Hold or Sell Property?

[Financial Dancer]

My mom is 64 and wondering if she should keep a 3-unit apartment in Los Angeles as her primary form of investment or if she should sell and diversify. Her main goal is to maintain financial independence without going back to work and she would like to pass on as large an inheritance as possible. Here are her details: Her Assets: 3-unit Property: Worth $1.3 million and if she sells she’ll have around $700,000 after taxes, fees and loan payoff. This property brings in around $15,000 in net profits per year. Assuming a 3% inflation, her equity is increasing by $39,000 per year. During the past 2 years, home prices have been dropping slightly. $110,000 in Stock $40,000 in Bonds and CD's $30,000/yr Pension Tax filing: Single If she retires at 66 she'll get $800/mo in Social Security, $1100 if she waits to 70. Should she sell the property and diversify into Stocks, REIT's, Bonds and commodities? She doesn't care so much about whether she owns or rents.

 

[haha]

My mom is 64 and wondering if she should keep a 3-unit apartment in Los Angeles as her primary form of investment or if she should sell and diversify. Her main goal is to maintain financial independence without going back to work and she would like to pass on as large an inheritance as possible. Here are her details: Her Assets: 3-unit Property: Worth $1.3 million and if she sells she’ll have around $700,000 after taxes, fees and loan payoff. This property brings in around $15,000 in net profits per year. Assuming a 3% inflation, her equity is increasing by $39,000 per year. During the past 2 years, home prices have been dropping slightly. $110,000 in Stock $40,000 in Bonds and CD's $30,000/yr Pension Tax filing: Single If she retires at 66 she'll get $800/mo in Social Security, $1100 if she waits to 70. Should she sell the property and diversify into Stocks, REIT's, Bonds and commodities? She doesn't care so much about whether she owns or rents.

Unless I missed it, you don't mention a home now. Does she live in her building?

How does she feel about managing it? Enjoy it? hate it? How is the neighborhood where the building sits? Is it trending up or down?

On a pure dollars and cents basis, she could clear $28,000 off the $700,000 from a building sale, if you trust the 4% assumption.

From your POV, there will be fewer headaches if she sells the building. Should management get tough for her at a poor spot in the housing market, taking care of it may well become your job.

Ha

 

[tryan]

Seems like a no brainer to sell ... clearing 15k on 700k is a mere 2.1% return. Use the 1.3M number and the return is even worst. I'ld be looking at rolling a peice of the take via a 1031 exchange so she can live free n'clear in a house/condo. The exchange would make part of the sale taxfree. If she lives in one unit 2 of the last 5 years she can shelter most - but not all - of the sale. Invest the rest - even CDs are paying 6% today.

No more managment/landlord headaches.

FWIW, the best I can pull with what I have left is 5% ... that's why I am still a seller. Add to the mix that property values are trending DOWN (because the run-up is unsustainable) and the answer is more obvious ... SELL.

 

[calmloki]

I vote hold. My reasoning is that as lending sources for less credit worthy and lower income folks dries up they come back into the rental fold. People who got into variable rate mortgages and lost their places become renters. Construction costs have been high and it has been cost effective to convert rental apartments into condos, so the stock of available apartments is low. Prognosis: low vacancy rate, increasing rent. Selling an asset that is looking like it's going into a more profitable phase for a lower (!) amount doesn't sound wise to me. Hang on for as long as she can handle the tenant issues and let the property appreciate. If she wants to pass on the largest inheritance possible that would argue for keeping the property as well rather than taking the tax hit now (inherit at the stepped up basis i believe).

 

[Financial Dancer]

I should have mentioned that Los Angeles rent control limits the yearly increase of rent to 5%. Also, I believe the housing bubble created a surplus of homes - since many people were speculating and buying homes as investments. Wouldn't these vacant homes eventually be rented out, thereby lowering rent prices? To answer a few of the above questions: My mom rents out a unit for herself. She doesn't mind managing the building herself.

 

[tryan]

Since she's in the building it becomes more of a quality of life issue. She should always be able shelter over half of the wad upon sale since it's a sale of the primary residence. Question is: why is she considering selling? Something has her thinking ... time to go.

If you planted the idea ... then back off. She's happy ... leave her alone.

If it's her idea, then I'ld sell.

FWIW I won't be in the residential rental bussiness at 65.

 

[Financial Dancer]

Since she's in the building it becomes more of a quality of life issue. She should always be able shelter over half of the wad upon sale since it's a sale of the primary residence. Question is: why is she considering selling? Something has her thinking ... time to go.

If you planted the idea ... then back off. She's happy ... leave her alone.

If it's her idea, then I'ld sell.

FWIW I won't be in the residential rental bussiness at 65.

Tryan,

It's a 3 unit and my mom lives in one of them. Wouldn't she only be able to shelter 1/3 of the property if that's the case?

I've been telling my mom that she should sell for a few years now. But she's a smart lady and gets feedback from others besides me; and ultimately, it's her choice. Now that everyone talks about the bubble, I wonder how low it's going to go. Maybe it has bottomed out already. I doubt it but it's hard to predict the market. But even if it has bottomed out, I wanted to know what all of you thought of this property as her main investment. I've been hearing a lot about asset allocation and reducing risk by investing in several non-correlated assets. I figure a big no-no is to have 80-90% of one's life earnings in a single property.

 

[tryan]

Well, her purchase price comes off the top then up to 250k (single filer assumed).

I am not an accountant ... but my guess is she'll max out the tax exemption.

 

[kcowan]

If the primary concern is asset allocation, then consider getting a HELOC and investing in other equities.

Also she might try putting it on the market to assess demand. She might catch an overextended speculator who now likes income-producing property. She might even continue to rent her unit from the new owner and get a discount for her property manager duties.

 

[Financial Dancer]

If the primary concern is asset allocation, then consider getting a HELOC and investing in other equities.

The problem I see with a HELOC is the high interest rates. The costs would wipe out any benefits of investing in another asset class. Even if she were to earn money by investing with a HELOC, the risks would be too high.

 

[tightasadrum]

My mom is 64 and wondering if she should keep a 3-unit apartment in Los Angeles as her primary form of investment or if she should sell and diversify. Her main goal is to maintain financial independence without going back to work and she would like to pass on as large an inheritance as possible. Here are her details: Her Assets: 3-unit Property: Worth $1.3 million and if she sells she’ll have around $700,000 after taxes, fees and loan payoff. This property brings in around $15,000 in net profits per year. Assuming a 3% inflation, her equity is increasing by $39,000 per year. During the past 2 years, home prices have been dropping slightly. $110,000 in Stock $40,000 in Bonds and CD's $30,000/yr Pension Tax filing: Single If she retires at 66 she'll get $800/mo in Social Security, $1100 if she waits to 70. Should she sell the property and diversify into Stocks, REIT's, Bonds and commodities? She doesn't care so much about whether she owns or rents.

I don't think it's all about ROI here. You stated that her goal is to "maintain financial independence" without going back to work. The key word is "maintain." That says to me that she is doing just fine right now, thank you very much. One concern over the long haul to me would be the location. If it's in an area you don't mind your mom living in, and you can project the same into the future, it will work.

Another issue, which you have not mentioned, but I wonder about, is how close are you to the apartment? Are you involved in any of the maintenance work? If so, are you bothered by this, or do you enjoy helping your mom on these occasions?

Her other goal was to leave you an inheritance. As someone mention earlier, the cost basis steps up at her death. That's a home run! Zero tax, except for that little problem called estate tax. Then you can sell it and invest it in whatever companies are still in business by then if that's what you want.

My advise? Listen to your mom, and help her do what SHE wants to do.

 

[honobob]

Unless she has a compelling desire to sell she wold be making a financial mistake to sell.
She’s got free rent $18,000yr(est). Net income $15,000. Appreciation (your figure) $39,000 = $72,000 added each year to the $1.3M!!
If she sold and netted $700K and paid cash for a condo I’m guessing she’d be buying $400-700K to get a decent place and then be paying increased property taxes of $4,000 to 7,000 a year. So she lost $15K income a year and $18,000 a year minimum in appreciation and added $4,000 increase in taxes. She needs to earn $37,000 a year on the leftover proceeds ($700,000- new home purchase) just to break even. Sounds like a lose/lose to me.
I’m guessing that she has actually seen 10% annual compounded appreciation. Purchase price in 1987, $200K, sound about right? 10% annual appreciation would put it at about $1.345M now. My CA appreciation has been 11% a year since 1986. So just 10 years from know her net rents could be $25,000 a month (3%annual) and the property could be worth $2.2M (5.5%) to $3.7M (11%) In 20 years when she’s only 84 the property could be worth $4-10M using the same figures with rents of $33,000 a month.
Even if she sold and rented at $18K a year with 3% increases and invested the $700K at 8% she’d only have $1.3M in 10 years and $2.4M in twenty years. Give me the $10,000,000 and monthly rents of $33,000 any day!

 

[Enuff2Eat]

honobob, you're a smart guy. for me personally, everytime i sold i made mistake. Had i hold everything i bought i probably am a little richer today, perhaps $300k to $450k richer...


enuff

 

[tryan]

yeah, forget the heloc ... rates are prohibitive (I've got 2).

I don't see double digit home prices appreciation, going forward, any more than I see double digit wage appreciation. The two cannot diverge forever (really doesn't matter where). I mean, where are these people working that they can afford 10k/mo for thier apartment (sorry hono ... somebody had to call you on that one)?

 

[honobob]

yeah, forget the heloc ... rates are prohibitive (I've got 2).

I don't see double digit home prices appreciation, going forward, any more than I see double digit wage appreciation. The two cannot diverge forever (really doesn't matter where). I mean, where are these people working that they can afford 10k/mo for thier apartment?

My mistake, I meant yearly and mixed it with my own rent projections 20 years from now. Actually it's about $28K NET annualy based on his 3% although historically its been more like 5% which would get Mom $42,000 a year net I paid $250mo in 1977 for a studio and I now get $1,000 mo for a similar studio. Rents in the 9 county Bay Area were just reported 9% up YOY.

Even if you don't believe that 30 year double digit will continue Mom (and her estate) still comes out a couple million ahead (at 5.5% appreciation)in only 20 years vs. selling now.

 

[tryan]

Yeah, if you can hold "forever" you'll do VERY well ... But if this cycle is anything like what I went thru in Boston (1989-1997) it'll be a decade before those 2005 highs are seen again. At the risk of repeating myself ... I wrote checks at 3 closings as a SELLER after holding the property 12 years.

Mom will be 74 ... still taking ~2% return on her largest asset. I just point out that it's still a nice time time to sell. Coming off an all time high AND taxes are the lowest we'll probably ever see (think Hillary)

 

[honobob]

Seems like a no brainer to sell ... clearing 15k on 700k is a mere 2.1% return. Use the 1.3M number and the return is even worst. I'ld be looking at rolling a peice of the take via a 1031 exchange so she can live free n'clear in a house/condo. The exchange would make part of the sale taxfree. If she lives in one unit 2 of the last 5 years she can shelter most - but not all - of the sale. Invest the rest - even CDs are paying 6% today.

Tryan
She's already living "free and clear" AND has $15K net income to boot(plus $39,000 a year in appreciation per OP) To do a 1031 exchange she has to buy a replacement RENTAL property. She still has to live somewhere and unless she's going to Thailand she'll be spending $1500 a month rent or $400,000 earmarked out of her $700,000 proceeds. $18,000 a year rental would require $450,000 nest egg to support (18K X 25 ).

So, $700,000 - $400,000(condo purchase) = $300,000 left. Now she has $5,000 property taxes plus at least $2400 condo fees for a total of $7,400.
Her $300,000 is earning her $18,000 (remember she had free home + $15,000 spending money) so now she has free house with $7,400 expenses out of her new $18,000 income that equals $10,600 spending money. And now her heirs will receive 3% appreciation on a $400K condo, $12,000 a year instead of $39,000!!!
What's her upside? Not dealing with 2 renters? I think she could buy alot of property management with the $4,600 yearly loss in income.

jberkman, are my financial estimates reasonably close?
Tryan, am I missing something?

 

[Financial Dancer]

The $15,000 she makes on the property per year includes her rent money, which means she clears around $3,000 per year after she pays rent. So assuming inflation of 3%, she is bringing in around $42,000 total per year after rent is paid, but the increase from inflation she doesn't get unless she HELOCs or sells.

Is it wrong to include inflation in the money she is earning on her property?

I wanted to answer a question posed earlier. I live far from my mom and I don't help her with maintenance.

Someone mentioned step-up basis on the property after she dies; but doesn't that also occur with a taxable investment account? That's what I've heard anyways.

The way I look at it is if she sells, she can diversify her property money. I've read from others that taking 4% out per year would be pretty safe, so that would give my mom over $30,000 per year. This is less than what she makes in inflationary increases, but in my mind it is much less risky. the housing market in CA is very unstable right now.

But I'm asking all of you because my mom wants other advise before she makes a decision.

 

[haha]

The $15,000 she makes on the property per year includes her rent money, which means she clears around $3,000 per year after she pays rent. So assuming inflation of 3%, she is bringing in around $42,000 total per year after rent is paid, but the increase from inflation she doesn't get unless she HELOCs or sells.

Is it wrong to include inflation in the money she is earning on her property?

I wanted to answer a question posed earlier. I live far from my mom and I don't help her with maintenance.

Someone mentioned step-up basis on the property after she dies; but doesn't that also occur with a taxable investment account? That's what I've heard anyways.

The way I look at it is if she sells, she can diversify her property money. I've read from others that taking 4% out per year would be pretty safe, so that would give my mom over $30,000 per year. This is less than what she makes in inflationary increases, but in my mind it is much less risky. the housing market in CA is very unstable right now.

But I'm asking all of you because my mom wants other advise before she makes a decision.

I think there are a lot of reasons to seek liquidity at her age, particularly as she is apparently alone as manager. It really depends on her. Would she rather stay in place, live the life she has grown accustomed to- or does she want to clear the decks for a more unfettered existence, possibly with more travel?

IMO, if she sees herself wanting to make a change anytime in the next 5 years or so, now could be a good time. Otherwise, nothing wrong with staying with a winning game, as she apparently does not need greater cash flow to fund her lifestyle.

Ha

 

[kcowan]

The problem I see with a HELOC is the high interest rates. The costs would wipe out any benefits of investing in another asset class. Even if she were to earn money by investing with a HELOC, the risks would be too high.

Then I think you just answered your own question. If the property values and HELOC interest rates cannot sustain an attempt at asset allocation, it would seem to be a time to test the resale market. Let her offer to stay there and have her rent reduced by her property manager duties. Then you can both breathe easier.

And if it doesn't sell, then you know this is just so many machinations. Remember that staying put also has some serious risks. At her age, rolling the dice on future rental property values seems to be more risky than warranted.

 

[Red Rover]

Also, I believe the housing bubble created a surplus of homes - since many people were speculating and buying homes as investments. Wouldn't these vacant homes eventually be rented out, thereby lowering rent prices?

I wouldn't worry too much about people speculating in LA renting their houses and competing with your mom's building because with the cost of housing in many parts of the city anyone who rents out their recently bought house probably won't make enough in rent to cover the house payment for long. Plus, in a lot of areas in LA, the houses and apartment buildings are in separate neighborhoods so there isn't a lot of overlap between the two.

It depends where in LA your mom's place is but if it's in a rent controlled area the property will likely get more valuable and renting probably won't be a problem in the future. If it's a rent controlled area it's likely in a desirable LA location.

Apartment buildings in LA will continue to be valuable as time goes on because it's cheaper to renovate there than build new and the competition is actually less there than in a lot of cities because demand usually stays pretty high. I would totally hold the rental property for as long as possible. If I could buy a rental property anywhere it would be in LA because demand is usually always high there.

 

[tryan]

The $15,000 she makes on the property per year includes her rent money, which means she clears around $3,000 per year after she pays rent.

WOW! THAT's rent control for you ... why on earth anybody would pay 1.3M for this is BEYOND ME. If she sold, would her unit also be rent controlled? If so she can have her cake and eat it too. Invest the 1.3M AND live in the same unit forever. This is a REAL NO BRAINER.

Any assumption about future price appreciation is a fairy tale ... and - therefore - should not be placed in the equation.

Yeah a 1031 exchange is not needed (the tax break comes with being a primary residence).

 

[honobob]

Tryan She will only have $700,000 to invest and she has to pay for housing out of that. In the SFbayarea an owner would not be able to keep their apartment after selling. Even if the new owner allowed her to stay and $1,000 a month is market she would still be looking at $2,700 a month rent payments in the future with the allowable 5% increases.

I'm thinking that a large portion of that $700,000 is fairytale appreciation. Most business decisions are based on anticipation of future events. Home appreciation can be anticipated. California urban areas have enjoyed double digit appreciation for over 40 years. The OP is lowballing this at 3% ($39,000). Why would think that there will be no appreciation in prices in LA? Do you also think rents will not increase?

The OP did not say if the other two units were at market. If not then there is a potential upside should those units become available and she could greatly increase her rents AND her market value of the property. The day she sells she forgoes these opportunities.

 

[haha]

The day she sells she forgoes these opportunities.

The way I read your posts is that there is never a good time to sell RE. The buyer is always right, the seller always wrong. How can that be? It implies a market permanently out of balance.

Ha

 

[tryan]

Tryan She will only have $700,000 to invest and she has to pay for housing out of that.

700k seems low ... not getting enough info from the OP. Max tax bracket is 36% then add CA state tax. Seems like she's loosing too much to taxes. Unless there's a mortgage ...

In the SFbayarea an owner would not be able to keep their apartment after selling. Even if the new owner allowed her to stay and $1,000 a month is market she would still be looking at $2,700 a month rent payments in the future with the allowable 5% increases.

5% rent increases are completely acceptable for her since she can park the wad - at no risk - and make a greater return. Bummer if she can't stay ... need to hear from the OP on that.

I'm thinking that a large portion of that $700,000 is fairytale appreciation. Most business decisions are based on anticipation of future events. Home appreciation can be anticipated. California urban areas have enjoyed double digit appreciation for over 40 years.

Loosers of this game are turning up every day ... that's why we have the mess we do.

The OP is lowballing this at 3% ($39,000). Why would think that there will be no appreciation in prices in LA? Do you also think rents will not increase?

Ah, because when you buy today at 1.3M you're looking at ~9K/MONTH NEGATIVE cashflow (depending on how you financed this beast). Rent control killed this deal.

The OP did not say if the other two units were at market. If not then there is a potential upside should those units become available and she could greatly increase her rents AND her market value of the property. The day she sells she forgoes these opportunities.

There are greater opportunities in CDs (even greater in a bond/stock fund). AND no need to wait.