Analyzing Returns on Properties held for 20+ Years

27 Replies

Hey all,

So my grandfather started investing in real estate over 30 years ago and has not sold a single property. I'm currently trying to analyze how well each of these properties performs year to year to see if any are worth selling or in need of some tlc to get them to perform better. Since many of the properties have been held for 20+ years, they have appreciated greatly and are owned free and clear, are there any different metrics to consider beyond things like CCR, IRR, NPV, etc.? And is there any reason why any of those metrics I mentioned shouldn't be used for properties held this long?

Don't over complicate things and get caught up in analysis paralysis.  All you need to know is what the current market is and does he want to exit. Return to date should have anything thing to do with it since you can't change the past.

Thanks for your response @Jim Pellerin ! Can you elaborate on what you mean by "what the current market is"? Do you essentially mean that if our market is around its peak and he wants to exit, then do so, otherwise don't?

When doing your calculations make sure you are using the present value of the properties in calculating returns. Because he has all properties paid off it is important that you take into consideration the opportunity value of that dead equity. You should be basing your returns on a minimum 10% return on equity before you calculate any possible cash flow from the property itself.

Attributing a return to your dead equity first will normally result in consuming all income from the property resulting in the property itself having negative cash flow. At this point in time all the properties, unless they are of a very low value, are most likely a liability having negative cash flow. Your grandfathers money would probably be better off moved out of real estate and into a more passive investment vehicle.

He could refinance to pull equity or, based on possible adjustment to the market, he could sell. Selling may  be his best financial decision at this time.

@Thomas S. that's a very thorough approach to it thank you!

I definitely didn't consider using the present value of the properties so that is useful to know, do you mean that for calculations like CCR to use the present value in place of the initial cash outlay you'd normally use to calculate it? I'm not sure I entirely understand what you mean about a return from dead equity will consume all income and cause cash flow to be negative. Can you expand on that please?

If updating the interior or exterior will allow you to increase rent and get paid back in "x" number of months, I would do it.

On the other hand if you have good solid tenants I wouldn't mess with anything.

Since your grandfather had these for 20 years some of the tenants may be due for a rate increase without any improvments

@Jim C. those are great trade-offs to consider, thank you!

Based on your original question, in your opinion is there a different approach you would suggest taking depending on the property type?

I don’t have any experience with commercial rentals yet and my residential is extremely limited. I didn’t want to offer residential if you only had commercial

@Austin Petrie I see you're in Los Angeles, Are the properties in LA or spread out across the United States? If the properties are in Los Angeles, Exit all of them immediately and let someone overpay in the current LA market, Then purchase an apartment complex at the Institutional grade that will deliver you a couple of million a year in cash flow.

When I worked in Private Equity and a new client showed up with over 20 million worth of debt free real estate spread out over 15 or more properties, It always surprised me that consolidation into one asset never came to mind. 

  

Austin the bigger thing to do here Is estate planning.. this is a gold mine.. I am sure you understand that..

so it really depends on where he lives and inheritant tax.. most folks like this want to hand this stuff down so you want to get with a good CPA and get your tax planning done.. makes not difference if its making 10% like @Thomas S. Is alluding to with huge valuations in Denver I suspect its not..  but with millions up millions of free and clear property don't go chasing yield.. no need to do that.. just make sure the estate does not get taxed to death..  If the long range goal is to hand it down  and there are multiple heirs.. maybe his vision is giving a property or two to each of them. And of course done correctly you get stepped up basis for tax purposes then you can sell and not pay huge gains.. although you will have to talk to CPA about recapture.. or you do what a lot of folks do and 1031.. or you just live with the comfort of knowing you have millions upon millions of free and clear real estate. your grand dad is one smart guy .. 

Don't just sell them - you will pay one hell of taxes.....1031 them into big multifamily which is performing really good......or have a potential to add value if you're in that business

there is such a wealth on knowledge in this thread and many many options for your situation, and they’re all right. 

Maybe your first step should be to figure out what YOUR long term or short term goals are and then figure a way to make the properties work towards those goals because you have so many really good options to work with. 

I don’t want this to sound morbid or cold but it’s another option for you.

Talk to your grandfather about bringing you in as a partner. This way when he passes you will not be stuck with inheritance tax. 

This is all great information thank you everyone! It is nice to know that there are a lot of different possibilities for a situation like this depending on what we want to achieve as the end result.

Be cautious about trading in these properties for “high return” properties.  These are paid off, proven properties, and may be on cruise control. Don’t let greed get rid of a good thing for the promise of higher returns.  Yes he/you can make more money with that equity, but he’s already achieved the goal... he won.

I'm not an expert on holds that long, but I strongly advise getting a CPA in on this for another reason. I'm pretty sure you need to start thinking about 1031 sooner than later because you can only depreciate the property for something like 27 years. I know for me, the depreciation goes a long way towards reducing my tax liabilities. 

I don't know how it works if a depreciated property gets passed down in inheritance though, whether the depreciation gets reset or what. Like I said, the CPA might be a good idea for more than just the previous reasons mentioned.

Hey Austin, To put some solid numbers together, I think you should have the places inspected, then appraised and inspect the books closely to determine past returns. Are there a lot of deferred maintenance, pending lawsuits, or nightmare tenants looming? If not, past returns should be a good indicator of future performance. I would recommend you be present with the inspector to get a feel for the places and determine how much you personally wish to be involved with them. Good luck, Gordon 

@Austin Petrie , So many folks with good ideas of what "they" would do.  Or advice on what "you" should do or exploring what "your" goals are.  But that is the absolute wrong approach.  Start with your Grandfather.  This guy is a STUD!!!!!

1. First of all he has a business model that has worked pretty darn well for him for a bunch of years so don't discard that quickly because of what some spreadsheet tells you about hypothetical/potential returns.  It's certainly fine to run your break even analysis on rent/repairs and market rent comparisons.  But those are things that fall under the umbrella of his current business plan.  But I'd be very cautious of pushing him out of his comfort zone for a few points of return.  It sounds like you and he have a good relationship.  Your turn will come.  

2. You know his business model.  What are his goals?  As @Jay Hinrichs said this is the perfect time to be thinking about estate planning.  But I wouldn't be too quick to get yourself on any kind of title or into any kind of entity right now.  As it stands these properties will get a huge bump in basis if your Grandfather owns when he dies.  Theres not much depreciation left and between recapture of depreciation and the appreciation from the Denver  market there more than a little gain that could be taxed heavily if not planned for in a good transitional estate scenario.

 3. That being said, if there are dogs in there that you and he agree would be better off gone then you're going to have to look to 1031 exchanges to avoid a horrendous tax hit that your grandfather has been avoiding for decades.  And doing a 1031 in this market at this time requires some very thoughtful and thorough due diligence to beat the scenario where he is right now.  Debt free 20year holds in Denver means that he was buying at the end of the RTC crisis and  right when telecom was just starting to lift Denver from the horrendous housing slump of 86 - 94.  Those properties could could sustain a massive hit to value and still deliver him a big chunk of gain simply by holding.  Your calculations using current value as @Thomas S. rightfully suggests will reveal a really crappy return on equity.  But my guess is that his cash on cash is pretty darn strong.

So put on his glasses and look at the property through those.  Your grandfather's done pretty well keeping it simple.  99.99% of the people reading these posts will never do what he has done!  Take some time listen to and absorb his thought process.

@Dave Foster

Please do me a favor and don't speak for 99.99% of the people on this site.  There are a lot of great investors with really valuable real estate experience on this site.   I do understand that there are tire kickers in here, but I see a lot of quality people on this site.  And while not all of us go through stuff other people do, it does not diminish people here.

I am a buy and hold investor,  and you will find there are a lot of people who will one day be in this situation.  And he asked, didn't he?

@Austin Petrie -  Stick to Jay Hinrich's post.  But, one other word of encouragement.  Analysis is actually a smart move.  Your doing analysis can teach you what a good return is versus a great one.  So I say, buy your grandfather (not father guys) lunch, and tell him you would like to analyze his investments in properties...to learn more about it.  Calculate his yearly return.  Look up market rents, and market prices for his properties.  Go at it.  Have fun with it.  And learn.  And then follow what Jay said. 

@David Moore , you are absolutely correct.  I didn't mean that to come across in a perjorative manner at all  only as a figure of speech indicating my admiration for the grandfather - not a comparison.  I could have said that better.  There's many paths to success and none is right for all. 

I was also speaking to myself - I sold a bunch of Denver property when I left - Boy do I wish I had known Grandfather then :)

Thanks , your advice to @Austin Petrie is right on and my apologies to everyone out there doing it.  Grandfather is someone we can look to as a great example of how one person worked his plan and made it work.

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