Author Topic: Case Study – Paid off Rental – Significant Repairs Needed. Repair or sell??  (Read 2628 times)

robbinew

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Market Value:  $400,000-500,000? (In excellent condition, it would be 600+).
Original Purchase price: $215,000 (1997)
Term remaining: 0
Amount remaining on mortgage: $0
Gross Rents:  $52000/yr (10 small units, rarely vacant)
Taxes and Insurance: $15,200
HOA costs: 0
Deferred maintenance notes: YES!!
1.   Historic building in historic district (rental market is absolutely on fire right now).  Repairs (see below) require lengthy approval process and can probably be done over 3 years.
2.   City Assessments:
     a.   Need to fix replace box gutters/soffits, including decorative pieces, and maybe parts of the roof infrastructure.  It’s a big project.  Let’s say this will cost 50k.
     b.   Fire escape needs replaced (20k ??).
     c.   Assorted concrete and painting work (10K)
3.   My parents own this building (in their names).  They are retired and don’t want to deal with it anymore.  They want to sell – they weren’t happy with the letter from the city.  I fear this is a bit rash.
4.   I live near the property (and my parents) and want to take over management and oversee repairs.  I grew up in the neighborhood and think I have a good feel for the market, rents, etc.  I'm currently getting estimates and putting everything together to present to my parents and brother to make the final determination. 
5.   I also want to move the property to an LLC owned by my parents, ensure it flows through a living trust, etc.  I’ll run it and take a small salary.  Eventually my brother and I own 50/50.

Questions: 
1.   Seems like a no-brainer to do repairs and keep.  I think 100k is the max repair bill.  That’s high but still only 2 years of gross rents.  Right?
2.   Thoughts on paying for it?  We could self-fund with a loan (commercial equivalent of a HELOC?)  We could look for equity partners, etc.  I don't want my parents to cash out retirement accounts to do it.
3.   Thoughts on conversion to LLC?  I’ll have a lawyer set it up and work through the Operating Agreement - how should ownership be handled?  Up to my parents if they want to give us some, I suppose.  It's intertwined with their finances and I don't want to mess them up.

Thanks for reading!


Bearded Man

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What is the actual PROFIT from rents? After accounting for all expenses? That is the key thing you are missing before deciding if it is a "no brainer" or not. 52K gross rents is great, unless only 20K of it is profit. And putting 100K in repairs into the place has to be factored in as well. Can you get higher rents with the improvements to offset the costs? How much time do you have to spend on managing all of this? Could you get the nearly the same return with less risk and effort elsewhere?

Kouhri

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I would definitely fight to keep this property because :

A - I'm a sucker for historical buildings
B - I personally don't buy into the "what could I buy for more returns using the proceeds from this sale*
C - it's seems like you are willing and able to do/organise the work required
D - Its 10 units with great reliable occupancy so pretty safe
E - if the rental market in the area really is really on fire like you say then you might be under-rented at the moment, and almost certainly will be able to up rents following the improvements  (as long as it's not just invisible structural stuff that most tenants don't care about ) if the roof repairs make the building more pretty totally for the win.

However,  I think it's important to work out whether the building will ba able to turn a profit. If the (somewhat deferred ) maintenance plus the taxes and insurance you have listed are the only operating costs I agree it's a no brainer. But if there is likely to be other costs that you've missed or if these are likely to increase following improvements then it may not look so rosey in terms of cash flow. Otherwise, It's a great return on the capital you'll need to inject to get the building up to code assuming your estimated costs don't blow out big time. 

The only other note of warning I might put down  is that you said the rental market is booming right now, are you confident that the long term prospects of the area are good?

Please let us know what you all decide :)

former player

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You don't say anything about day to day expenses, but with a paid off and fully-let building I'd be surprised if it weren't cash positive at least.  You also seem to be saying that $100k in repairs is worth $200k on the value, which looks like a bit of a no-brainer: it would be a 100% return on investment.

The personal side looks a bit more tricky.  From your point of view you like the building, want to manage it, live in the neighbourhood.  But you need to consider your parents' and brother's points of view.  For instance, what are your parents currently doing with their $52k per annum income from this building?  How important to their finances is it?  Do they need/want available capital more than income, or income more than capital?  And your brother: how does he feel about this building and about your potential inheritance from your parents?

My suggestion would be that you work up a proper business case to put to your parents, copied to your brother, setting out the financial benefits of renovating and keeping the building, and offering to manage the repairs and on-going management on a professional basis as a side-hustle to your main job.

Then recognise that in the end the decision is up to your parents, that if they want to sell that is up to them, and that good family relationships are worth far more to you than any one building, however historic.

adamcollin

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Selling the property will be  a better idea.

robbinew

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What is the actual PROFIT from rents? After accounting for all expenses? That is the key thing you are missing before deciding if it is a "no brainer" or not. 52K gross rents is great, unless only 20K of it is profit. And putting 100K in repairs into the place has to be factored in as well. Can you get higher rents with the improvements to offset the costs? How much time do you have to spend on managing all of this? Could you get the nearly the same return with less risk and effort elsewhere?

Thanks for the feedback - here are the details from the tax return:

Gross Rent    $52,630.00
Auto/Travel    $280.00
Cleaning/Maintenance    $1,726.00
Commissions    $-   
Insurance    $2,263.00
Legal/Prof Fees    $10.00
Mgmt Fees    $-   
Mortgage Interest Pd    $215.00
Other interest    $-   
Repairs    $9,027.00
Supplies    $294.00
Taxes    $12,936.00
Utilities    $4,062.00
Depreciation Expense or Depletion    $8,184.00
Other Expenses    $1,084.00
Total Expenses    $40,081.00
Income    $12,549.00

Thanks!

jwright

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You may want to look at the Historic Rehabilitation Tax Credit.  You could qualify for 20% federal credit on a residential rental property and I believe most states (all?) have a state income tax credit as well.  My state has a 10% credit, a neighboring state has a 25% credit.  We also have local property tax incentives on historic buildings as well.   If you can't use the tax credits, you may be able to sell them to an investor depending on the circumstances. 

zephyr911

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Those taxes are a bitch!

I don't think I saw an answer on whether rents could be increased post-repairs. We bought a duplex last year for $70K in Huntsville AL and after putting a few thousand bucks (let's say our labor made it $10K) into one side, we moved the rent from $450 to $600, and then $625 with a cheap w/d set for an effective 21% ROI on those repairs.

There should be something like that for you in this deal. This sounds like an okay rental property with its current financials. Sinking six figures into it should improve the outlook by at least several thousand a year just to keep the return level.

robbinew

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Those taxes are a bitch!

I don't think I saw an answer on whether rents could be increased post-repairs. We bought a duplex last year for $70K in Huntsville AL and after putting a few thousand bucks (let's say our labor made it $10K) into one side, we moved the rent from $450 to $600, and then $625 with a cheap w/d set for an effective 21% ROI on those repairs.

There should be something like that for you in this deal. This sounds like an okay rental property with its current financials. Sinking six figures into it should improve the outlook by at least several thousand a year just to keep the return level.

Whenever someone moves out we increase the rent - this year's gross rent will probably end up at 54 or 55K.

Thanks!

Bearded Man

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What is the actual PROFIT from rents? After accounting for all expenses? That is the key thing you are missing before deciding if it is a "no brainer" or not. 52K gross rents is great, unless only 20K of it is profit. And putting 100K in repairs into the place has to be factored in as well. Can you get higher rents with the improvements to offset the costs? How much time do you have to spend on managing all of this? Could you get the nearly the same return with less risk and effort elsewhere?

Thanks for the feedback - here are the details from the tax return:

Gross Rent    $52,630.00
Auto/Travel    $280.00
Cleaning/Maintenance    $1,726.00
Commissions    $-   
Insurance    $2,263.00
Legal/Prof Fees    $10.00
Mgmt Fees    $-   
Mortgage Interest Pd    $215.00
Other interest    $-   
Repairs    $9,027.00
Supplies    $294.00
Taxes    $12,936.00
Utilities    $4,062.00
Depreciation Expense or Depletion    $8,184.00
Other Expenses    $1,084.00
Total Expenses    $40,081.00
Income    $12,549.00

Thanks!

So basically, you are earning 2% on your money: 13K profit/600K invested(value)...for a job...with a lot of risk...

You could buy two houses in the Midwest with the 100K you would spend on repairs, and have the same profit, with a FRACTION of the cost, effort and risk. This isn't a profitable investment worth the time. Not by a long shot.

It's rather obvious and simple to calculate whether it or not it is a profitable investment worth the time; are you sure you are going to be able to take on all these repairs and manage all these units, or is it possible that you are getting in over your head with something you don't understand? Not knowing what you don't know can hurt you.

I suggest starting out landlording on a much smaller scale, like a single family home to gain experience. I assure you, with 10 units, to earn 12K a year, you are going to really be hating life. I earn almost that from ONE rental worth about 150K, near Seattle, one of the worst places to be in the rental business.