Inherited Commercial Property - Should I sell?

Question

Hey Everyone,I'm admittedly quite new to this site and still trying to learn even the basics, but I have a somewhat imminent decision to make and I was curious your thoughts.For context, both my grandfather and father passed away last year and I'm on the tail-end of finishing a dual probate process. Important to this discussion is that there was some commercial property my grandpa owned, which my dad then inherited, which in turn my brother and I inherited. As it stands, I own 1/8th of the property, my brother 1/8th, and my aunt & uncle 1/4th. The other half is owned by the family of my grandpa's former business partner, whom I've never met but seem quite reasonable and manage all details of the property for a 10% fee. As we approach the end of probate, my aunt and uncle are asking to buy my brother and I out of our share of the property for an all cash amount. Specifics are below:Location: Boise, IDAppraised Value: $1.2M as of July 2017 (thus my share is effectively $150k at this cost basis)Monthly Rent: $8,400Monthly Management Fee: $840Additional Retention: $1,500 (this is for insurance, taxes, repairs, etc.; anything not spent for the year is prorated back to everyone at EOY)Ultimately we're renting at an annual rate of 0.84%, which is obviously below the 1% rule I keep reading about. However, I'm unsure if that rule applies to all properties or just residential. The building is fully paid off, and we have a tenant who rents the entire property. I understand we've kept them at a lower rate to ensure their stay because historically they've been great. I believe their current lease is through the next two years. All in all, it's a steady cash flow to me of around $9k a year after all taxes and expenses. Personally, I view this property as a passive asset for myself in a city that's growing at a strong pace, and as a diversifier to my already quite liquid portfolio. I'll literally do nothing but collect the cash each month.My question to everyone here is how you would you approach this situation? I don't think I'll have much say in upping the rental amount (in large part because I'm not majority owner), so I'm anticipating a somewhat deflated rate for the tenure of my ownership. As such, I'm effectively receiving a 6% net return on my investment ($9k/$150k), which may be below average equity returns, but it's also somewhat fixed and I personally believe the market's entering a low-return environment. This 6% return also doesn't take into account potential property value growth.I welcome absolutely all advice and education (please correct me if I'm mistaken in my views of anything above!). I told my aunt and uncle I'd have an answer for them sometime next week, and if I need to get more info I'm sure that's possible. Lastly, family dynamics are not something I'm interested in bringing into the discussion unless necessary. We have an amicable relationship and I've been very generous with them on other fronts. I solely want to make the decision to sell or stay in the context of what's most business savvy. And as a bonus question, if you were in my seat do you think it's worth approaching my brother to buy his portion for $150k? That's a possibility and I have the cash to pay it in full.Thank you!!

Caleb Heimsoth · Answer

@Chris Kyle well it’s good to know you got the tax situation handled. So assuming you buy your brother and get the 300k, and it earns you 6 percent I’d say that’s okay. It’s not a great return but it’s not awful either.Correct me if I’m wrong but this sounds like an almost entirely passive investment? If that’s the case then 18k a year is not to shabby. However (and I think this is the larger point) I think it really depends on the size of your portfolio and your time to retirement. If this 300k represents say 25-50 percent of your entire investment portfolio I would say that’s not okay and to sell and diversify. If it’s say like 10 percent I think that’s fine.The other thing to think about is how likely is it to keep appreciating? If the likelyhood is high (and it sounds like it may be) I’d keep it and maybe sell to your relatives down the road at a higher evaluation. If you don’t need the cash now, and it’s a small percentage of your portfolio I think you’d have little to lose by doing this.Now if you need the cash and want to diversify I know there are note funds out there that pay 10-12 percent, market typically is 8 percent but only long long term and buy and hold real estate is probably 12-15 percent total return.If you sold and none of that sounds good you could invest the proceeds in syndications which typically pay 8-10 percent, but that’s assuming you’re an accredited investor

Chris Kyle · Answer

@Caleb Heimsoth Fantastic, I was really hoping someone would opine on this subject. Thank you!Yes, this is effectively a passive investment as I'll have no real responsibilities catering to the property whether it be tenants or paperwork. This comes out to be just over 20% of my portfolio, so in that context it's certainly high. However, and to your point, I think there's great potential in appreciation. I'd need to perform more due diligence on the property itself, but from recent experience selling a residential property, I received literally 50% over the appraisal value. That's what's so enticing and my major hope that some aspect of that applies here. If anything, receiving something like 4% annual appreciation value then bumps my net 6% to 10%, which is all the better.I have plenty of cash on hand too, so there's no huge liquidity issue from my end, and I have a good job that covers all my other needs. This whole situation is primarily a learning experience and additional means for growing my income.Thanks again for all your insight, Caleb. I definitely feel more empowered than I did before, and you brought to light many points I hadn't yet considered. You certainly speak well for this community.

Chris Kyle · Answer

@Caleb Heimsoth @Russell Holmes Thanks, both of you. Yes, I'd already verified with my attorney that the cost basis was the same as the appraisal rate at time of death, which was the $1.2M. So there'd be no taxes on that front, but I've actually already sold another property, so I have some 1031 funds to use should I want to make an offer above cost basis to any of the shareholders.No worries if neither of you have insight on this matter, but my main focus now is determining if the ROI is worth the held up equity. Assuming I'm able to procure my brother's share, is $300k netting +6% each year a worthwhile investment relative to having it in the market with more liquidity and potentially higher returns? In the context of my total portfolio I want to say yes, but I have no real basis for determining what average real estate returns should look like. Guess I know my homework for the weekend!

Russell Holmes · Answer

@Chris Kyle @Caleb Heimsoth some great points have been made here too which I can't add much. I am 'just' a Realtor but also the son of a CPA and grandson of a Stock broker so I have a decent level of understanding on inheritance laws. Chris, your cost basis in this property is what it is worth when you inherited. If you sold now, I don't believe you pay any tax on it as you didn't gain compared to inheriting it. If you hold and it appreciates, you'll only have capital gains over it's current value. Other than that point, I agree with the outlook of trying to get a full 1/4 or sell your 1/8th.

Caleb Heimsoth · Answer

@Chris Kyle no problem! I am relatively new to investing (about 2 years total) and only own a couple rentals but I have done a ton of reading and try to comment as much as possible on BP.From what you’ve described I would buy your brothers share and do nothing else. You sound like you may be an accredited investor so I would look into some note funds or syndications. Personally that is the route I will likely go when I am older. I am in my early 20s and hopefully I am accredited by 35. You can google the requirements for that but usually it means you’re fairly successful. Assuming I reach this by my 30s I could 8-10 percent annually for the next 30 years. I have already seen first hand what this does to someone financially. Basically means you have more money then you’ll ever need (assuming you don’t have expensive hobbies like a private jet lol) which I do. Hope this helps. Let us know how it goes.

Russell Holmes · Answer

Also, consult a real CPA and or attorney before making a move. I did sleep in a motel 8 sometime in my life, but I don't have my CPA license :)

Caleb Heimsoth · Answer

Chris Kyle no problem, happy to help. So with your aunt and uncle having kids and sounds like it’s rather unlikely they’d let you buy their share, I would either buy your brothers share and then keep that or if he won’t sell I would sell your share as discussed in my first comment. The other thing to consider is the tax implications. I’m not an expert but f you would get a large tax bill then don’t do that and try to 1031 exchange it f possible.

Chris Kyle · Answer

@Caleb Heimsoth Thanks for the response and condolences.My aunt and uncle just retired and have three kids. I know their goal is to obtain additional passive income for their stage in life, and eventually to have something they can pass down to my cousins. As such, I'm unsure I'll be able to acquire their share now or even later, but perhaps I'm mistaken and it's worth the conversation. I hadn't thought about having multiple heirs "dilute the pot" and create a potential headache in the future - I'll certainly have to think about it.I think cash flow is the primary function of this property, but then again, I don't know much about commercial real estate. The location is in Boise, which has experienced quite the real estate boon the past few years, and I don't anticipate that to let up. Having this be worth significantly more in the future sure would be nice!Thanks again for taking the time to respond. I really appreciate it!

Caleb Heimsoth · Answer

Chris Kyle first off sorry for your losses. I imagine that was tough. Second to your original question I would probably do 1 of 2 things. The first I would see if you can buy your brothers share now and see if your aunt and uncle would let you buy theirs down the road. I am not sure if your aunt and uncle have kids or what their age is but if they don’t want to sell you their interest now and leave it to their kids down the road, more and more heirs will become involved making it harder and harder to get anything done. Just keep that in mind. If you can figure out a way to consolidate your families ownership to one person (you) over time, I would probably do that. If that’s not an option I would sell your share to your aunt and uncle, but at a slight premium Of say around 175k. Point is make sure you get too value for it. But make sure not to damage family relationships. This of course changes if the location or the land of the property is worth a lot more than it is according to its cash flow profile. For example if it’s in a major city and in the path of progress the land itself could be worth millions. You see this often with family farm land that’s been in a family for a long time. Land as is isn’t worth much but if a developer wants to buy it, it can quickly become millions