Family Inherited Large Property in LA - How much is it worth?

11 Replies

My grandmother bought a minority share in a commercial property nearly 50 years ago. She passed on her shares to my mother and her siblings about 20 years ago. They together own 25% of a large commercial building in Commerce City, Los Angeles, CA. It has been paying them together $50k a year (take home) for the last decade. 

They want to sell now! What do you think it's worth? 

Here is my reasoning. On investments like this, you should expect a 6% to 10% return. That return will come in 2 parts: equity and income. Equity is just the value of the building/land. Income is of course what you get paid from rent. Let's assume that the equity will grow by 3% each year. That means 3% to 7% will come from income.
Now we do a little algebra ;-) 

Min: Income = 7% of Estate Value = 7% * Estate Value
Max: Income = 3% of Estate Value = 3% * Estate Value
Min: Value = Income / 7% = $12k / .07 = $171,400
Max: Value = Income / 3% = $12k / .03 = $400,000

So I would guess as much as $400 and as little as $170k. 

However, if you use an equity growth rate of 4.5% (which is the average return in LA over the last 50 years), the numbers change a lot!
Max: Value = Income / 1.5% = $12k / .015 = $800,000
So it could be as high as $800k for each share!

Definitely need a good real estate agent to help us, right? 

Updated about 1 year ago

I just realized that I used $12k as the income, not $50k. $12k is what my mom receives (25% of the $50k). Those numbers should be 4x'ed. Value is between $170k*4 and $800k*4, so $680k to $3200k.

@Andrew Erickson

Valuing commercial property is pretty straightforward once you understand NOI and cap rates. There is some local knowledge in there for what this type of property would trade at depending on a few things that are beyond the scope of this post. If you want to understand the value of the commercial property then you just need to know income minus expenses = Net operating income (NOI). Luckily, we have that 50k number. Now we just need the cap rate for the area which let's say is around a 5.

So here is my guess on value given the information I have. The NOI of 25% of this property is 50k. At a 5 cap that is worth 1M. This would make the total NOI of 100% of the investment 200k and worth 4M. The folks who own the other 75% could have the first right of refusal and a way of valuing the property, you need to check the documents related to the ownership.

@Andrew Erickson

First: It's not as simple as saying it's worth 25% of the total market value. You have to consider how the partnership is structured, how cash flow is distributed, how much control your interest has in the management of the property etc. it's not uncommon for there to be a considerable discount to the market value of a limited partners shares due to lack of control over the factors listed above and the inability to mortgage your portion separately. Does the property have a mortgages on it? Any person buying this would be subject to the existing debt stack.

Second: Simply saying you should expect a certain return for a property like this may not jive with the market. What kind of property is it? Retail and office have very different risk profiles. Who is your tenant? Is it Starbucks or is it some local attorney with 2 years left of his or her lease? Is it single tenant or multi-tenant?

I would talk with a reputable commercial broker in your area to explore the marketability of the shares and possibly hire a local appraiser with experience in partial interest valuation. An assignment like this would be more expensive than a traditional mortgage appraisal due to the added complexity of valuing the partial interest. I think the last one I did I charged about $4000.

I know companies that buy commercial real estate partial interests. They typically DO NOT pay market price.

In whatever structure your family has ownership in the docs usually spell out if someone dies or heirs inherits the interest what the buy out or sell options available are. Sometimes the other members have the right to buy the interest at a fixed price or by some other outlined evaluation process. Additionally the other owners sometimes have control and voting rights on who the purchaser of the shares can be and have final approval and say if they are approved or not.

It's all about the entity structure and what original docs said and any amendments since then.

The other part is if you are allowed to 1031 exchange your interest into another property or not? For that checking with a 1031 company now can make sense. If you cannot 1031 exchange the taxes can be really high as much as 50% of equity gain or more in some cases!

There can be long term capital gains tax, depreciation recapture, possible Medicare tax, and state income tax. Sometimes people have carryover losses they can take to help offset some if they do not 1031 exchange. That is a discussion for your tax professional to analyze the situation.

No legal advice given.      

Idk what it is worth but if it kicks out $200k cash flow annually, this has to be north of 1 mil imo..small empty lots in LA can be over 1 mil. Lee mentioned 4 mil, I bet it is closer to that than 400k. Good luck!

Commercial property such as this is valued based on financials and then, what a willing and able buyer is willing to pay. The way you are attempting to evaluate the property value is not quite accurate and as Joel stated, you really need to get some professional help here and consult your real estate attorney Tom go over the partnership docs. Those will stipulate how your 25% portion may be sold, transferred, distributed, etc.

Originally posted by @Parker Eberhard :

@Andrew Erickson I’ll give you $170k

There is no deal making in the forums, however, this is clearly intended to be funny so rather than remove the post, I’m going to vote for it! 
LOL!

@Lee Ripma and @Will Barnard and everyone else, thank you for your responses!

I just realized that I used $12k as the income, not $50k. $12k is what my mom receives (25% of the $50k). Those numbers should be 4x'ed. Value is between $170k*4 and $800k*4, so $680k to $3200k.

Yes, I agree that $50k income with a 5 cap would value it at $1mm. Is it as easy as just looking at the cap rate? 

Also, yes the by-laws of the partnership are very important. Unfortunately, them seem to have been lost in the last 50 years (or never even written). We have been working with a lawyer to figure that part out. 

You need to see if the other owners want to buy out the interest. Any other company that buys partial interests or an outside investor coming in is likely to pay much less than face value for it.