As you purchase real estate assets for future success you have some basic planning issues to consider:
- Usually real estate investors establish an initial investment time frame for each investment, typically 5-10 years with a median hold time of seven years.
- This usually works off the initial purchase costs and gives you some time to improve the operation of the property and allow it to appreciate in value. With time and physical and managerial upgrades you can improve the prospects for consistent returns.
The Basics
Some of these upgrades might include:
Improving the Building
- Replacing roof and gutters,
- Completing a new paint job,
- Resurfacing the parking lot
- Repair of damaged siding,
- Improving the landscaping and site signage
- Replacing the HVAC units,\ With high energy efficient units
- Completing Interior property upgrades
Improving Management
- Increasing rents
- By reducing vacancy
- Reducing tenant turns
- Improving customer service
- Generating ancillary income
- Changing lease terms by increasing common area costs that tenants will pay
Set Exit Date
I recommend setting an exit date keyed to cash flow, expense and, appreciation of the asset and tax implications.
After the Basics
Once you have completed the basics and the investment is making a significant return and has appreciated in value, you have a few choices to make about the future of that specific investment:
- You can keep the property:
- This means you will most likely need to refinance at the end of your first loan term
- You will have to decide if you want to pay it off and if there are benefits to paying it off.)
- Refinance the property and use the proceeds to reinvest in a larger property
- Sell the property through use of a 1031 exchange and trade in to another property
- Sell the property and pay taxes and depreciation recapture.
- Gift shares of your property to loved ones or charity ( if you have an LLC)
Real estate investments, especially in the short term, don’t always make money. A number of issues can present themselves throughout the process, but it’s important to remember not to panic and sell the property too soon. Give yourself a chance to renovate the property, improve the occupancy rate and deal with the vagaries of the local economy. There could be external factors, such as the area’s real estate market, local employment and health of the area’s economy that are creating stumbling blocks for you.
For example – many years ago, we managed an apartment property that was located close to a freeway and jobs. That property was like a slot machine, we never had a vacancy. Not three miles away we had another property that ran a continuous 10 % vacancy rate, and had a hard time attracting quality tenants. You would think that three miles would not make a difference, but it did. (The same issues apply to commercial properties.)
The bottom line is that not all properties make money. If you make a mistake and buy the wrong property and you are not making money, try to see if you can fix it in less than twelve months. If that is not possible take your lumps and get out. If you can sell it for more that you purchased it for, you may want to wait to evade short term capital gains taxes. (These are higher than long term capital gains taxes, which apply after the first year – please confirm your particular situation with your CPA). Consult with real estate professionals and your CPA to understand what options you may have for selling the property or holding out for improved cash flow.
The Future
Imagine you are now at the end of your investment career. Your assets are all in a trust and you want to have your kids enjoy the fruits of your investments. You have many choices. First you need to establish if your heirs want the real estate investments, or just want the cash. If they want the real estate investments then you have to strategize five things:
- Which one of your heirs will take over from you?
- What is the operating/ownership structure of your entity in the event there are multiple heirs?
- Will all of the future heirs have a vote in decision making or will there be a leader/manager
- You may want to consider assigning a family leader ( though this may cause friction based on conflicting family needs)
- Do you need money from your investments till you pass?
- Do you want to give to charities?
- What are the tax implications?
Once you have considered these questions and assigned future leadership, what is the best course for your investment to take? Here are a few strategies we have used in the past that have seen success.
- Shift from residential properties to single tenant commercial properties for ease of management.
- You could invest in an UpReit and have the kids inherit the UpReit shares
- You could give to a charitable organization and create a generation skipping trust, so the grandkids get the money (to avoid some state taxes)
- Sell your assets and pay the taxes (not your best choice, especially if you sold assets and traded up over and over again using 1031 exchanges.)
OR … leave well enough alone and have them figure it out after you die. ( At over $10,500,000 in estate value, combined federal estate taxes kick in; in many states, estate taxes start at over $1,000,000 so the tax hit is not huge if your estate tax is under $10,500,000.( Every case is different – please check with your CPA and estate Attorney so this is not a bad idea.)
Summary
As you plan ahead you need to always plan on your final exit from your real estate investments. As your need for cash and your desire to manage the details of your real estate empire diminishes (it may or may not), you need to simplify your decision making. The more assets you have the more confusing the variables. At that stage you may only want a pain-free check every month. Worrying about tenant retention and the health of your investments should eventually become a job for the next generation. You want to reach this point but it takes years of skilled planning to position yourself, your family and your investments for future success. So, don’t wait until the last minute to reposition your portfolio, include these decisions in your long range planning and your life will be much easier and less stressful.
Clifford A. Hockley is President of Bluestone & Hockley Real Estate Services, greater Portland’s full service real estate brokerage and property management company. He is a Certified Property Manager and has achieved his Certified Commercial Investment Member designation (CCIM). Bluestone & Hockley Real Estate Services is an Accredited Management Organization (AMO) by the Institute of Real Estate Management (IREM).