I just inherited 100% of a debt-free apt complex that the accountants say will give me $100,000 per year in distributions. I am an artist and cannot even balance my checkbook. I have no skills in real estate. The complex is 40 years old and needs about $300,000 to bring it up to date. I have an offer of $900,000. My problem is I don't like to borrow money.
Restatement: I have inherited a free-and-clear apartment property with good cash flow. I have no financial or real estate skills, personally. The property is run down and needs work. I have an offer to sell the property. If I keep it, I don't want to borrow money for the repairs. What are my options?
I present four options for your consideration below. Gaining ownership of this asset is terrific news – your income is about to increase thanks to this inheritance. Your objective is to make the right long-term decision for you and your family because you don't want to screw it up. That is admirable. And you are willing to admit that you do not possess the skills to make this happen. Let's find you some answers!
First and foremost: Make sure someone is managing the asset. Find the right people that understand property management is more than just collecting rents. An apartment complex is a business entity that is in operation 24-hours a day. Then, hire a professional property management company. I would get referrals from the local Apartment Owners Association to find a manager. They will need the leases and any recent operational financials you may have on hand. They will also need to know the name and contact information of the property insurance provider.
Then, hire a real estate attorney and real estate accountant to "manage the manager." The attorney and accountant should not be the same person or from the same firm. This is just a simple check-and-balance. The real estate attorney and accountant's job is to assure the property manager is doing their job and keeping the asset viable and revenue-generating. Have the accountant make sure the property insurance is in full force and that real estate taxes are paid current.
I would shy away from hiring family members for management or accounting. Third-party non-related persons are much easier to fire if necessary. Our objective is to create a clear path forward without distractions from anyone that may have ulterior motives. Fine, call me paranoid – but this is my best advice.
Second: get an appraisal. Get an independent assessment of the value that you pay for yourself. The appraisal delivers an unbiased opinion of the value of the asset in its current condition.
Third: Get a capital needs assessment to determine property needs to operate successfully in the future. The evaluation should include estimated costs to accomplish the work. That said, I can tell you what I would do from there going forward. I'll admit up front that this is probably not the path forward for you, but hear me out (just in case). What would JW do?
WWJWD: Once I established that the amount to redevelop the property is $300,000, I would borrow $500,000 against the asset. I would earmark $350,000 for the repairs and set aside $50,000 for reserves towards future capital expenditures. The last $100,000 is mine to keep (tax-free).
This strategy will likely drop the $100,000 in annual distributions to $50,000; however, the asset is now on solid ground with all repairs completed and reserve money on hand for whatever else may come up. If the actual repairs are less, the unspent funds are added to the reserve account. If the repairs go over budget, then money comes from the $50,000 held in reserves. Next…it must be time for a vacation!
Here are some options that may fit with where you find yourself that exclude the WWJWD option.
Option #1. Sell as-is. Tomorrow. You have an offer on the table. This is found money. You have no skills for this endeavor. Take the money and hire a tax accountant and investment advisor to help you build a personal financial plan.
Option #2. Sell as-is. Tomorrow. Take the money and pay off your existing residence. Of all the things that people can do with a windfall, removing all your residence debt should be high on the list. It creates a great sense of comfort, knowing that you have a roof over your head no matter what's happening in the economy or with your income.
Option #3. See First, Second and Third actions above and determine value independently. What if the value is $1,500,000! There's an easy way to find out; hire an appraiser. The easiest way to find an appraiser is to ask your bank for the appraisal services they hire to evaluate similar properties.
Once you have a manager, lawyer, and accountant in place, this takes the pressure off of making an immediate decision. You can take a little time to think through your decision about keeping the asset or selling it outright.
Option #4. Redevelop/repair the asset from cash flow. Immediately address public safety matters; repair broken glass, doors, or pipes. Fix concrete walkways and add lighting. Consider committing 60% of net income to repairs.
All of this work will require hiring a general contractor to schedule the work over several years. The contractor will work closely with your property manager and your accountant to get paid as work is completed.
During this time, you are receiving 40% of the cash flow. Once the work is done, if the net income was $100,000 – with all the improvements – you may see $120,000 after all the work is done! Why? With all the upgrades and professional property management in place, rents will have increased.
Option #4.1. Once the work is all done, get another appraisal to see if there is a change in value. Use the same appraiser that completed the first appraisal.
The big decision is about whether to keep or sells the property. Getting to a point where you can make that call requires some homework and planning. Between now and then, get a professional property manager in charge of the property and a few other people around you to assist in assessing the asset. Whether you keep or sell at the end of the day, this is a personal decision as much as a financial decision.
If you decide to sell, your next big decision will be reinvesting proceeds wisely. Consider hiring a Certified Financial Planner on a fee basis to provide you with quality guidance and investment advice that fits your circumstances.