Multifamily Expense ROTs and Ratios

blog Jun 22, 2018
Assigning a contract in Pennsylvania may cost you transfer taxes
Expense Rules of Thumb and Ratios

One of the first things that we talked about is what we call the Pennsylvania transfer taxes. One of my students was asking me a question and I thought his question was ridiculous. Then, he posted the same question on the Whatsapp group with all the other OWNER FORUM members on there and they all thought his question was ridiculous. His question had to do with transfer taxes. 

What he was planning on doing was signing the purchase and sale contract in the name of ABC LLC, his entity. When he goes to buy the property, the bank wants him to sign a contract to the entity that is getting a mortgage who is going to own the property, 123 main street LLC. So all he does is just take one piece of paper that says assignment right on the top. And he goes through it. And he says, OK, I assign this contract from ABC LLC to 123 main street LLC and transfer. So both are done. 

He got on Whatsapp and sent me an email saying, “hey, I'm trying to figure out how to avoid transfer tax on a double closing because I'm going to be doing this.” I'm like, there's no transfer, you're just assigning the contract, you're not buying it from the ABC LLC and then transferring it to buy a new deed to 123 Main Street LLC. This is a very simple thing. It happens thousands of times a day. Why are you getting all hung up on it? That's what my answer to them was and everybody else's answer to him on the Whatsapp group was exactly the same thing. 

Then, he sends me a link about the Pennsylvania realty transfer tax regulation. Folks listen to this. This will blow your mind. The amendment for the tax regulations provided, among other things says that, 

“the realty transfer tax would be imposed on amounts paid for the assignment of a contract to purchase real estate. Even where such a contract was assigned to a buyer's wholly owned SPE (Single Purpose Entity). “

So in other words, they amended the regulations in Pennsylvania. It’s like saying, hey, you know that simple little thing that you guys used to do, it's now going to cost you thousands and thousands of dollars for nothing. 

Remember, there is a reason why the government did this because the government knows what's best for you and they're protecting you and they're making sure that you are going to be all set. They're taking thousands of dollars out of your pocket for absolutely nothing. Typical government move. It's almost like the person that came up with this had never spent a day in the real world. 

This attorney that wrote this web page whose name is Lauren W. Taylor, T.A.Y.L.O.R., with the firm Fox Rothschild. She wrote this great article and she puts in five bullet points that clearly state exactly what needs to be done to protect yourself from that problem. And the key thing I can tell you right now is that the things that she says need to happen. They need to happen in the purchase and sale drafting stage. You've got to know this now when you're writing it. 

This is Pennsylvania. I'm not saying this is for everybody. You just got to understand that. What I also want to tell you is if you watch any of my videos and my training videos you know how I start them up. I start up by saying I'm an attorney. I'm not your attorney. Hire an attorney. So what I did with my students, I drafted the purchase and sale contract for them. I actually have a document that we use that we make sure it has all of the provisions in it that we're looking for. And then I tell you to give it to your local counsel. That's the person that's going to be representing you at the closing table. Give it to them and have them give it their blessing because I'll tell you right now, this type of issue, I can't know. My clients are all over the country. I can't know all of these laws. That's why I always specifically tell you I don't represent you, but you do need an attorney. You always do. Don't try to cut corners. 

An attorney is the best insurance you can possibly ask. So just keep that in mind when you're going through that, especially if you're from Pennsylvania. You've got to know this stuff, guys. Lauren Taylor thank you. 

The other thing that we talked about is the rules of thumb for the expense ratios. Now the expense ratios, when you understand the expense ratios, shouldn't be based upon the quality of the asset that you're buying. I can tell you right now that it's so easy. You can quickly figure out whether the seller is bamboozling you or attempting to bamboozle you just by the numbers. The numbers don't lie. And that expense ratio numbers that we use are the same and have been for years. You can take them to the bank. So that you have an idea what the guy is telling you is in A class property or let's say, you'll know by looking at it that it's a C class property.

You look at the numbers and you quickly look at the expense ratio of the property is at 30% - there is just no way you can ever own a multifamily class A property at a 30% expense ratio. You go to the broker and you say, hey broker this isn't going to fly. I'm going to bump up the expense. And the broker will say, “Oh, well, no, this is what the guy is doing right now”. All I can tell you is all you have to do is ask the broker if he has ever owned a property like this one. And if he has, how was he able to run it at that expense ratio because he can't do it. 

In a C class property, especially if it's at all bills paid property where the landlord is paying all the utilities, 60% expense ratio. I got a student that just sent me over a quick down that he got from a wholesaler and he's saying, “hey, this a C class property. It's near the airport in this particular city. Solid C, 30% expense ratio.” Now, it doesn't work that way. It can't work that way. The expense ratios are solid numbers that can be taken to the bank. All right. So just keep using those numbers. 

We also went through all the rules of thumb for all the different expenses and what they should be based upon the quality of the asset, based upon where their location is. So that's what we talked about in the class. Learned a ton of other great questions from students. 

We've talked about this one particular student who had a deal accepted only to find out that the seller was expecting him to assume the existing mortgage. Well geez, I think that might have been kind of important to let us know that that was part of the requirements of the deal before you put together a draft memorandum. I mean, it wasn't even in the offering memorandum. So we go back to the drawing board in that particular deal. But hey, that's the name of the game. That's how these deals. You got to break a few eggs. 

If you want to find out more about the Owner Forum send an email to my assistant, Deb at [email protected] and she'll hook you up with some information about how it works. We'd love to have you. It is a great group of people if you're serious about multifamily and if you plan on buying within the next six months you must be in the Owner Forum. It's as simple as that.

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