What would you do? Inheriting small portfolio...

Question

Hello everyone,

My name is Mark and I am a life-long Chicagoan. I come from a financial industry background, but am new to real estate investing and would like to start to get more involved in the industry. This post is the first step in my journey.

I'm in a position to inherit a small "portfolio" of rental/investment properties. I use the term, portfolio, loosely. My relatives own several single-family and multi-family properties in the city (Chicago) - they are not incorporated; they own them as individuals. These properties were accumulated over several decades and they are paid off, so effectively 100% equity.

My goal would be to continue to try to expand the portfolio by purchasing additional ones. My questions are:

1) Should I put them in a holding company/LLC?

2) What is the best way to leverage this equity?

a) one forum mentioned Home Equity Loans, but another suggests Cash-out Refi?

b) Are both possible in Illinois?

c) Are there any other suggestions?

For the experienced investors: what would do in this situation? Any feedback or suggestions would be greatly appreciated.

Thank  you,

Mark

Mark Ainley · Answer

@Mark N.  You have options but most anyones answer here should be "depends" because you have to account for liability and income tax situation and one choice might favor your curcumstances better then another.  With leverage you have options these days to get a blanket loan accross all of them for a longer fixed term so you have many options to explore there too.  I can refer you to a couple of lenders that can make sense or an attorney that can structure you properly.

Kendall S Jones · Answer

you may already know that when a property is inherited the basis is "stepped up" to the current market value. That is not true if they are gifted to you or transferred some other way. That means  you could maybe sell one of them and pay zero taxes and then use that money to update the others and/or purchase new ones.

Alternatively, you've essentially begun the BRRRR strategy, where rather than adding market value through rehab you've added value through decades of ownership and are now positioned to scale up. Take a look at David Greene's new book, just released, on the Buy, Rehab, Rent, Refinance, Repeat Strategy

Good luck - some exciting times ahead!

Henry Lazerow · Answer

Congratulations! As mentioned above check with accountant on tax situations first off. If these are 2-4 units you should be able to pull equity pretty easily on the first few through a cash out refinance with good terms 30 year, rates around 5-5.2% right now 2-4 units. If go over the conventional limits/# properties commercial blanket loans can be great option.

For expanding I put together below a brief what's hot right now for the north side.....

Type of building: 3 and 4 units cashflow much higher then 2 units. Brick or frame does not matter. Frame will cashflow slightly higher due to lower acquisition price but most people desire brick hence the premium. Coach houses are great you will see some 3 units front bulding + a 4th unit coach house. If it's a big enough coach house can get rents very high.

Neighborhoods....

Appreciation/rent growth: Avondale, Logan Square, Old Irving Park, Humboldt Park (North of North Ave.), Hermosa, Pilsen, Heart of Chicago, Little Village, Albany Park. These areas are all seeing strong growth/gentrification.

Higher yields out of class A: Roscoe Village and the West Lake View areas. I have helped clients do a few flips/BRRR's in these areas and it's awesome as the properties are cheaper then further east to buy as-is but tenants are all still class A and pay similar rents once rehabbed. West Town is also a good spot class A tenants strong demand at a decent cap.

Peter Halliday · Answer

You also need to talk to a good accountant too.  Between a lawyer and tax accountant you would get advise that's more tailored to your situation and goals.  Your strategy should be informed by your goals.  How rapid do you want to expand?  A conversation with several loan officers should give you some ideas on the different ways to access the equity.  Maybe a blanket loan through a portfolio lender.

Weston Couch · Answer

@Mark N. Hello Mark, just speaking to your first question from experience because I am not your attorney and cannot give legal advice here. We specialize in protecting real estate assets, and when I sit down with clients, I always discuss (1) their personal assets, and (2) what their current investments portfolio and other business ventures are before discussing (3) their future goals. Each of these variables will dramatically change the advice I give the individual asking me this question. Generally though, I break it down into the "five pillars" of protecting your assets.

The first pillar is avoiding unnecessary and risky activities (don't drink and drive, insurance generally won’t cover your poor decisions) and take good care of your investments(maintain your property, etc) - these simple steps will help you prevent lawsuits before they even occur.

The second pillar is a good insurance policy as that cover the majority of your exposure. However, insurance is limited because it only protects you from one type of liability: accidents/negligence. Insurance doesn’t protect you from any part of the sale or acquisition of a property (e.x. Somebody wanting to sue for you backing out of a bad deal or accusing you of selling them a property with defects like unknown termite damage). Insurance also doesn’t protect you from misunderstandings, especially those made in writing and email. What happens in these misunderstandings is that something goes wrong either in the sale or after, and then they sue you for some statement you made that they “misunderstood”. That lawsuit is a claim for fraud, and that’s what fraud typically is...a misunderstanding and someone being “injured” and wanting to hold the other responsible for it. Insurance never protects you from these kinds of claims and they happen all the time.

The third pillar applies after you have good insurance You need to protect yourself from what insurance doesn’t cover by compartmentalizing your assets. Compartmentalization means that if something happens to one property, people suing can’t touch you or the other properties. You should use either LLC’s (the old and expensive way) or a Series LLC (the new and more cost/time effective way). No matter where you live or where you own assets, I personally recommend the Series LLC to be a great tool for the individual investor who is planning to expand their operation, as it allows for you to scale infinitely for FREE. If you’re interested in using an LLC, this article  also further explains the advantages of a Series.

The fourth pillar is somewhat similar - you want to separate your operations from your assets. One company owns everything and does nothing (this is your SLLC a/k/a “asset holding company”) and a completely separate company handles all of your operations (this is a traditional LLC a/k/a “operating company”) For the operating company which serves as your face to the world and through which you do all your business, you establish a Traditional LLC to carry out the operations of your investments. The operating company takes on all of the liability that would otherwise blow back on you including: paying property management, paying contractors, collecting rent, marketing, etc.

The fifth pillar is owning everything anonymously. If people don’t know that you have assets, then they are less likely to sue because there’s no use in suing people that qualify for food stamps. This anonymity can be accomplished for free by using land trusts to own your companies as well as the assets. Trusts create this anonymity by removing your name from public record. Even if they can see you used to own a property, when properly transferred it will look like it was sold to investors. If they somehow guess you are the owner though, it still doesn’t matter because you would not be the owner. The land trust and the LLC are the owner of the asset/real estate, so even in the scenario that potential litigants guess, they would guess wrong.

Of course, these are principles that can vary in how useful they are for each real estate investor, but from what you've described, they could be very useful for you, given how you're anticipating multiple rental properties. From our experience,  real estate investors have a high chance of running into a legal issue that this type of protection can help with once they're renting multiple units over the course of 5-10 years. If you're interested in knowing more, please feel free to connect with and DM me.

George Skidis · Answer

If the owner's of the properties are not yet deceased get them to put the properties in Illinois Land Trusts. These avoid probate and help maintain privacy. It creates a blurred line between it was there's and now it is yours. Otherwise the title says from John Smith to Jim Smith and creates a searchable pattern in the county records.

Why do you need to borrow money against an asset that is paid for. The gravy train is running. Why give half of your profit to the bank in interest?

1. Have the properties professionally appraised at time of inheritance. That becomes your bases should you decide to sell them. Long term or short term does not matter. That is the basis at acquisition. Example property sells for $100,000. You have no appraisal then it is $100,000 of capital gains. Property appraised for 80K sells for 100K only 20K of capital gains.

2. The appraisals can serve a dual purpose in letting you refi them. If there is already and existing loan you should consider whether a new loan makes sense. Maybe the existing terms are better than you can get when that day comes.

3. You cannot get a home equity loan on a house you do not live in. Rentals are not your home. They are your investment.

4. My opinion LLC's are overrated. An S corp does the same thing and in Illinois they still cost less. Under the new Tax Cuts and Jobs Act the S-Corp also gets more favorable treatment.

5. You first line of defense in a liability claim is an insurance policy. Failure to adequately insure your risk can get the LLC set aside and the plaintiff can them go after your other assets. Get 1 Million in liability and another million or so as umbrella coverage.

6. Place the ownership of these Illinois properties in separate Illinois Land Trusts. For privacy and to avoid probate.

Alina Trigub · Answer

@Mark N.

Welcome to BP! Congrats on your inheritance!

We all can give you our opinion, but at the end of the day, your best bet to speak with a real estate attorney who is also a CPA that can provide guidance from both angles. This is because for example, you may  need to put it under WY LLC from legal position, but it may make sense to have it under Local LLC from tax position. This is not the right strategy, rather an example I'm using to demonstrate to you the importance of speaking with an expert in the area! Especially since this is out of your current expertise.

If you need some names, PM me.

Jacob Sampson · Answer

I think you have been given great advice that I, likely, can't improve upon.  That being, said I will advise under the "any other suggestions category".  The only question you need to act on right now is the business entity one.  Get that taken care of then spend the next year managing and getting to know your portfolio and the business in general.  Take your time.  You may find you hate this business.

Mark N. · Answer

Guys, thanks so much for your prompt replies and advice.

@ Mark Ainley - thanks a ton! I might take you up on the introductions, let me circle back please.

@ Henry Lazerow: really appreciate the brief - I'm currently based on the NW-side and have been thinking to start searching in that area: Irving Park, Portage Park, and even East Dunning have been on my radar, particularly for single-family rentals on the latter.

To offer a little more detail on my end.

The existing ownership is that all properties are currently owned by one individual. I will likely be the   sole proprietor, but I have considered naming one other relative as an  officer or member - I haven't crossed this bridge yet. We are still  discussing how to transfer titles? My relative's attorney is simply a family attorney and not a real estate specialist; same goes for the accountant.

The properties  consist of two 3br/2-story single-family homes; two 2-unit/2-story attached duplexes  w/3br each; and one 3-flat unit with 8br/total. All are brick construction,  no major repairs necessary, and have garages; all are located in the SW-side "Bungalow Belt" of Chicago.  Garage spots for the 3-unit are rented separately.

Rents for the properties are below market:  currently gross approx. $11,000/mo combined. I believe there is room to  increase rents for each unit. The 3-flat could use some updating, however.

My  goal is to leverage the equity of these properties to purchase  additional income-producing rentals: either single-family or  multi-family.

What would you do? Inheriting small portfolio...

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