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301: Ask Buck? 1/29/22

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Buck: Welcome back to the show. I always am very much partial to the questions that you ask me via video. So I have one more here that I’m going to play and we’ll start with that one. This is David. 

David: Hello, Buck. I really appreciate you taking time to answer our questions like this. And this may be a question that’s going to be asked a few times because the law is changing but I’m wondering what your view is on the fact that they’re sunsetting the bonus depreciation law and how you’re going to be moving forward in terms of taxes as it relates to dealing with capital gains and not having to pay as much in taxes. Will you simply focus on 1031 exchanges or is there some other vehicle that you guys are working on? Thank you so much. I’ll look forward to your answer. 

Buck: Thanks for the question, David. So let’s just review again. So everybody’s kind of on the same page. Now, first of all, why is this important? I really think it’s important if you don’t understand bonus appreciation cost segregation analysis. For those of you who are listening and don’t understand what David’s question is here, make sure you start with the last Ask Buck episode, because we spent a lot of time on this whole bonus depreciation cost segregation analysis stuff, which is critically important to real estate investing. But to get to your question here, David, just as a review of the actual legislation. So 100% bonus depreciation is intact for 2022 this year, and then it goes down by 20% every year, and then it essentially is phased out in 2027. Now, if you do not understand again the significance of bonus depreciation as it relates to real estate and cost segregation analysis, I’ll say again, please listen to last week’s episode of A Buck. But again, before I try to answer that question, let me also preface my comments by saying I am not a CPA or tax attorney, so I’m not giving you advice here. But let me say a few things about your question, David. In my humble opinion, I would say that the best immediate strategy is to maximize the law now. Right. By racking up these paper losses through investments that you make. Because even if you can’t use them now, you can carry them forward for other gains. So the depreciation losses, they’re losses like anything else that don’t disappear. If you’ve got a bunch of losses, you’re going to hold on to them until you use them. Right? So that’s one thing. The second, even though bonus depreciation is scheduled to sunset over this period of time, we really just don’t know what’s really going to happen. Right. Legislation is always changing. And to project out five years in what I would call a schizophrenic political environment would be kind of pointless. Right. So focus on what we can do in the immediate future with the laws that we know are relevant right now. And again, even next year, we’re still at 80%. And if you do the math like we did last week on Ask Buck, you can see. Okay, so maybe you invest your profits and some level of your basis your initial investment, you still could potentially wipe out most, if not all of your gain. So again, take advantage of what is now. Don’t worry too much about one or two years from now because things could and likely are going to change in some manner now three, I would say, although bonus depreciation may go away because the legislation is suggesting it goes away, cost segregation analysis is not going away. There’s no legislation or any reason to think that it would. It’s simply an engineering study that is separating out real property from personal property. And personal property is depreciated over five years, even without any sort of acceleration from bonus depreciation. So even if there’s an expiration of bonus depreciation, you should, in theory still get 20% depreciation per year just as part of the cost segregation analysis. Okay, so maybe it’s not 100%, but it’s 20% and it’s split over five years. So anyway, you can continue to build up those losses. Unfortunately, your question about 1031, there’s really no good way to do a 1031 exchange in a syndication model, unfortunately. But I would just say this too. Again, we’re trying to look at from now to 2027. That is a million years in the investment world when it comes to taxes and stuff, because usually the tax game, at least for me and for most people I know, is a year to year. What’s the law? What’s the rule? How do we use the law to our advantage from a year to year basis and understanding the tax world? From what I’ve seen, necessity creates ingenuity. And so, in other words, stay tuned to see what we can do in the future. Hopefully that answers your question or addresses a little bit. I know it’s a little bit unsatisfactory, but it is what it is right now. 

Next question is a written question from Jung Lee. Jung says, Hello, Buck. I’ve been an avid listener of your podcast. Thanks for all you do. I know 2021 was a year of cryptocurrency where a lot of people seem to have jumped into it a lot more. And I’m curious what you think of the future of cryptocurrency lies thinking about not only Bitcoin, but also theorem and Solana and some of the other currencies. And I’m also curious on your thoughts for NFTs. 

Well, Jung, thanks for the question. First, NFTs, with regard to NFTs, I answered a question about what I think of those in the last show. So go back to that. But let’s talk a little bit about my thoughts on cryptocurrency, which I’ve mentioned before. But I think it’s worth mentioning. I’m certainly not the authority on cryptocurrency. I am more knowledgeable than most, maybe a little bit more knowledgeable than what would be considered dangerous, but by not much more. So I split cryptocurrency digital currencies into two main buckets. Okay, first Bitcoin, and then there is everything else. Okay. Now to me, and I think to others, there’s a camp that thinks like me that there’s Bitcoin as digital gold. And I think that institutional markets, Wall Street, everybody is essentially legitimized Bitcoin as a source of digital gold, as an asset that has value. But that’s where I think the irony is, too. Right. Because that Bitcoin, when it was the original Bitcoin paper, and the Bitcoin people, they were sort of like rebellious, supposed to be creating economy outside of the Wall Street economy and all that stuff. But what’s happened is that the irony is the fact that Bitcoin has actually been adopted by Wall Street and by mainstream economy. And now that is really what’s driving up the price so much. Right. So it’s kind of paradoxical because the very thing that Bitcoin was trying to get away from is essentially driving up the price, which is becoming part of ETFs and institutional investing and all that. Now, of course, right now, as you know, if you’re in the market, we do have a pullback going on, and that only amplifies another one of my opinions is again, related to the fact that Bitcoin has ultimately become a mainstream asset. The fact that Bitcoin and other cryptocurrencies are following the other markets to me says that it is not different from the other markets. It’s not walled off from the rest of the economy. Right. And it’s not too surprising. Right. It really isn’t that surprising to me. Now, listen, if Bitcoin is digital gold, then what is everything else? Well, essentially, the rest to me is either software or some sort of memcoin. Right. There are tons of legitimate currencies, digital currencies out there. And what are they really? I mean, they’re really essentially kind of like stock. Right? There’s stock except in distributed ledger based software companies. Right. They’re not owned by one company. They’re owned by the people, the tokens. Right. But there are lots of them that are legitimate. And the software companies are different from Bitcoin. Bitcoin is digital gold. Right. It’s like the.com era and what happened in the.com era, most people remember that most of those.com died off like Pets.com and all that. They went south and they went to zero and all that stuff. But it’s also important to remember that in that.com era, that was also the era that brought the likes of Amazons and Google’s and all those companies, the tech companies that changed the world and made some people very, very rich. And to me, that’s essentially what’s going to happen with cryptocurrencies, with the non Bitcoin cryptocurrencies that represent some sort of software or applications, there will be some that do very well, and then there will be most that go to zero. So I think that’s how I see it. I don’t see it as a flash in the pan. I think it’s very real. But I think it’s yet to really declare itself, and it will continue to declare itself over the next few years. As far as Bitcoin goes, what do I think? Again, it’s my opinion, but I think Bitcoin, regardless of where it ends in the next week or two, I’m still thinking $250,000 Bitcoin within five years. I believe that to be the case, I think a lot of people do. That leaves one category of cryptocurrencies, which is the memcurrencies and the Mem currencies like Dogecoin and Sheba. Now, I could be wrong about this, but I see no value in them at all. And I see them pretty much doomed to fail is nothing more than fat. So that’s kind of where I’m at in the cryptocurrency world. Again, that’s my opinion. 

Next question is from John, says Buck, I’ve been enjoying your weekly podcast. I was wondering if you would provide some questions and answer sessions in the future. Well, we are actually. Anyway, he says we are planning to sell some of the properties we held since 2010 in 2024, because we don’t think price appreciation can go much more, but expenses are rising. What are your thoughts with the liquidity event if you’re in the same situation? Well, if you were thinking of selling in 2024, John, I guess my question is why don’t you just sell now, right? We’re in a hot market you’ve been holding since it’s like over a decade. When you said 2010 to 2024 versus 2022, I would guess you’ve probably gotten a significant amount of your appreciation. But personally, if it’s me, I’m thinking of taking chips off the table because, listen, you could potentially make more money by selling in 2024, but you could also not make as much money in 2024. Does it make sense, therefore, to hedge by selling some of some maybe not all, but some of those chips off the table? I would think so. But again, I’m not here to give you advice. Maybe you could think about it this way. Maybe if you’re holding it that long, you can sell enough assets to at least get out your initial investment and then keep the rest going, sort of in a quasi infinite return model. That’s another concept. Right. But I am a big fan of this idea of taking some chips off the table right now, and that’s certainly what we’re going to do with our investment group this year as well, doesn’t mean you have to liquidate everything. But it’s about hedging right. Taking off some profits, maybe half your profits or whatever, and then letting the rest ride and see if it goes even further. Now, going back to the second part to think about of your question is why else might you want to sell now as opposed to wait until 2024? Well, going back to that question of bonus depreciation phase out that we had a little earlier, if you sell this year, you can reinvest with 100% bonus depreciation and probably offset your gains. So you’ve got the tax advantage situation there, whereas in 2024 you’d have bonus depreciation going down to 60%. It’s not bad. You could still probably offset a lot of that by reinvesting basis at that point. But it’s not 100%. So there’s another reason to consider selling now instead of 2024. A third point to consider would be interest rates. Okay. They’re going up a little. It’s not a bad idea to take some chips off the table. And again, we’re doing that in Investor Club with our assets, too. We’re not selling everything, but we are definitely hedging. And I think you probably already know that because you’re part of the investor group. But hopefully that answers your question. I mean, certainly that’s what I would do. I would certainly think about it in terms of any assets that you own that are significantly appreciated right now to seriously consider taking some of those chips off the table right now. 

Okay. Next question is from Scott. Scott says in what circumstance could cap rates rise as the Fed tries to keep rates down? 

I think tries is the operative word there because cap rates and interest rates kind of follow each other. Right. So it’s what actually happens. Right. So let’s review this. So understanding the relationship between cap rates and interest rates, it’s actually really critical. First of all, what is the cap rate? Let’s get really basic. Well, it’s simply the net operating income divided by the current market value of the property. Okay. Again, net operating income divided by the current value of the property. Now another way to think about that, which might actually be easier, is it’s the yield that you would get if you paid all cash for that property. So a cap rate of five means that if you bought your real estate all cash, no mortgage, your investment yield would be 5%. So why do interest rates affect cap rates? That’s the next question. What do you use leverage for? Well, you use it hopefully to amplify gains. And in order to increase your yield, to increase that 5% cap rate, to do a return of 8%. 9%, whatever, the interest rate on a mortgage must be less than the cap rate, because if it’s not, what’s going to happen? If the interest rate is greater than the cap rate, then you’re going to lose money, not make it. Right. So that’s why they follow each other. Think about that. You’re not going to do a 6% mortgage in a five cap building. That means you’re going to have like, you’re going to lose money. So again, cap rates follow interest rates. And if interest rates are lower, you can buy a building at a lower cap rate because you can get the debt to lever up that yield. And of course, sellers know this. So they can offer the real estate at a lower cap rate. Right. And the cap rate for real estate, of course, is also based on supply and demand in a given market. Los Angeles, for example, is going to have a much lower cap rate than Oklahoma City because cap rate is usually also inversely proportional with the potential appreciation of the market. So there’s lots of things that go into that right. You might get a short term, you might get more cash on cash, but your appreciation, you’re not going to get. So that’s what those cap rates are factoring in. So while in general, though, cap rates are moving in the same direction, you’re going to find some different Deltas and different markets. So long story short, the answer to your question, in my opinion, is it doesn’t really happen. Market cap rates and rates and interest rates will move in tandem. 

All right, next question is from Ernie. Ernie says Hi, Buck. Thank you for taking the time to share your insights and wisdom with us. I prefer writing because I think I can be more concise than when I speak. 

Okay, well, thanks, Ernie. I’d rather hear your voice, but that’s fine.

So here’s my question. Given the longest lock up period for the ATM fund. And he’s referring to the WF Velocity ATM Fund, which I could talk about because that is a Reg D 506 C offering available only to credit investors. But he says, do you expect there to be a significant reduction in the real returns in the face of a currently high inflation which will likely not abate for quite some time? Your other syndication, the projects he’s talking about from the Investor Club, have a way to be indexed to whatever inflation turns out to be over the lockup period, and that the sale price level counted for inflation that has occurred over the period. The ATM fund does not seem to have the ability that ability, from what I can see. Well, this isn’t part of the question, but it seems to me it might take a couple of years of inflation to normalize, but it won’t be in the 2% range the Fed is looking for. Hence the reason for my question. I don’t have a Crystal ball, but I’ve watched the Fed get it wrong over and over again. 

Yeah, that’s true. 

So, Ernie, it’s a good question, and it’s the type of stuff you really ought to be thinking about as you’re investing in these types of things. Okay. Now, as you know, what you’re talking about is this WF Velocity ATM fund, which essentially has a straight line of returns, monthly returns for seven years. Now, the cash on cash is very high, but it’s like a bond at the end of the day. Right. So like a bond, the value of your real returns is correlated with what inflation is. In other words, if you’re getting 25% cash on cash, which gets people, particularly the less sophisticated investors, super excited right away, and you say like 24, 25% cash on cash, that number in real number yield is going to be better for you if inflation is running at 2% than it is when it’s running at 6%. That’s very true. So it’s like a bond. It’s the same concept. Even though it is equity, this one is a straight line return. So how do you potentially mitigate the effects of inflation on those kinds of returns? Well, one of the really good things about this is the cash on cash is very high, which means the internal rate of return is very high, which means it takes account the time value of money. All I’m trying to say here is that your capital return is pretty quick. If you’re not taking into consideration the tax benefits. It’s four years. If you are, it’s three years. The math will tell you very clearly what you need to do in order to mitigate the effects of inflation on a straight line return like that. And that is invest those returns that you’re getting on a monthly basis back into something else as soon as humanly possible. In other words, if you got $25,000 coming back from your ATMs this year, make sure, in my opinion, I’m not telling you to do anything. But if it’s me and it is me because I have a lot of these myself, I quickly reinvest them back into other stuff. And that’s what the math will tell you. It’s just a matter of velocity, as we always talk about it’s, about maximizing the internal rate of return. Now, the other point that you bring up is a good one and that you’re talking about the other stuff that you said is index to inflation, not really quite index per se. But I think what you’re trying to say is that, okay, most of the other stuff we do is real estate with rents and real estate apartments and stuff. Right. And these types of assets inherently hedge inflation. Why? Well, what is inflation? It’s basically the cost of living. So if the cost of living goes up, it’s reflected by inflation. And that means our rents are going to go up as well. So we’re offsetting inflation. And that’s why the vast majority of my investments continue to be in real estate, because I would rather hedge. 

Okay. I think that is all of the questions I’m going to do for now because that’s a lot of information and it might be a value to go back and listen to some of those things again. With that being said, we’ll be right back after this break.