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  • Deborah Luedy

Investment Series: Case Study – Where is my $1.1M better invested


It is with great frequency we are asked to identify individuals or companies who place equity into certain commercial real estate projects. The range of equity requests may be as low as $750,000 for a down payment to as high as $2BN for large infrastructure projects.

Not long ago we were asked to identify a provider or investor who would consider a placement of a little over a million dollars to close on a senior living development site of which would pay the equity source a 5% annual return on a 2- year term. One of the exchanges we had with a private investor was more interesting than most. The ‘most’ is more like thank you but not interested. One particular investor however took the time to explain how he saw the ‘opportunity’ for himself. It went something like this…

“My net return on a predicted 5% return on $1,100,000 is $55,000. In so doing his net return after adjusted taxes of (25.5% federal and 8.2% state = 33.7% in 2017) would be $36,465 or real return of 3.315%. If the $55,000 addition in gross income moved him into a higher tax bracket for the year, net after-tax return on investment would be less.”

For a hypothetical high-income earner, taxes will further reduce net return in this scenario. The top federal tax rate is 37% on incomes over $500,000 and the top California tax rate is 9.7% on incomes up to $551,473 and 12.3% of all income over $551,473. So, just assuming the top rates for the hypothetical investor living in California, without any 12.3% added increment in state tax, after taxes the investment return drops by 46.7% from $55,000 to $29,315. That is a real return of 2.665%. The inflation rate in the United States was 2.1% last year, so the investor is a little ahead if he or she uses the return buying core goods and services.

Now, thinking of what economists call opportunity costs, an investor can earn a virtually riskless 1.07% tax-free return in a Vanguard California Municipal Money Market Fund or a low-risk, tax-free return of 2.22% in the Vanguard California Intermediate Term Municipal Bond Fund. And there is virtually no risk in the 7-10 year Treasuries yielding around 3% if you hold them to maturity.

The prospective investor went on to say… the tax consequences of raising $1,100,000 in cash at this time would mean pulling approximately $360,000 from another investment outside of his money-market funds, in order to raise the total amount of the $1.1M. In so doing at that time, his capital gains tax would be nearly $53,000 whereby negating any possible real return. In addition he would lose the annual income in dividends from the approximate $360,000 invested in equities (stock), roughly 2% or about $7,200 resulting in yet another opportunity cost.

In summary, for a very high-income investor, this particular real estate opportunity did not promise to be very profitable in a financial sense. However, this could make sense to other investors who have lots of available cash who values real estate investing over bonds and equities and who somehow has other tax advantages and who may want something to do or to feel important about – such as building senior living communities.


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