Poll

Should I buy out my parents rentals for $900k?

Buy parents rentals! $0 money down your crazy not to!
3 (42.9%)
100% leverage is way too risky! I would never do this!
4 (57.1%)

Total Members Voted: 7

Voting closed: April 09, 2023, 12:31:35 AM

Author Topic: Should I buy out my parents rentals?  (Read 1500 times)

Swish

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Should I buy out my parents rentals?
« on: March 09, 2023, 11:31:35 PM »
Hey everyone! Its been a while since my last update so here is the current opportunity that has come up.

My SO asked me to not buy any more real estate for the rest of 2022 after we closed the two duplexes and apartments but it is now 2023 is a new year and new opportunities exciting. Currently we are working on the purchase of a commercial property with a partner that is chewing up all of my cash available for down payments that we are set to close within the month.

Wouldn't you know it my parents come along in the middle of all that and informed me they are considering getting out of the their rental properties as they are in/near retirement. Currently they own 5 with gross rents of ~$106k per year. Of the five properties 3 of them are 100 year old homes. Typically I tend to shy away from these unless they have abnormally good returns and stick to 1970's or newer construction.

They indicated they are hoping to sell them for $900k which at a 7% cap rate is a great deal. The issue is I don't really use cap rates and use ROE typically. For those of you who measure cap rates the worst year they have had on them places net income at $69.4k/.07 = $991.4k which I think is an ok deal in that sense. Two of the homes are in excellent shape and are a steal at $180k each but the other three are very mediocre at best at $180k each and being older homes if I was purchasing from a stranger I wouldn't probably consider them despite the potential for higher returns.

Those of you plugged in before know I think cap rate is a less than ideal measure when comparing new opportunities so the year one ROE I am estimating at 25% down, 5.5% interest rate and financing the DP at 8% interest only is the following: $69.4k - (225k *.08) - 36.3k (yr 1 Int) = 15.1 /225k= 6.7% using their worst years numbers. Now this is nothing to get excited over on its own but considering I would be putting $0 money down it makes me pause to consider it.

The fallacy in my ROE calculation is that I would be borrowing the DP from my parents and then paying it back when I refi the properties between years 7-10 so technically I would be increasing my net income using none of my own funds as a 100% leveraged deal so ROE is also not a good measure in a deal like this. This feels like a good opportunity but it does carry a fair amount of risk.

Pro's:
  • Helps parents with retirement income as they would get $1500/mo in interest payments from me until I refi and lumpsum pay them back
  • $0 money down to increase my portfolio a fair size
  • Two of the homes I am very interested in owning and fit the style of rentals I prefer
  • properties have been owned in family over 10+ years and maintenance and issues in all but one home are under control
  • three of the properties are multifamily
  • City currently is offering a grant (80% to max $15k) to update grandfathered nonconforming multiunit homes to meet bylaw this affects 2 of the older homes
  • known homes and long term tenants as I help my dad manage them today already
  • 4 of the houses are in great neighbourhoods
  • less than 3% historical vacancy rate
   

Cons
  • Lower returns than I normally expect out of older homes
  • will not take very much maintenance/renovation costs to eat up my $15k annual profits in first 5 years
  • Interest payments on $225k for potentially 10 years
  • a relative lives in one of the units and pays 40% below market rent and I suspect it would not go over well at thanksgiving if I raised rent or kicked them out. They do not maintain their space well.
  • outside my 25% debt to equity rule for new purchases
  • If I renovate the update the units to become conforming it will take ~one month each and I'd have to either find temporary accommodations for the tenants or evict them to take advantage of the grant
  • 3 of the homes are outside my ideal type of rental property
  • 100% leverage

I feel pretty indecisive on this one which is a tad odd for me so I am more than welcoming any holes to be poked in this chain of thought or opinions for or against!

Thanks for the read. I look forward to the discussion!
« Last Edit: March 09, 2023, 11:51:44 PM by Swish »

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Re: Should I buy out my parents rentals?
« Reply #1 on: March 10, 2023, 02:30:51 AM »
What are your parents' motivations?  Are they trying to get an easy exit?  Help you out?  Keep their real estate income without the management hassles?

Is there anyone else in your family that is going to be interested in this deal, want a slice of the pie, think you are getting an unfair advantage?

Can you take just the two that are your ideal and help your parents sell the others?  Take them all and sell the other three off quickly?  If you have to take the package are you going to resent the money and effort you have to put into the ones you don't really want and are they going to unbalance your real estate investments overall?

Look, you've obviously got the practical and financial sides of the real estate business sorted.  It's the family side that is the issue.

Freedomin5

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Re: Should I buy out my parents rentals?
« Reply #2 on: March 10, 2023, 06:46:14 AM »
Option 3: Only buy the two you want.

Swish

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Re: Should I buy out my parents rentals?
« Reply #3 on: March 10, 2023, 07:24:45 PM »
What are your parents' motivations?  They are approaching retirement and are sick of managing tenants & repairsAre they trying to get an easy exit? Forsure! Help you out? More they have seen how much my business has grown and I think they see I have energy they don't anymore Keep their real estate income without the management hassles? Yes I think they are very interested in having a bit of income from the properties without the hassle

Is there anyone else in your family that is going to be interested in this deal, want a slice of the pie, think you are getting an unfair advantage? Probably, no one else likes rentals they mostly see them as a big PIA but people sometimes complain about the results even though they never take the risks. The most important to me would be my one brother and I don't think he would care I should ask him.

Can you take just the two that are your ideal and help your parents sell the others? I think they pitched it as an all or nothing because they know the couple are great and the others are more challenging Take them all and sell the other three off quickly? This is an option that solves their problem by me just taking all 5 but then there is transactions x2 would be better if they just sold them off directly  If you have to take the package are you going to resent the money and effort you have to put into the ones you don't really want and are they going to unbalance your real estate investments overall? I don't think so after we passed 5 rentals I don't find the amount of effort has scaled proportionately. They would be a lot less work than a couple apartment's I have taken on that has turned into quite a labour of love that I really enjoy.

Look, you've obviously got the practical and financial sides of the real estate business sorted.  It's the family side that is the issue.

Thanks for the input. Ya I think the family dynamic is what is giving me pause.

Swish

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Re: Should I buy out my parents rentals?
« Reply #4 on: March 10, 2023, 07:25:35 PM »
Option 3: Only buy the two you want.

That would be ideal!

PMJL34

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Re: Should I buy out my parents rentals?
« Reply #5 on: March 11, 2023, 12:02:27 PM »
How much of a "deal" are your parents giving you? Like what do you think the combined appraisal would be for all 5?

Like others have said, keep/buy 2, sell/dump 3 is the goal. With that said, I can see how it would be in the parents' best interest to sell all 5 if you aren't going to buy all 5.

Best of luck!

Dicey

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Re: Should I buy out my parents rentals?
« Reply #6 on: March 11, 2023, 12:12:20 PM »
I just saw a mention recently of a loan type that's been kind of resurrected since mortgage rates have been rising. I'm vague on the details, but someone in the hive will know, I hope. Basically you structure the deal in such a way that spreads the seller's gain out over many years, softening their tax consequences. I think it's structured like an installment loan. I remember people doing them...last century...so I'm fuzzy on the specifics. Might be worth looking into.

Sibley

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Re: Should I buy out my parents rentals?
« Reply #7 on: March 11, 2023, 08:26:05 PM »
I just saw a mention recently of a loan type that's been kind of resurrected since mortgage rates have been rising. I'm vague on the details, but someone in the hive will know, I hope. Basically you structure the deal in such a way that spreads the seller's gain out over many years, softening their tax consequences. I think it's structured like an installment loan. I remember people doing them...last century...so I'm fuzzy on the specifics. Might be worth looking into.

seller financed loan is probably what you're thinking of. Personally, I'm way too lazy to go through all that hassle. I much prefer to just pay the mortgage and get a 1098 from the bank.

https://www.investopedia.com/articles/mortgages-real-estate/10/should-you-use-seller-financing.asp

Dicey

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Re: Should I buy out my parents rentals?
« Reply #8 on: March 11, 2023, 08:45:47 PM »
I just saw a mention recently of a loan type that's been kind of resurrected since mortgage rates have been rising. I'm vague on the details, but someone in the hive will know, I hope. Basically you structure the deal in such a way that spreads the seller's gain out over many years, softening their tax consequences. I think it's structured like an installment loan. I remember people doing them...last century...so I'm fuzzy on the specifics. Might be worth looking into.

seller financed loan is probably what you're thinking of. Personally, I'm way too lazy to go through all that hassle. I much prefer to just pay the mortgage and get a 1098 from the bank.

https://www.investopedia.com/articles/mortgages-real-estate/10/should-you-use-seller-financing.asp
It's definitely seller financed, but it's the way the loan is structured that benefits the seller. I'm going to pretend I didn't read the second sentence. It's almost like saying making coffee at home is too much hassle, so you're opting for Starbucks. I consider myself quite the sloth, but I try not to be where money is concerned. Also, if you buy one, two, or three (for example), the bank may tap you out. If you do a package deal with the seller, there's no one to answer to and you can buy as many as you want if he has a number of really desirable properties.

FINate

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Re: Should I buy out my parents rentals?
« Reply #9 on: March 11, 2023, 09:35:13 PM »
I say "no," but not because of leverage. You wouldn't even consider 3/5 of the units if not for this special situation, why set yourself up for frustration and regret? The family member at 40% below market rent is a hot mess of a problem to inherit. If your concerns about the older properties end up being true, you're likely to feel like you got the raw end of the deal. If something goes sideways and you can't make payments (sometimes shit outside our control happens) then your parents are screwed.

IMO, I would thank your parents for the offer but politely decline and encourage them to sell for the best price they can get on the open market, and wish them all the best in their retirement. No hard feelings. No "talking shop" at family functions. No future drama. Nice and clean.
« Last Edit: March 11, 2023, 09:37:25 PM by FINate »

406MtnFire

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Re: Should I buy out my parents rentals?
« Reply #10 on: March 16, 2023, 10:11:50 PM »
Offer to help them sell the less ideal 3 and take the good 2.

Sibley

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Re: Should I buy out my parents rentals?
« Reply #11 on: March 17, 2023, 08:11:52 PM »
I just saw a mention recently of a loan type that's been kind of resurrected since mortgage rates have been rising. I'm vague on the details, but someone in the hive will know, I hope. Basically you structure the deal in such a way that spreads the seller's gain out over many years, softening their tax consequences. I think it's structured like an installment loan. I remember people doing them...last century...so I'm fuzzy on the specifics. Might be worth looking into.

seller financed loan is probably what you're thinking of. Personally, I'm way too lazy to go through all that hassle. I much prefer to just pay the mortgage and get a 1098 from the bank.

https://www.investopedia.com/articles/mortgages-real-estate/10/should-you-use-seller-financing.asp
It's definitely seller financed, but it's the way the loan is structured that benefits the seller. I'm going to pretend I didn't read the second sentence. It's almost like saying making coffee at home is too much hassle, so you're opting for Starbucks. I consider myself quite the sloth, but I try not to be where money is concerned. Also, if you buy one, two, or three (for example), the bank may tap you out. If you do a package deal with the seller, there's no one to answer to and you can buy as many as you want if he has a number of really desirable properties.

I don't drink coffee, so no Starbucks. I also have zero interest in being a landlord, so the situations where it may be particularly advantageous will not occur for me. If in future I decide to sell my house and it makes a lot of sense to act as the bank, then I'll consider it, but everything has its price. Sometimes the money isn't worth the price.

former player

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Re: Should I buy out my parents rentals?
« Reply #12 on: March 17, 2023, 09:48:52 PM »
Offer to help them sell the less ideal 3 and take the good 2.
Except that means helping to sell the house that a relative is renting at 40% of market and doesn't maintain.  Guess who's going to get the blame once the house is sold and the relative evicted by the new owner?

Dicey

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Re: Should I buy out my parents rentals?
« Reply #13 on: March 18, 2023, 02:36:13 AM »
I just saw a mention recently of a loan type that's been kind of resurrected since mortgage rates have been rising. I'm vague on the details, but someone in the hive will know, I hope. Basically you structure the deal in such a way that spreads the seller's gain out over many years, softening their tax consequences. I think it's structured like an installment loan. I remember people doing them...last century...so I'm fuzzy on the specifics. Might be worth looking into.

seller financed loan is probably what you're thinking of. Personally, I'm way too lazy to go through all that hassle. I much prefer to just pay the mortgage and get a 1098 from the bank.

https://www.investopedia.com/articles/mortgages-real-estate/10/should-you-use-seller-financing.asp
It's definitely seller financed, but it's the way the loan is structured that benefits the seller. I'm going to pretend I didn't read the second sentence. It's almost like saying making coffee at home is too much hassle, so you're opting for Starbucks. I consider myself quite the sloth, but I try not to be where money is concerned. Also, if you buy one, two, or three (for example), the bank may tap you out. If you do a package deal with the seller, there's no one to answer to and you can buy as many as you want if he has a number of really desirable properties.

I don't drink coffee, so no Starbucks. I also have zero interest in being a landlord, so the situations where it may be particularly advantageous will not occur for me. If in future I decide to sell my house and it makes a lot of sense to act as the bank, then I'll consider it, but everything has its price. Sometimes the money isn't worth the price.
Sibley, nevermind. The article you quoted is not what I was thinking of, and I was using Starbucks as an example. I was trying to help the OP, and definitely not suggesting you become a landlord.

totoro

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Re: Should I buy out my parents rentals?
« Reply #14 on: March 18, 2023, 09:59:19 AM »
We have rental property and offered a similar buy-in for our young adult children, although they are still in university and can't do it yet. 

100% leverage is a gift if it it as a fixed term rate for a long-term loan, but is repayable at any time.  I don't view this as high risk myself in this situation as long as proper agreements are drawn up.

Your parents will benefit from this deal as well of course.  The interest is taxable income, but the principal portion is not, and will increase as time goes on.  This may be a better return than they will get from another safe-type low hassle investment of the capital, and they could structure the sale over a few years to deal with large capital gains.   Win:win.

There may be other ways in the US to do this and transfer to a family member - not sure - in Canada an adult child can be added onto a primary residence with no tax consequences, for example.

However, this has to make financial sense for you.  I would recommend doing up a spreadsheet for each property and running the numbers.  Make sure you evaluate the specific known risks and opportunities.   Then offer on the properties that make sense and allow flexibility for tax planning for them (ie. title transfer in a year they don't sell other properties).   

As a parent, I would be happy to have this type of offer come back to me.  If they are overwhelmed with selling the others, offer to assist them with the sale as part of the deal.

Swish

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Re: Should I buy out my parents rentals?
« Reply #15 on: March 18, 2023, 11:36:39 PM »
I say "no," but not because of leverage. You wouldn't even consider 3/5 of the units if not for this special situation, why set yourself up for frustration and regret? The family member at 40% below market rent is a hot mess of a problem to inherit. If your concerns about the older properties end up being true, you're likely to feel like you got the raw end of the deal. If something goes sideways and you can't make payments (sometimes shit outside our control happens) then your parents are screwed.

IMO, I would thank your parents for the offer but politely decline and encourage them to sell for the best price they can get on the open market, and wish them all the best in their retirement. No hard feelings. No "talking shop" at family functions. No future drama. Nice and clean.

Thanks for the input here. I listed these issues more because I can see the other people I am related too having issues with it if these problems ever reared their head. I definitely wouldn't lose sleep but it wouldn't help the perception amongst the family that I am a robot. I think this is the crux of my indecision is I can live with the math but the fuzzy issues are hard to quantify. I don't think either of us would feel like they got the raw end of the deal as I definitely don't see it as they are doing me a favour as I have a lot more rentals than they do. Maybe a better approach is to sell the three and then look to try and reinvest the funds to get properties more aligned with my strategy.
« Last Edit: March 19, 2023, 12:04:20 AM by Swish »

Swish

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Re: Should I buy out my parents rentals?
« Reply #16 on: March 18, 2023, 11:40:30 PM »
How much of a "deal" are your parents giving you? Like what do you think the combined appraisal would be for all 5?

Like others have said, keep/buy 2, sell/dump 3 is the goal. With that said, I can see how it would be in the parents' best interest to sell all 5 if you aren't going to buy all 5.

Best of luck!

I think the 3 that are older would sell for $180k less realtor fees and the two I am interested in easily $250k+ maybe even more. Realtor fees in our area would run them ($6kx5)+(.03x540k)=$46.2k so I think I am netting out approximately 140k ahead and they are $90k behind.

Swish

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Re: Should I buy out my parents rentals?
« Reply #17 on: March 18, 2023, 11:54:02 PM »
We have rental property and offered a similar buy-in for our young adult children, although they are still in university and can't do it yet. 

100% leverage is a gift if it it as a fixed term rate for a long-term loan, but is repayable at any time.  I don't view this as high risk myself in this situation as long as proper agreements are drawn up.This is really interesting as I also do not see a ton of risk between myself and my parents. Even financially if there was trouble with it my other business interests could make them whole.

Your parents will benefit from this deal as well of course.  The interest is taxable income, but the principal portion is not, and will increase as time goes on.  This may be a better return than they will get from another safe-type low hassle investment of the capital, and they could structure the sale over a few years to deal with large capital gains.   Win:win. Yes agreed. They proposed it as me doing a refinance some day to buy them out but I believe they are hopeful that I just never buy them out and continue to give them income every month through  their retirement.

There may be other ways in the US to do this and transfer to a family member - not sure - in Canada an adult child can be added onto a primary residence with no tax consequences, for example. I am in Canada and we actually already did this with their primary home. Technically I own it on paper but they pay for everything related to it. $0 probate on it when they pass someday and if the current government is successful on removing the primary residence capital gains exemption we will avoid an expensive bill in the event of a disposition.

However, this has to make financial sense for you.  I would recommend doing up a spreadsheet for each property and running the numbers.  Make sure you evaluate the specific known risks and opportunities.   Then offer on the properties that make sense and allow flexibility for tax planning for them (ie. title transfer in a year they don't sell other properties).One idea I had was making the sales price the same as their purchase price then they could recover the difference through additional interest payments in the future. This would allow us to spread that gain over multiple tax years in the form of interest. I still need to run the math though as I suspect just biting the bullet on the capital gains now is the more favorable route.   

As a parent, I would be happy to have this type of offer come back to me.  If they are overwhelmed with selling the others, offer to assist them with the sale as part of the deal.This is good to hear from someone on the other side. The biggest draw for me is I feel like they have taught me a lot over the years and if I can provide some peace of mind for them going into retirement I would love to do that and the opportunity already aligns closely to what I am already doing just not exactly the way I have built out my business. I think this is what has made me seek out other advice as this feels like a more emotional decision and those types of decisions I usually just avoid them. I am more of a numbers guy.
« Last Edit: March 19, 2023, 12:05:52 AM by Swish »

Swish

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Re: Should I buy out my parents rentals?
« Reply #18 on: March 19, 2023, 12:03:01 AM »
Offer to help them sell the less ideal 3 and take the good 2.
Except that means helping to sell the house that a relative is renting at 40% of market and doesn't maintain.  Guess who's going to get the blame once the house is sold and the relative evicted by the new owner?

Yes I'd definitely be blamed and that wouldn't bother me. TBH I care kinda but not totally. Its more of "I care because they care" situation. This person has been gaining an advantage from their generosity but my parents have a strong sense of obligation to help them out and I don't think there is anything wrong with that.

totoro

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Re: Should I buy out my parents rentals?
« Reply #19 on: March 19, 2023, 06:58:50 PM »
>One idea I had was making the sales price the same as their purchase price then they could recover the difference through additional interest payments in the future.

Be careful.  Transfer for under market value to a family member can be deemed tax avoidance by CRA and could be reassessed at FMV.

Swish

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Re: Should I buy out my parents rentals?
« Reply #20 on: March 21, 2023, 12:13:05 AM »
@totoro Thanks for the caution. My suspicion is them paying a capital gain now would cost less than the interest income reported as revenue as the capital gain only 50% is added to their income as taxable whereas 100% of the interest income is taxable in their hands. I have not worked out the math on that to verify but paying the capital gains would definitely avoid those risks.
« Last Edit: March 21, 2023, 12:14:47 AM by Swish »

totoro

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Re: Should I buy out my parents rentals?
« Reply #21 on: March 21, 2023, 07:26:07 PM »
I'm not sure what you mean.  They will have interest income and a capital gains tax in the same year and interest income from an equivalent to mortgage going forward.  The capital gain is only 50% of 50%, but all of your other taxable income gets assessed at a higher rate - sometimes 50% - the year you have a CG. 

The good thing for them is that the return of principal is completely tax exempt (the equity paydown on the loan), and this grows over time.

I'd do a spreadsheet.