McNellis on Real Estate: Safe As Milk

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Where land is plentiful and current zoning more of a suggestion than a commandment (say, in oh, no more than 85 percent of the country), economic obsolescence—and breathtaking loss—requires no more than an idiot with a pot of money and a dream of a new building next to yours. The formula of doom is as simple and as inviolable as the Pythagorean theorem: developer + money + easy zoning = death-spiral overbuilding.

This is exactly why the smart money loves core properties. Since developers can somehow always come up with the money (let’s face it, that’s what they do), the best defense is to own properties in the handful of coastal cities where the zoning process makes water boarding appear humane.

Yet even a building as safe as milk still loses value every year through what too many view as merely a tax benefit—depreciation. Rather than simply a happy paper loss on April 15, depreciation is as real and painful as a root canal. Buildings wear out. The IRS has decreed that 39 ½ years is the standard useful life for buildings and allows one a roughly 2.5 percent deduction for depreciation every year.  This also means—because the IRS has it about right—that a building is cooked when the depreciation burns off. Your children can either scrape your worn-out building and start fresh, or go the more expensive route of gutting and rebuilding it.

Either way all you have left is your residual land value. If you have chosen your land carefully—i.e. on high ground yet within walking distance of big water—your land appreciation should more than offset your building loss. If not, you might be reminded of another old real estate joke:  How do you make a small fortune in real estate? Start with a large one.

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