property will have appreciated $350,000 after ten years.

2.) Keep the apartment building. Borrow against the building at 5.5% interest rate for 70% of the value ($350,000). Take the $350,000 and use it as down payment on the above-mentioned triple net lease property in #1. However, one I borrow against the apartment building, the net effect on the apartment is a loss of negative $200.00 per month, or $2,400 loss annually. But, I would own both properties instead of only one.

Which would you do, #1 or #2, and why?

2

vasi69,

You actually have a third option which would be to keep the apartment building and continue as you have been. This is the safest course but not the most profitable. (current net 23k)

Your next option would be to borrow against the equity in the apartment building and buy the commercial building. (current net 34k - 2.4k = 31.6k)

Third option sell the apartment and buy the commercial building. (current net 34k)

On the surface, it would appear that last option would be a better cash flow, but this would not take into account increases in rent from inflation, the increase in value of the properties from appreciation, and tax credits from depreciation.

Lets look at rent increases first. If you figure that the rents for the apartment building increase at only 3 percent per year, in 10 years your income from the building would be about 32k (total income 32K + 34K - 2.4k = 63.6K). After 3 years of ownership of the commercial building, your net income would be approximately equivalent to your current income of the apartment building alone. After the fourth year, you will be ahead of the game. Also after the lease is up on the commercial property, you can increase the amount of the lease for additional cash flow, but if your tenant moves it may take some time to find another tenant (possibly years).

Next lets look at depreciation. I do not know the situation on the apartment building, so we can ignore it for now. (It would only be appropriate in the 2 scenarios where you keep the property if you can still depreciate it). If you consider the price of the improvements to the property to be about 90 percent of the price, you would be able to depreciate $1.8 Mil over the life of the property (29.5 years if I am not mistaken). This should offset about $61K per year in income (passive of course). That means that you would have no income from this property as far at the IRS is concerned and may be able to reduce other passive income. In 10 years of owning these properties, you should not have to pay anything to the IRS from owning them.

Lastly, lets look at appreciation in the value of the properties. If you assume a 3 percent increase in value, then at the end of 10 years, the apartment building should be worth $690k for an increase of $190k. The commercial property should be worth $2.76 mil for an increase of $760k. If you keep both properties, appreciation would be worth $950k.

To sum it all up, if you kept the apartment building, you would have rents of $275K plus increased equity of $190k for a total of $465k. If you sold the apartment and bought the commercial building, you would have rents of $340k plus $760 of increase in equity for a total of $1.1 mil. If you keep the apartment building and buy the commercial building, you will have rents of $351k plus an increase of equity of $950k for a total of $1.301 mil. The real increase in value of these properties would occur after the 10 years are up and you could increase the price of the lease. Also you might try to structure the lease as a 5 year lease with an automatic renewal for 5 years but at an increased price (10 to 15 percent).

HTH
Wilson

3

Over the course of your net lease you’ll only be making 110,000.00 more than if you just stick with your two story property, If you sell it now and go withis scenario wouldnt you think that it would be at an overall loss ;l considering that your $500,000.00 building will apprteciate at least $100,000.00 over the next 10 years. And since most commercial leases are 10-15 years you’ll be locked into a lease with a tenant on your net lease property.

I suggest you keep your two story and get an equity loan…at a loss of only $2,400.00 per year you’ll still be better off 10 years from now when your net lease expires.