As I previously reported, Foxton’s the now-defunct east coast discount shop, is, well, defunct.  They recently fired most of their staff and declared bankruptcy.  What to do with the thousands of listings they had, however?

RIS Media reports that a tranche of some 1400 of them have been taken over by another broker, Fillmore, for about $110,000, which puts a value of $78.57 per discount listing.  With most agents spending hundreds or thousands of dollars in acquisition costs per listing, this sounds like an absolute bargain.

However…these being discount listings, the math might be different.  For a full service listing netting, say, 2.5% on the listing side, I’d be willing to pay significantly more than $78.57.  I believe Foxton’s, however, only charged a few thousand dollars per listing, out of which they had to cover employee costs (their agents were largely salaried, not commissioned), office costs, and the nifty little cars each agent got.  This model only works well in volume, when the market is spinning along comfortably.  With the market slowdown, however, things didn’t go so well.  As Foxton’s VP of Sales Mark Horvat delicately puts it:

We regret to inform you that, due to the recent down turn in the residential real estate market, Foxtons has decided to conduct an orderly liquidation of its business.

If Foxton’s couldn’t make it happen with their fees, how will Fillmore manage it?  Only two ways to do so profitable that I can see:

1. Charge more.  This is a non-starter, however.  The listing agreement that Foxton’s clients signed specified a certain listing fee, and Fillmore would be contractually bound.  Mark Horvat again:With the exception of the identity of the listing broker, all of the terms of your listing agreement with Foxtons would remain the same.
2. Lower costs.  Fillmore doesn’t seem to be going down this road either.  It appears they’ll be launching new satellite offices, hiring some 40 top-performing Foxton’s agents, buying their agents laptops, renting them cars, and putting them through their “Fillmore University” training program.

The math just doesn’t make sense to me.  If Foxton’s couldn’t swing it financially, how is this not financial suicide for Fillmore to take over the listings at the same fee, with the same cost structure?  What am I missing?

Foxton’s did not, apparently, have any Boston coverage.  If it did, I find myself wondering if Redfin might have tried to purchase any of those listings.

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Dsiclaimer: The following post is based on a presentation by Christopher Thornberg, an economist at Beacon Economics, that I attended last night, courtesy of my accountant, Tom Wagstaff of Petrinovich, Pugh and Co. This is a departure from my normally upbeat view of the local economy, and fortunately they re-opened the bar following the presentation for all the Realtors in the audience to drown their sorrows.

Economist Chris Thornberg showed some pretty convincing evidence for his expectation that housing prices will fall between 20% and 25% over the next couple of years, primarily because the ratio of home prices to incomes is higher than anytime in history, almost double the peaks in previous economic cycles. Gloom and doom for an hour, ah it brought tears to the eyes of many a Realtor in San Jose. Smugly I said, ” . . .but I live and work in Palo Alto, land of Stanford, Venture Capital, Facebook and Google! Sushi on every table and a BMW in every driveway! We are our own little world here, so we don’t have to worry about the housing market meltdown in Nebraska, or even the East Bay.”

Not so fast. The lastest housing boom has been driven by increasing housing prices, driven in part by cheap credit and loans. More people got these loans, bought more expensive houses, so the demand for these loans went up, and the cycle accelerated.

Now the appreciation is going the other way (flat to negative), and the equity that has driven consumer spending over the last few years (cash out refi = new boat), has gone away (bye, bye boat, and house!).  Thornberg forecasts that the subprime meltdown will be followed by Alt - A defaults (already happening) which will pull down the high-end markets from below (that would be Palo Alto, Los Altos, etc.). Even if the Fed were to reduce interest rates to 0%, it wouldn’t fix this mess. Much like last night’s temblor in San Jose, Palo Alto will be on the periphery of this shakeup. We won’t be knocked flat, but we will rock and roll a bit, and not in the fun way. Sigh . . .

To add to the gloom, I have been attending recent forums for candidates for Palo Alto City Council. Whether the topic is Palo Alto’s aging libraries, or green initiatives, the same topics keep coming up: Infrastructure, Schools, Tax revenue.

If you live or work in Palo Alto, I highly recommend you take an interest in the upcoming City Council race and the issues the candidates are raising. You can learn more about the issues and candidates on the Palo Alto Weekly website.

Happy Halloween!!

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Looks like my big idea won’t be unveiled till part 6!

All together now:  I am neither an accountant nor a tax attorney.  More importantly, I am not your accountant or tax attorney.  What follows is simply my layman’s understanding of a particularly obscure part of the tax code.  Before you try any of the below, be sure to consult with the appropriate professional.  ‘Nuff said.

Let’s take a brief digression into the arcane world of sale-leasebacks of depreciable assets from government entities to private entities.  Financial alchemy at its best!

Here’s how it works…*

A government entity — say, the City of New York — has a very large depreciable asset on its books — say, the subway system.  Depreciable assets, as we’ve seen, are a pretty valuable way of reducing one’s tax bill.  Problem is, the City of New York, as a tax-exempt institution, doesn’t actually have a tax bill that needs reducing!

Across the street is a private entity — say, Goldman Sachs — with a boatload of taxable income, sitting there in public view of the salivating money-grubbers at the IRS.  If Goldman Sachs owned that subway system, now we could take advantage of that depreciation.

Voila!  A perfect opportunity for financial arbitrage, creating a win-win for the City of New York and Goldman Sachs at the expense of the taxpayer.

The City of New York sells the subway system to Goldman Sachs for, say, $10B.  An instant later, the City of New York leases the subway system back from Goldman Sachs — good thing, too, since Goldman Sachs may be good at many things, but running subway systems isn’t one of them!

Goldman Sachs now has a $10B depreciable asset on its books.  I have no idea what the IRS’s depreciation timetable for subway systems looks like, but trust me, depreciating $10B will spit off many, many millions of dollars of tax savings each year.

The relationship between this piece of tax arcana and real estate depreciation?  Stay tuned for episode 7 of my ever-expanding trilogy.

* This example is completely ficititious.  As far as I know, Goldman Sachs does not own the New York subway system.  Deals similar to this, however, happen quite frequently between public and private entities.  See, for instance, this (rather dated) report from the Congressional Budget Office.

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As a relative newcomer to California (six years and counting) I’ve only experienced mild earthquakes so far.  A few minutes ago our whole house started shaking for about 10-12 seconds.  The news reports it as a 5.6 magnitude quake, with the epicenter some 5 miles north of San Jose.

I guess that counts as a real quake, right?

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Avid Mortgage Maniacs will note that it has been a while since my latest post. A little vacation and spending some time actually selling houses has kept me distracted for the last couple of weeks, but I’m back on track with thoughts on how the mortgage crisis (it’s still there) is affecting folks in Palo Alto and the surrounding communities.

To paraphrase Dirty Harry: A man’s got to keep his priorities straight

Optimists Unite!: At the recent “Reach the Summit” Economic Forum sponsored by Absolute Mortgage Bank, Partner Joel Spolin presented data on the mortgage meltdown, and showed statistics on where foreclosures and short sales are taking place. The short take is that demand for homes in the Palo Alto area is high enough that we aren’t seeing declining prices. This gives people who get in over their heads the option of selling their homes and avoiding foreclosure. We also tend to have more financially savvy homebuyers here (again due to prices) that they better understand these loans, both the upsides and downsides. You can download all the presentations here.

Yesterday, Eric Trailer, also of AMB told me that they haven’t had any of their local loans default - I’m sure that lenders like Countrywide and Bank of America could say that.

Pessimists - It’s not over yet! - Bank of America announced on Friday that it will be closing its wholesale banking operations and laying off about 3000 employees in January. Merry Christmas to you from BofA. Since the majority of mortgages are written by brokers and mortgage bankers through banks like BofA, WAMU, etc., BofA seems to be cutting off its proverbial nose to spite its face. It makes the shareholders happy though.

Blah, blah, blah . . . What does this mean for Bob and Betty Buyer who want to buy their fixer upper in Palo Alto’s Midtown and can swing the payments on a million dollar loan? Here are my thoughts:

1) Talk to a local mortgage banker or broker - they aren’t as affected by nationwide market conditions and have the ability to “shop” your loan to more potential lenders. Think nimble vs. big.

2) Be realistic about your budget, future plans (Are the kids going to Stanford or SJ State? Both are good schools, but leave different sized dents in the pocketbook). A good lender will discuss those kinds of future expenses and plan for them. There is a difference between what you can qualify for and what you should spend.

3) $1,000,000 for a house in Midtown?!? You had better rob a bank or two. You will need about $1.3M. Don’t believe me? The median home price this week in Palo Alto is over $2,200,000.

Ouch!

Thanks for reading.

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Curbed.com, the spicy real estate blog serving up rich tidbits of new developments, sold-out penthouses, celebrity real estate, Eichler porn, and other Gen-X and -Y delectables, just raised $1.5M in funding.  (Source:  the New York Times and WebProNews.com)

That’s right, folks, a blog — something unheard of in real estate a scant 18 months ago — has just raised $1.5M to expand its operations, and this despite the general nation-wide slowdown in the real estate market.  Real estate blogging, my friends, is growing up.  It’s not a passing fad, or a way for bored agents to spend time online.  It’s becoming serious business.

Curbed’s business model is advertising driven, and while you wouldn’t be surprised to see companies like Trulia advertising there, the site has managed to attract a broader array of advertisers, including financial services and cars.

Want to predict the future of real estate blogging?  Quite simple:  read up on what’s happening in blogging in the technology and political worlds, both of which got in on blogging a few years earlier.  Blogs like Robert Scoble’s and Michael Arrington’s (on the technology side) and Arriana Huffington’s (on the political side) have 8-digit valuations.

Congratulations Mssrs. Steele et. al!

[Update:  I have not been able to find out what percentage of Curbed.com Mr. Steele had to part with to get the $1.5M in funding, leading to the obvious question:  What is the current valuation of Curbed.com?  Speculation here suggests somewhere in the range of $6M to $12M.]

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This is part four of a three four five-part series on depreciating real estate investments and how it affects your tax bill.

Part 1 talked about the basics of depreciating real estate investments.  In a nutshell, you can depreciate the non-land value of your real estate investments (but not the home you live in) over a 27.5 year period and use this depreciation as a “passive loss” write-off against your regular income.

Part 2 discussed the IRS limitations on the same.  For folks earning $100K per year or less, you can only write off up to $25K of passive losses in a year.  For every dollar you earn above $100K, you lose 50 cents of maximum allowable depreciation write-offs; at or above $150K per year in income, you can no longer deduct passive losses.

Part 3 discussed a Hummer-sized loophole in the IRS limitations having to do with real estate professionals who invest in real estate.  If you qualify as a “real estate professional” in the eyes of the IRS, then you no longer have the $25K limit or the $100K threshold.  You can write off pretty much all your depreciation against your income.

My standard caveat on such matters:  I am neither an accountant nor a tax attorney.  More importantly, I am not your accountant or tax attorney.  What follows is simply my layman’s understanding of a particularly obscure part of the tax code.  Before you try any of the below, be sure to consult with the appropriate professional.  ‘Nuff said.

Cost segregation, or component-ized depreciation takes the tax benefits of real estate investment depreciation to the next level.   Instead of depreciating the non-land portion of your real estate investment over the 27.5 years the IRS mandates for real property, you segregate or component-ize the investment into smaller chunks of personal property, each of which has a much more aggressive depreciation schedule.

Take our imaginary $500K property from part 1 of this series.  You’ll recall that $225K of that was the land value, leaving $275K to be depreciated over 27.5 years.  What if that $275K could be depreciated much more quickly?  Clearly, you’d end up with more depreciation that you could write off against your income.

Here’s how you accomplish this particular piece of tax alchemy.  You break down your $275K depreciable real asset into numerous smaller depreciable personal assets.  Your $275K property is actually the sum of:

• 14 windows at $500 each = $7000.  The IRS allows you to depreciate windows over, I believe, 7 years.  Instead of depreciating $7000 over 27.5 years (a paltry $250 per year),  you depreciate $7000 over 7 years, giving you $1000 per year in depreciation.  Voila!  Out of thin air, you’ve created an additional $750 in depreciation, which at a 30% tax rate, saves you $225 per year.
• 1 stove = $300.  You can depreciate appliances over 5 years.
• Blinds and drapes = $5000.  5 year depreciation schedule.
• Fence = $10,000.  15 year depreciation schedule.
   
• etc. etc. until you component-ize the whole property.

Your $10,000 per year depreciation now suddenly – magically — goes up several times, with your tax savings doing a similar bit of alchemy.

(For more information on cost segregation, you simply have to read what Jeff Brown has to say about it.)

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Greg Swann’s bloodhound inspired not only the name of his business and his blog, but also his weekly re.net writing competion, which in its short existence has inspired some very good writing.

This week’s three winners were as follows:

1. Geno Petro wins the Odysseus Medal for his post Memoirs Of A Big Fat Liar.
2. Krista Baker takes home the Black Pearl Award for writing Negotiating Commissions with Buyers.
3. Gary Elwood grabs the People’s Choice award for proposing a radical idea about getting people to believe you by, uh, telling the truth:  The Curious Secret to Getting People to Believe You.

Head on over to the Bloodhound to read more, then visit this week’s winners yourselves.

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Shailesh and Aimee Ghimire of the Arizona Mortgage Guru blog hosted this week’s Carnival of Real Estate, and with Halloween just around the corner, used a “scary” theme.

I’m honored to have been the top pick this week with my article on, as Shailesh puts it, the “scary” amount of money Active Rain could have made in their failed acquisition by Move.com.

Also featured were

• Joshua Dorkin of the BiggerPockets blog with his thoughts on  Investors Working on Foreclosure Deals: Avoid Fraud Suspicion - Disclose!
• Cliff Jacobsen talks about the Zillow-ERA deal with his article on ERA Lands On Zillow, One Small Step For A Search Engine, One Giant Step Toward A National MLS

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Shades of Douglas Adams…While nowhere near as entertaining as his (increasingly inaccurately named) 5-volume Hitchhikers’ Guide to the Galaxy “Trilogy,” this series looks like it may also turn out to be a 5-part “trilogy”.

And again, let’s dispense with the legal disclaimer to keep my attorney happy:

I am neither an accountant nor a tax attorney.  More importantly, I am not your accountant or tax attorney.  What follows is simply my layman’s understanding of a particularly obscure part of the tax code.  Before you try any of the below, be sure to consult with the appropriate professional.  ‘Nuff said.

Article one of this series introduced the idea of the depreciation tax benefits of real estate investing.

Article two explored the two limitations of these benefits:  First, they cap out at $25K, and secondly, that $25K limit begins to peter out if you earn between $100K and $150K, and they disappear completely above that.

This article and the next will continue to lay the groundwork.  The idea I’m aiming for will (hopefully) be presented in article 5.

We may all bitch and moan about NAR (I know I do!) and the respective state associations.  One thing they’re absolutely great at, however, is making sure that the laws — including the tax laws – in Washington DC and the state capitols are beneficial to those of us in the industry.  (As a sidebar, I’m somewhat torn about these beneficial tax laws.  The real estate professional side of me appreciates them tremendously every April 15th.  The citizen side of me wonders what scheme Uncle Sam will think of to relieve me of those funds in another way.)

Here’s the great little real estate investment secret for those of us in the industry.  It goes something like this:  If you’re classified as a “real estate professional”, then there is no limit to the tax deductibility of depreciation.

Huh?  Here’s what that means:  If you’re a “real estate professional”, and you earn $175K per year and have $50K in depreciation, all of that is tax deductible.  You simply don’t have to worry about the $150K income limit, or the $25K deductibility limit.

The IRS has some very specific rules about how you qualify as a “real estate professional.”  Many NAR members wouldn’t qualify, while many non-NAR members would.  The rules have to do with, among other things, what your principal line of business is, and how many hours per year you work in a real estate trade.  See this IRS publication for more details.

Let’s run through the same four examples as in my previous article, comparing the tax treatment of “real estate professionals” with “normal” people.

• Let’s say you have depreciation of $10K and your income is $80K. “Normal” person
  Potential tax savings:  $3,000
  Actual tax savings:  $3,000Real estate professional
  Potential tax savings:  $3,000
  Actual tax savings:  $3,000
  
  

  Verdict:  No difference.

• Now let’s say you have depreciation of $40K and income of $80K.“Normal” person
  Potential tax savings:  $12,000 (if there were no $25K limit)
  Actual tax savings:  $7,500
  Lost tax savings:  $4,500Real estate professional
  Potential tax savings:  $12,000
  Actual tax savings:  $12,000 (since all of the $40K depreciation is tax-deductible)
  
  

  Verdict:  Real estate professional ahead by $4,500

• You have depreciation of $20K and an income of $140K.“Normal” person
  Potential tax savings:  $6,000 (if there were no $100K threshold)
  Actual tax savings:  $1,500
  Lost tax savings:  $4,500Real estate professional
  Potential tax savings:  $6,000
  Actual tax savings:  $6,000 (since all of the $20K in depreciation is tax-deductible)

  Verdict:  Real estate professional ahead by $4500

• Finally, suppose your income were $175K and you had $20K of depreciation.“Normal” person
  Potential tax savings:  $6,000 (if there were no $100K threshold)
  Actual tax savings:  $0
  Lost tax savings:  $6,000Real estate professional
  Potential tax savings:  $6,000
  Actual tax savings:  $6,000 (since all of the $20K in depreciation is deductible)
  
  Verdict:  Real estate professional ahead by $6,000

 Overall verdict:  For real estate investors with incomes above $100K and/or depreciation losses above $25K, being classified as a “real estate professional” can have huge tax advantages.

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