October 18th, 2024 | Private Equity, Gas Prices, Money Spending, Income Tax vs Property Tax on Inherited Property, Sirius XM Holdings, Inc. (SIRI), Vistra Corp. (VST) & Etsy, Inc. (ETSY)

Smart Investing with Brent & Chase Wilsey

Where does private equity invest the money, you give them?

Private equity invests money in many different areas, but the problem that they are having is that both them and venture-capital are sitting on $2.6 trillion, which is a record high. Ultimately, they are having a hard time finding where to invest. A private equity firm generally has to earn between 12 and 14% on their investments to cover their management fee and pay investors a worthwhile return. One area they have been attracted to is HVAC, also known as heating, ventilation, and air conditioning. Other areas of interest have included plumbing and electrical companies. Over the last two years, private equity has purchased nearly 800 big HVAC, plumbing and electrical companies. It is also estimated there are plenty of smaller deals that just don’t show on the radar. I do believe somewhere down the road someone whether it’s the consumer, the employee, the business owner or the investors is going to lose. Basically, private equity is trying to streamline these smaller businesses into bigger businesses to cut costs. Many times, this changes the way they do business and it could place a larger emphasis on making more new sales rather than doing repairs, which leads to bigger profits. I do worry about the business owners who are told they can still run their business the way they want and keep a 20 to 25% stake. If things get difficult, the private equity firm with a 75% ownership will override the small business owners’ decisions.

Are gas prices going up or down in the future?

A big factor in the price of gas is the price of oil. If you live in a state like California, then you can add other factors like taxes and regulations. Oil has remained somewhat reasonable falling under $70 a barrel in the last few weeks, it then recently crossed $80 a barrel on concerns in the Middle East. We know there is potential for a major disruption with tensions between Israel and Iran showing signs of escalation. The war in Ukraine continues to linger on, but so far it has not deterred Russia from selling their oil to countries like China and India. We also have a change in our president quickly approaching and everyone has to ask themselves, who would be more likely to tame the violence in the Middle East? If the next president cannot reduce or stop the fighting, we could see Israel start sending missiles towards Iran’s energy infrastructure. This could then lead Iran to try and restrict or block oil tankers flowing through the Strait of Hormuz. These actions would likely cause oil to skyrocket to over $100 per barrel, which could mean a 20 to 25% increase in the price of gas at the pump. What has kept oil and gasoline prices low so far has been slowing demand from a weak economy in China and talks of OPEC exporting more oil come December. It’s also important to know that there is less oil in storage than the historical average, which could mean there is pent up demand to refill that storage. If you’re an investor, I think it makes sense to have at least 5% of your portfolio in oil and natural gas companies because I believe the upside in the price of oil unfortunately is much greater than the downside.

Are you still spending money in this economy?

Retail sales have continued to prove resilient as in the month of September we saw growth of 1.7% when compared to last year. With the decline in the price of gasoline, gas stations saw a decline of 10.7% compared to last year and if this component was excluded from the headline number, retail sales would have grown at a stronger rate of 2.8% in the month. Areas of weakness included furniture and home furnishing stores (-2.3%) and electronics and appliance stores (-4.6%). One area that showed positive growth for the first time in a while was building material & garden equipment & supplies dealers. It was a very small annual gain of 0.5%, but could this finally be the turning point for a group that has struggled tremendously over the last couple years? Areas of strength in the report included nonstore retailers (+7.1%), health and personal care stores (+4.6%), and food services and drinking places (+3.7%). While the growth in retail sales isn’t setting the world on fire, I believe this report provides further evidence that this economy is in alright shape.

Income Tax vs Property Tax on Inherited Property

There are many factors to consider when inheriting real estate, especially in California, and the tax impact is one of the largest. When receiving an inheritance of property there is an income tax consideration and a property tax consideration. When capital assets, such as real estate, are sold for more than they were purchased for, the increase in value is considered a capital gain which is a type of income. When property is inherited, it generally receives a step-up in basis which means the original purchase price is no longer relevant and the new income tax basis is the value of the property as of the date of death of the owner. This means a parent who purchased a property for $200k and passes away when it is worth $1 million can leave it to their children who will not be responsible for the tax on the $800k gain. If they do sell, they will only need to report income on the appreciation after the date of death, or the amount over $1 million. This is obviously a benefit and applies to other assets as well such as stocks and bonds. However due to Prop 19, there may be a counteracting property tax implication when inheriting real estate. In California the property tax assessed value can only increase by a maximum of 2% per year, even if the fair market value of the property increases much more than that. Because of this people who have owned properties for many years are paying relatively little in property taxes compared to the actual value of their real estate. However, when the property is inherited, the property tax assessed value increases to match its fair market value, resulting in a much higher property tax bill every year going forward. As a result, vacation homes and rental properties that were great investments become unaffordable when the heirs receive them. This often causes the sale of the property, which fortunately can be done income tax free due to the step-up received at death. There is an exception to this property tax increase where if children inherit the primary residence of their parents and begin treating that property as their own primary residence, they may add up to $1 million to the property tax assessed value before being required to pay additional property taxes. Understanding these tax issues can help you determine when property should be held or sold before or after an inheritance.

Companies Discussed: Sirius XM Holdings, Inc. (SIRI), Vistra Corp. (VST) & Etsy, Inc. (ETSY)