Debits & Credits

High-Tech Turf

written by Howard Shwiff

Smart apartments are what renters want. Bring your rental property to the next (tech) level—and have Uncle Sam foot some of the bill.

Real estate vs. high tech. So what if you didn’t buy high tech stocks like Apple or Google or Netflix way back when. Hey, you’re a real estate investor, and doing just fine thank you. In a round-about way, those high tech firms are largely responsible for pushing our rents and property values up. Our sky-high 18 Gross Rent Multiples vs. their 35 PE ratios; what’s the difference?

Let’s look at merging real estate and high tech into a “Smart Apartment.” But before you invest in tech for smart apartments, consider the market economics (will tenants pay?) and, of course, the taxes. I’ll leave the unique San Francisco ROI economics for another study. In most of the markets I mention in this article, smart apartments achieve a competitive edge, higher occupancy and garner premium rents.

Who is the market for high tech?
That’s simple: techies are high tech adopters, and the majority of high tech adopters are millennials.

Millennials are moving to several U.S. markets, including the Northwest (specifically Seattle and Portland), the Carolinas (specifically Columbia and Raleigh-Durham), and Northern California (specifically Sacramento and San Jose, but also San Francisco), Texas, Virginia, and Colorado. San Francisco’s attractiveness is doused somewhat by its unaffordability due to high rents and high taxes. Nevertheless, it’s obvious that millennials are making their way here. The districts with the highest increase in millennial population include the Castro District, Glen Park, the Inner Mission/Mission Bay, and Russian Hill (neighborhoods that are popular for nightlife, dining out and their proximity to the downtown workplaces). Some telltale signs that you own property in a millennial/tech adapter neighborhood include Skip, Scoot, and Jump bikes and e-scooters. (Should we include trending e-toy shops?)

What kind of tech does the market want?

How can we “tech out” our properties and get Uncle Sam to help foot the cost? Below are a few options. .

Millennial renters want more services, convenience and time—the new luxury amenity—all from smart technology, including:

Smart video monitoring and smart door locks for safety and security.
Smart light controls for energy efficiency.
Charging stations in property garages for charging electric vehicles.
What’s popular with owners and property managers?
Smart light controls and solar energy panels for energy efficiency.
Hardware and cloud software for running a family apartment management office.
Software to automate rent billing and collection.
Social media “tweeting” technology to market and rent apartment vacancies.

The “virtual doorman” is a type of high tech security that works 24/7. Some apartment complexes have set up automatic package acceptance rooms. Video surveillance can scan garages, parking lots, entries and hallways. Keyless locks respond to phones, and can be controlled from anywhere there is WIFI. However, you should also expect that deadbolt and key locks will get removed and lost, as will your access to the units.

Energy Efficiency
Smart lighting and HVAC thermostat controls that can be controlled from anywhere by apps. We use to call it energy conservation, but that was when the tenants were asked to reduce personal consumption. Now they want it all done for them.

When all these smart home devices are interconnected via the tenant’s “virtual personal assistant” (VPA), it morphs into a “connected home ecosystem,” which frees renters up from virtually all responsibility or need to stay home! Perhaps owners will also reap the benefits of less wear and tear on their property.

Amazon Echo is one of a range of hands-free speakers and devices from Amazon that can be controlled with your voice. The voice-controlled “personal assistant” on these devices is called Alexa, which will perform various tasks for you and control various systems.

I even found technology for the bathroom. Search YouTube for “Paper is Not Dead.”

So, before I get deep into tax angles and 179ing, here’s what else I found: Technology is being built into new apartments across the nation, kind of’ like the Uber-ing of the industry. Whatever a tenant wants, they are want to be able to pick up their cellphone and handle it. Some want to look inside their refrigerator and see what they need, when they are already at Safeway. Some want to call home and start dinner cooking before leaving the office, or dial their apartment from Tahoe to unlock the apartment door for the cleaning person. And while these remotely driven tech gadgets are easiest to wire in during construction, contractors can always find a way to install them in our Victorians and Deco apartment buildings.

These tech gadgets are also making it easier to do business for property managers and rental agents. One of my last buildings ran on QuickBooks, and I handled turnovers by placing ads on Craigslist. Man, am I old school! The management software that you can get today (and then 179) will administer most of the property management and leasing while you’re browsing at MOMA, plus make your reservation for dinner at the Radhaus.

Other management benefits include the ability to collect rents online, making it easier for tenants to stay on top of their rent. Smart utility meters help quickly identify areas of waste, loss and leakage to prevent both property damage and
unnecessary bills.

Bottom line, you should invest in taking your properties high tech—if your tenants will pay for it. There are three basic steps. First, figure out what will take you property way past just modernized and make it appeal to the techie population. Second, install it and make sure that your CPA 179s it. Third, set aside about three weeks to fill out all the forms to file for a capital improvement passthrough with the San Francisco Rent Board, to make the cost worth it in rent controlled apartments.

What Is a Section 179 Expense?
Essentially, this IRS tax code allows businesses to deduct the full purchase price of qualifying equipment purchased or financed during the tax year. So if you buy (or lease) a piece of qualifying equipment, you can deduct the full purchase price from your gross income. Sounds a lot better than depreciating the investment in qualified improvement property over a 27.5-year (residential) life. You can generally expense qualified leasehold improvements up to $1 million (adjusted annually for inflation) under Section 179, as opposed to depreciating them. 

Favorable tax rules are a big reason why you chose to invest in real estate, and they are a big part of how wealth is accumulated, and passed on, through real estate investing. Passed on when you pass away, partially thanks to depreciation, which is where we will connect real estate and high tech.

All businesses deduct standard operating expenses, but they pay out cash for those operating expenses before they are allowed to deduct them. The kicker in real estate investing is non-cash depreciation, the sweetener to the pot, the category that kicks the after-tax cash flow up annually by taking tax shelter from investment dollars spent years ago, but does not require another cash outlay this year. Instead of immediately deducting costs that are considered “improvements,” you are supposed to deduct a little piece each year, pro rata over time. Voila: depreciation.

And recently, Congress gifted us with “bonus depreciation,” whereby depreciation may be expanded to 100% of the cost of 1) personal property (not building); 2) regardless if it is new or used; 3) but only property placed in service after September 27, 2017; 4) with a useful life of less than 20 years, et cetera.

Then there is Section 179 expensing, which also allows for immediate expensing of capital equipment, and that’s been enhanced both through ceiling limit increases and by what types of property qualifies for the deduction. For example, personal property used in rental properties such as furniture, refrigerators, ranges, and the like used to be ineligible for the Section 179 deduction. Now under the new law, these assets are eligible for the deduction.

If you want to get depreciation esoteric (more aggressive), there’s a tax planning strategy called “cost segregation.” You have a cost segregation study performed by an engineer to “break down” the building into its separate parts and allocate the cost between the building and the personal property included in the building’s cost. There are numerous occasions, and court cases, that could justify an item being categorized as 1245 personal property as opposed to 1250 real property. It comes down to what assets are related to the operation and structural components of a building versus what assets are related to the taxpayers business. A “seg study” may now include your acquisition of used property and immediately expense it. That sounds as good as “double declining” depreciation, which we used back in the 70s after the 1971 Congress enacted tax benefits favoring real estate investments, to stimulate investments in real estate and thus the economy. I wonder why Congress/Trump passed such a real estate favorable tax package in 2018.

Isn’t it great to have all these ways to depreciate the cost of the building, even while the property is steadily increasing in value? Go figure! Elizabeth Barrett Browning forecasted it: “How do I love thee? Let me count the ways… and, if God choose, I shall but love thee better after death.” Browning must have been writing about all the ways to use depreciation, dreaming of receiving a “stepped up basis” …. (even) “better after death.”

So it’s depreciation and especially the Section 179 tax rules, at least today, that provide almost irresistible, favorable tax treatment for your dollars spent on improvements and additions, which is how it becomes more affordable to purchase some high tech goodies. And I’ve done enough research to tell you that we (your CPA firm) will almost certainly “179-it.” So the old excuse “Well, my accountant says I cannot expense things like that; I have to depreciate them” is out the window under current tax rules. 179 may go on a different line of your tax return, but the improvement is going to get 100% deducted for the year you install and pay for it.

The important thing is to use tax dollars to reduce the net cost of investment and installation. I’ll stop there because we really need to invest in some more computer memory and speedy processing chips to remember all these tax rules and exceptions and years and forms.

In Summary
If you want the prestige of owning a smart apartment property, buy one in Seattle or Denver. Otherwise, have some fun; select some high tech gadgets that appeal to you and your tenants, and make the property work better. Your CPA will look up how to tax treat it. Maybe we’ll 179 it, or at least depreciate it. Maybe for the year you do it there will be a State of Federal “tax credit,” the best of all tax breaks. Just depends on the year, and the way the wind is blowing in Washington, D.C.  Hmm… Wind turbines on top of the apartment building?

The views expressed by the author are the author’s alone and do not represent the views of any firm. Howard Shwiff has an MBA in Urban Economics. He is a California real estate broker, CCIM and CPM. His opinions are not necessarily the opinions of Shwiff, Levy & Polo, LLP