The New York Times either doesn’t understand basic accounting, finance, and tax principles, or it simply wants to be extremely biased in its reporting. Either way, the article’s conclusions and insinuations are simply way off base.
There’s a basic difference between net income and cash flow. Taxes are paid on net income. Cash flow shows the net proceeds received by the owner and is what the investor/owner is most concerned about. Here’s how it works:
Suppose a real estate developer built a $100 million building. Suppose the building earned $3 million annually in before-tax income. If the tax rate is 33 percent, as it approximately was before the 2018 tax cut, the developer would pay $1 million in taxes and would have $2 million left over as his cash flow.
That means instead of $3 million in taxable income, the venture would have a $1 million loss. Therefore, no taxes would be paid, meaning the owner keeps all $3 million in income.
The tax returns would show a $1 million loss, but the cash flow would be $3 million instead of $2 million—a $1 million cash flow increase due to the reduction of income taxes. Any student who has taken at least one course in accounting or finance should know this.
The second New York Times misunderstanding is the role of debt. Real estate is always a highly leveraged investment. That means there’s a large amount of debt used to acquire an asset. This is easy to understand for the average person.
A home is generally a highly leveraged investment, meaning that the buyer typically pays about 10 percent of the purchase price from their own cash and then borrows the other 90 percent from a mortgage company. A real estate developer does the same thing. In fact real estate investments would not be made if there was no leverage. And, please note, loans can come from banks all over the world.
In my example above, a $100 million building is constructed and yet it yields only $3 million cash flow. On an investment of $100 million that 3 percent return is not enough to justify the risk associated with a real estate venture.
However, if the developer used only $10 million of their cash (10 percent of the $100 million cost) and borrows the other $90 million, then a $3 million cash flow yields a 30 percent return on the $10 million of cash invested. That return justifies the risk. That’s how real estate works.
The New York Times further notes that Trump has “more than $300 million in loans he personally guaranteed [that] will soon come due.” They insinuate this will be a huge problem for Trump since his companies are reporting large losses.
The reality is that when lenders make large loans, they often amortize (spread out) the payments over 25 years. However, they make the term of the loan much shorter, often 5 to 10 years. When the loans come due, the lender often rolls it over into a longer term.
Sometimes, since real estate is an appreciating asset (meaning its value increases over time), the developer often seeks better terms, including a lower interest rate, when the loan is rolled over. Or seeks to re-finance with another lender who offers more favorable terms.
Since the building’s value has increased, it’s a less risky loan for the lender, who often agrees to lower terms.
We can assume that the intelligent reporters on the New York Times have at least a sophomoric understanding of accounting and finance principles. That means their reporting must be extremely biased.
It’s a sad day for the once very reputable New York Times.
