How would you improve your cash flow with $1.2M in townhomes?

Question

Hey guys, my situation is a little tricky so I was wondering if I could get some input from you all. This is kind of a “what would you do” question. Thanks for reading!Current situation:

I have five townhomes in the Minnesota suburbs that are fully paid off. They each have a market value of about $250k with a cap rate of about 5%. Currently these homes are all handled by a local management company over the past 10+ years and they've done a great job with lower than 5% vacancy rate. The rent from these properties are paying for my parents retirement. Some of these are in my name, one in my father's name, and one in wife's name. I report the earnings of all these properties as my personal income. I created a solo LLC last summer with the intention of asset protection and reducing taxes but I have no clue what I'm doing. I actually have a call with WealthAbility next week to see if they can help.

For the past 10 years I’ve lived in Singapore and the management company in Minnesota has done well for me so I trust them. I’ve only purchased property when I was in town with the help of a couple of trustworthy realtors. Now I will be moving to Switzerland for the foreseeable future and will need to be remote again.

My goal:

I would like to increase the cap rate to 10% to help fund my parents’ retirement since they are my dependents. I was thinking one course of action is to sell off these townhomes and buy quadplex properties through a 1031 exchange.

I’m not sure if this is the best course of action and I’m sure there are other options. I’ve no clue how to do this and never attempted.

Given my situation of living abroad and a $1.2M+ portfolio in Minnesota, what would you do? What would you do with the LLC structure and taxes?

Any comments and thoughts are welcome!

Noah Chappell · Answer

@Bill Zhou I also recommend @John Woodrich for taxes. He may also recommend good attorneys to work with. I'm fearful you'll run into the conundrum we're all facing right now, namely the best time to sell is the worst time to buy. Without razor sharp local knowledge, I'd be concerned you'd eat the capital gains or settle for a sub par asset if you're going the 1031 route. 10 cap properties are out there though possibly in less desirable peripheral markets, and likely requiring you/ a carefully chosen team to be local for some time to stabilize and put management in place. Investing as a money partner or limited partner in syndication doesn't sound bad, but depends entirely on your partner or GP. Honestly, 5 payed off townhouses are cash flowing well, and as I understand it they're affording your parents retirement. I might not rock the boat here.

I agree about liability protection at some point, you might get an attorney to clean things up with your LLC, quitclaim deed the properties in, etc.

Tim Swierczek · Answer

@Bill Zhou I would recommend you get your tax advice from @John Woodrich

For investing, I like sticking with what is working.  Since you will be out of the country the property manager will be important to your success and for that reason, I would stick with properties in their wheelhouse.

Bonnie Griffin Kaake · Answer

@Bill Zhou You asked about how to improve your cash-flow. If you haven't considered cost segregation on each of these properties,we need to talk. You have about 6% to 10% of what you paid for each of these in available after-tax cash-flow. Also, if you do a cost seg study on the property in your father's name and he passes, you can do another study when the property is in your name with no "recapture". You are likely looking at a minimum of about $75,000 in cash-flow with the 5 townhomes. Of course, it depends on how long you and your dad have owned them and how much you have put into capital improvements over that time. I would be happy to give you more information, answer questions and get you an estimate for you at no cost.

James Hamling · Answer

A credit union is not likely to be a good fit unless they are doing portfolio lending, and even then.

When get up to the Commercial Financing level, it's more similar to shopping for a GC, than like shopping for a mortgage. It's best to build a Portfolio Packet with a business plan prospectus, and to have the MAI Appraisal as supporting documentation for valuation points. You take that and you "shop" for your best financing, hitting up 20/30 professional commercial lenders. Than you take your best 3/6 offers and shoot back to them a request for their best competitive offer, state what your best current offer in hand is and ask if they can beat it. It's all about presentation, when they see an MAI appraisal they know you KNOW your s#*t, and with the business plan for utilization of capital.

Commercial lenders are in the business of selling money, in very large amounts. The live in business lending, so they expect a business level presentation, professionalism, and negotiation. Play your cards right and you can find yourself with a commercial mortgage in the 2% range and with a million+ line of credit for cash acquisitions that is pre-set to roll into a portfolio commercial mortgage, replenishing that million+ line of credit. Credit unions can not compete with this.

You had asked what the best thing was to do with your standing, I have detailed what is "BEST" thing to do, I make no arguments that is far from easiest, simplest or most known or written about, what matters is it's worth it.

John Woodrich · Answer

@Bill Zhou setup a consultation with @Brad Schaeppi at https://minnesotalandlordlaw.c... and he can discuss your options with you.

Eric James · Answer

Ideally you could refi your existing properties and use the funds as downpayment for new properties. However, I don't know how your current properties would cash flow with mortgage payments.

Tony Kim · Answer

LLC is probably not going to do much for you. I'm also pretty lukewarm on WealthAbility. Admittedly, I don't know much about them, but considering the kind of steep fees they charge, I'm pretty skeptical they can provide any better advice than some of the seasoned CPA's here on BP such as  @Linda Weygant, @Michael Plaks or @natalie kolodij (I know I'm leaving out a lot of other very talented BP CPA's). Also, any specific tax related question can be posted on the tax forum and you will get very good answers.

At a high level, it appears that you just need higher yielding assets to which you can perform like-kind exchanges. That's the key, isn't it? All the other tax-related questions can be easily handled.....the hard part will be to find $2-5 million worth of property that will provide the kind of yield you are looking for. In today's yield-compressed environment, they are out there but it's not as if they can be easily acquired without some sweat and hustle. And you will also find that properties that yield double what you are currently getting come with more risk. There are a lot of TK companies that will claim you can earn double-digit RoRs on the stuff they're selling, but real world TK experiences are much different.

John Woodrich · Answer

Somewhat of a messy situation, your LLC isn't offering you much, if any protection if the properties are titled in your individual names.  For tax purposes - I am not sure how everyone acquired the properties but you shouldn't be reporting your parent's income on your return.  Also brings up the question of gifting issues if they gave the properties to you or if you are gifting them the cash flow.

Timing a 1031 is going to be hard.  You may first want to talk to an attorney about your LLC, deed transfers to get you protection, and if you have gifting issues.  The deed issues will create more problems if you are to sell so that is where you will want to start.

The thought of going to 4 plexs to double your "CAP" rate will also be tough.  Properties under 5 units are typically not valued based on CAP rate but I suspect that is just a metric you are using to compare assets.

Bill Zhou · Answer

@James Hamling, really appreciate the detailed sharing of your experience! I agree, I definitely have a lot of house keeping to do as a first step. I haven't ventured into the commercial side but what you've explained regarding the confusion and lack of information makes sense. I am now taking steps to find someone to help me with asset protection. I just reached out to a credit union today to see about financing.

James Hamling · Answer

@Bill Zhou The best answer to this is a 3 step item, as you have 3 issues here to address and NONE of them involve selling.

First item is a bit of house-keeping, your entity and taxation structure is a bit of a mess and you need to address that to best position for moving forward.

I would advise forming an irrevocable trust, placing properties into an LLC entity owned by the trust. This is step 1 which is called "Protection".

Step 2 is called "Empowerment". You have solid performing properties, MN market is on the continued rise and we are not touching the ceiling yet so why dump something that is a proven performer with equitable room to grow? Makes no sense. What you do is get private appraisal by a top certified group, namely with a MAI Certified Appraiser, to appraise all the properties as a singular holding. Very important this step be done exactly as this because your next going to use this for step 3

Step 3 "O.P.M." With the MAI appraisal completed you are now going to go shop Commercial Mortgage financing to get your best offer on it as a whole. You will seek a 50% LTV offering, and make these lenders bid against each other. Your head will spin with some of the offers you get, near free $.

Step 4 "Action Jackson" Now you have a not only about $700k in liquid cash, or more, sitting in an account but at same time you had conversation with the commercial lender on use of funds which was to expand portfolio holdings and they gave you a rpe-approval for $4m in commercial mortgage financing to add properties to. So now you retain a REI Realtor to help locate and get under contract cash-flowing deals with good equitable gains outlook, and put that capital to smart use.

Following this method it's very realistic that you could be sitting with a $10m portfolio in very short order, all doing minimum 5cap. It's a math game, using the properties to secure more properties unlocks expanded equitable gains but also creates more security of performance via volume scaling for items such as maintenance and vacancy rate because now if/when there is any of those costs is averaged out among 50+ properties vs 5, making for a much MUCH smaller % hit, there in best retaining cash-flow security.

I will say this is a level of professional performance very VERY few have any experience in. I am one of the few who doe's, what I reference here is from 1st hand experience, not theory or what was read or heard, this is something I have personally been involved with and am actively involved with regularly at this time, we call it a "Tuesday" in my brokerage, lol. And this is why you will find little direction of accuracy on this, there is very few of us at this next elevated level where things leave standard residential and venture into Commercial world where all the rules change, and that is where your at, and most likely why it seems confusing and with lack of information, it is going from one world too another.

-OR- you can keep on keeping on in the residential world, add one here and one there, sell a performer and pickup an over-priced maintenance time-bomb of a 4-plex. The ugly truth of it is Professional Landlord organizations are reallocating portfolios right now, dumbing garbage on market for MFH because it's known novice investors and novice realtors are snatching them up, and we just shake our head and make bet's on how long until we buy them back in default at 70 cents on the dollar. And than there is the 2nd "dead pool" on how many cents on the dollar it will be bought back at. I kid you not, lists are being made for follow-up in 24-48 months when a boiler goes out, or a new roof is needed and owners figure out there 6 cap time-bomb just got a bill for maintenance equivalent to 4 years profits, lol.

Cap rates mean NOTHING until cap-x is ACCURATLY calculated, in entirety. Why do you think MFH pro's are building new? Because they can dump there existing with mountains of deferred maintenance.

How would you improve your cash flow with $1.2M in townhomes?

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