Inheriting Two Commercial Properties - Sell Both or Keep One?

[Carl Jung]

Hi,

Via a trust, I was given a choice to retain or sell two commercial properties one in Vancouver WA (multi tenant retail + freestanding bank building) and the other in Hillsboro OR (multi-tenant flex industrial).

Given the valuation of the two commercial properties and the fact that I need to split the estate 50/50 with another family member, I can only retain one property should I decide to do so. 

The Vancouver property is valued at about $4 million (6.25 CAP rate) If I keep the Vancouver property it would make up roughly 85% of my net worth, which doesn't fit any typical asset allocation model I know of. NOI is about $220K a year. Fully leased. A sale will generate capital gains taxes and depreciation recapture, however that expense will be shared with the other beneficiary as would any other estate expenses. There is no way to 1031 unless I convey the property to myself and hold for a year - in other words own it.

The Hillsboro property currently uses gross leases (without options) running into 2023. Currently non reimbursable expenses eat up a large portion of income. NOI is about 80K a year. To change leases and/or to re tenant will be a challenge/opportunity moving forward. A sale now is free of capital gain. Brokers indicate a potential owner/user may pay $2 - 2.3 million based on comparable sales in area, a premium of 500K - $800K over an investor using an income valuation ($1.5 million), however this buyer maybe harder to come by.

The biggest question my mind at the moment - Sell both properties or keep one and if I keep one, which one. Brokers are telling me if I want to sell, I need to do it immediately due to interest rates. I still haven't been able to determine the impact of the depreciation recapture (anybody know a good CPA?)  on the Vancouver property and it makes me nauseous to see the capital gains taxes (about $450K ) plus selling commission and excise tax evaporate into thin air. 

[Jason Turgeon]

So here you've got a $4M property and a $2M property and you're worried about $450k in capital gains taxes? Come ON, man! You've just won the lottery. Be grateful! The taxes are 7.5% of the total valuation. I would love to pay 7.5% taxes on that kind of money. Don't let taxes drive the decision. Plus, the taxes don't vanish into thin air. They come back around as paved roads, educated employees, clean air and water, world's largest military, etc. You're standing on the backs of other taxpayers. 

Interest rates are through the roof right now. I got quoted 8% today for an interest only cash-out refi from the same lender that gave me 4% in February. 30 year amortization is running 6.5-7% on residential investment properties, it was a full point lower or more 2 weeks ago. Assuming you own these properties free and clear, you can seller finance them for a reasonable interest rate while also saving a bit on capital gains if you structure it right. Seller financing will make the properties vastly more attractive to buyers and will help you sell fast at a good price. Just make the loan 20% cheaper than they can get from a bank and offer less hassle in terms of qualifying the buyer. Don't be greedy.

Unless you have some other use for the cash that is going to earn you more than the interest + capital gains savings combined, you might as well offer seller financing. I am not enough of a tax expert to calculate the savings, but maybe this article will help point you in the right direction.

Given that you haven't really expressed any desire to be in the commercial real estate business and that with interest rates and inflation both in conflict we're in for some unpredictable times, I'd sell them both. If the person you're splitting 50/50 with doesn't want to seller finance, keep the one that allows for seller financing and let the other one go. Heck, I might have a buyer for you at the right price and terms. Shoot me a PM. But don't be greedy. Offer them up at a 6.5 or 7 cap (or a bit lower cap rate with friendly financing terms) and just unload them. You don't want to be sitting on them for months and months in this environment.

[Michael K Gallagher]

@Carl Jung fantastic opportunity!  I don't know that there is really a right or wrong here...if it were me I'd be looking at keeping a property.  especially a commercial one.  because of that I'd be looking at the hilsboro property because it seems like its somewhat miss-managed at the moment with the lease structure, so there is upside once those leases are turned in 2023.   

However, what you really should ask is how do these results fit into your goals and your desires?  if taking the money and running or putting it into a different asset class is more interesting to you then go for that!  

[Scott Wolf]

@Carl Jung, where are you getting your capital gains tax information from.  If I remember correctly, if you're inheriting the properties, you get a stepped up basis, and there should be no capital gains from the sale.  Obviously consult a CPA.  Perhaps @Basit Siddiqi has some insight.

[Dave Foster]

@Carl Jung, Your flexibility with the 1031 is going to depend much on the nature of the trust.  It might be possible to dissolve the trust and distribute the property into you and the other heir's names as tenants in common.  At that point you could explore whether to sell both and use the 1031.  Or two sell one and use your share of the proceeds to purchase the other heir's interest in the property you would like to keep.  Definitely worth exploring the step up in basis for the trust as @Scott Wolf suggested.

[Carl Jung]

Quote from @Scott Wolf:

@Carl Jung, where are you getting your capital gains tax information from.  If I remember correctly, if you're inheriting the properties, you get a stepped up basis, and there should be no capital gains from the sale.  Obviously consult a CPA.  Perhaps @Basit Siddiqi has some insight.

 Unfortunately, one owner of the property passed in 2009 capping basis on half the property value at his date of death. The other owner passed in 2021 getting full step up. 

[Henry Clark]

@Carl Jung.  

Looked at your first post about 6 months ago.  Is this one of the properties?  

In that six months have you read all the posts, listened to all the podcasts, read all the books, gone to all the seminars, and also identified a mentor?  Basically have you become a commercial real estate expert?  

If this is 85% of your wealth then your around $2mm.  In that area is that $1mm house and $1mm 401k?

Do you plan to go down this track and become a commercial RE expert?

Do you have debt?

Are your kids about to go to college?

Are you near retirement?

Have you done a wealth management analysis for both risk management and return for your and your spouse?

Etc. Etc. 

Point- in this post you can’t convey all of the needed info and we can’t tell what you know or how you are interpreting it. 

Recommendation-  engage a wealth management professional.  Not a financial advisor.  Not a stock broker. Ask if they handle clients in the $2 mm and up level.

With that you get a TEAM. 

Good luck.

Back to the questions

Have you set up an llc?

Have you set up a trust?

Have all your assets ownership moved to that trust?

Are you and your spouses parents taken care of?

Do you have a health, life insurance, assisted living plan, etc

Did you establish a generational wealth plan?

If you keep an asset do you have a cost segregation study set up?  Timetable, it goes away 80/60/40/20 over the next years.  
How are your contracts?

Triple net?

The key is actually not the answer to these question, that is easy.  It’s knowing the questions that need asked 

Go get a team. 

[H. Jack Miller]

If they are good properties keep them both, every year you will pick up increases in rent and real estate is a great hedge against inflation, as well I would not look at CRE like you do a typical allocation in the equity markets.

[Paul Camuto]

Quote from @Carl Jung:

Hi,

Via a trust, I was given a choice to retain or sell two commercial properties one in Vancouver WA (multi tenant retail + freestanding bank building) and the other in Hillsboro OR (multi-tenant flex industrial).

Given the valuation of the two commercial properties and the fact that I need to split the estate 50/50 with another family member, I can only retain one property should I decide to do so. 

The Vancouver property is valued at about $4 million (6.25 CAP rate) If I keep the Vancouver property it would make up roughly 85% of my net worth, which doesn't fit any typical asset allocation model I know of. NOI is about $220K a year. Fully leased. A sale will generate capital gains taxes and depreciation recapture, however that expense will be shared with the other beneficiary as would any other estate expenses. There is no way to 1031 unless I convey the property to myself and hold for a year - in other words own it.

The Hillsboro property currently uses gross leases (without options) running into 2023. Currently non reimbursable expenses eat up a large portion of income. NOI is about 80K a year. To change leases and/or to re tenant will be a challenge/opportunity moving forward. A sale now is free of capital gain. Brokers indicate a potential owner/user may pay $2 - 2.3 million based on comparable sales in area, a premium of 500K - $800K over an investor using an income valuation ($1.5 million), however this buyer maybe harder to come by.

The biggest question my mind at the moment - Sell both properties or keep one and if I keep one, which one. Brokers are telling me if I want to sell, I need to do it immediately due to interest rates. I still haven't been able to determine the impact of the depreciation recapture (anybody know a good CPA?)  on the Vancouver property and it makes me nauseous to see the capital gains taxes (about $450K ) plus selling commission and excise tax evaporate into thin air. 

 Do you want to be a landlord? Seems like you know what you are doing with all the #'s you provided. Money isn't everything. It all depends what else you have in your life.

[Account Closed]

Non-residential commercial real estate is easy to own and, based on your apparent net worth, the income from these properties is decent. Unless you need a bolus of cash for some reason, I would keep them. You can always sell them later. 

[Drew Ogden]

Keep the bank, own it, 1031 it if you want to sell...  Who cares about diversification if it is a credit worthy tenant.

[Ronald Rohde]

The other way to examine is, if you were given the net proceeds in CASH today. Would you buy either of those properties? If the answer is no, then you must sell. Put it in the market, bonds, whatever, but unless its a perfect property, don't hold on to it because it was given to you.

Allocate your assets based on your goals, not the original form--no one keeps cash just because its a valid "investment."

[Shafi Noss]

@Carl Jung

Hi Carl, obviously the decision here depends on your priorities and values, what I think you're really looking for here is to get an outside perspective on how each decision might line up with those values, gather ideas you might not have considered, survey other people's opinions, and just generally try to move towards greater clarity on a complex decision. 

With that perspective, I'm going to throw out some thoughts and maybe some will stick. 

I see you're concerned about keeping a balanced portfolio, which sounds wise. If you have a lot of debt, then you don't have much equity, and your portfolio is still well diversified. On the other hand if you had low debt, you could refinance and invest the money you get, tax free (check with CPA), into a more diversified portfolio. So maybe you're in an okay spot there. Of course I'm just going off guesses here. 

Another thing to consider for your hold/sell decision: if you choose to hold, who controls the property between you and the other beneficiary? It sounds like you have decision making rights and would keep that if a property was held. I'll assume that for now, but if you'd have to have unanimous agreement, that would be a big point in favor of selling. 

In general what I see as the crux of the sell/hold decision is opportunity cost. A property to be held comes with a certain value profile of risk, management work, steady income, growth potential, tax savings potential, prestige if you care about that kind of thing, etc. 

For some upfront work and stress, you can convert that risk/income/work/growth/etc. value profile into a pile of cash minus switching costs. That pile of cash + some more upfront work and stress can then be converted into a different risk/income/work/growth/etc. value profile. I'll just call this a value profile.

If I were in your position, I'd try to get really clear on what the value profile is of each property, and then what alternate value profile you could create with the cash (doesn't have to be real estate), take into account the switching costs and switching risk, and decide which one you like better. 

Easier said than done, but perhaps some of that would be helpful to consider as you approach your decision.  

This also looks complex enough that some back and forth and something like a conversation or email exchange is probably a better information format for that since there are details that are both important, and difficult to type out without making the post inordinately long. I'm interested in this and would be open to it to bounce ideas around, but you might also consider hiring someone to give you focused time and expertise like another person mentioned. 

[Nikolas Engel]

@Carl Jung

Sell the Hillsboro and keep Vancouver.

Why? Hillsboro needs more work and attention but ultimately will attract the right-minded investor. Change in tenants, putting all on at least modified gross, better NNN leases will take time and effort. However, that is exactly where the beef is. These value-add opportunities are interesting for a lot of people, don't let your broker pressure you in selling fast.

Vancouver on the other hand looks like a stable property. I assume you would have minimal owner obligations at this point. However, do examine the leases in place and try to estimate if there will be a change in tenants coming up. The bank is for sure on NNN, how are the other multi-tenants doing?

In the end, what really matters is what you want. You could also sell Vancouver to invest in value-add properties like the HIllsboro where you need to do the heavy lifting while using the HIllsboro as a test run with comparably little money at stake since you own it already. This way you could scale but you also have a full time investor's job then :-)