You inherit a home, what are you going to do with it?
Jason was twenty-five when he inherited a rental house from his grandmother.
She had written him into her Will and gifted him a rental home. Because it was after her death and they lived in a state without inheritance taxes, there was no capital gains tax, estate or inheritance tax. He was surprised and flummoxed. What was he going to do? Sell the house, rent the house? Rent rooms in the house? Let his Sister stay in the home?
He turned to his mom who was a real estate broker, “Mom what do I do?”.
She answered, “ Your grandmother gifted you $50,000 for upkeep of the house, maybe you hire a property inspector to see what you need to do to make repairs that she may not have made, update the house and paint the inside and outside.”
Jason liked that idea, so he hired Margaret, a property inspector, to analyze the house. It was twenty-five years old. It had 3 bedrooms and two baths, a basement and a garage and stretched over 1600 square feet. (See sample inspection link below courtesy of TotalHomeInspection.com.) https://www.totalhomeinspection.com/totalhomeinspectionchecklist.pdf
Margaret pointed out the water in the basement, the leaking roof and the flaking exterior pain and the dated interior conditions. She also gave him the names of three vendors who could help him clean everything up.
He was stressed out and called his mom again. “Mom the repairs are going to cost a lot!!” She answered, “It’s the best investment in your future you will ever make.”. He bit the bullet, interviewed the contractors and picked the one that seemed to be the most sensible and efficient.
Two months later the renovation was done.
Preparing to Own a rental
He had interviewed property managers before they fixed up the house and they said that in its current condition, it could rent for $1600 a month. Once the house was fixed up the number increased to $2500 a month. That made him happy and so he agreed to rent the house.
Forming an LLC
As he was working through the process, the property manager asked him if he had a Limited Liability Corporation,( LLC) to hold the property in. He did not, but it seemed like a good idea to him. He called a local attorney that agreed to prepare the LLC documents for him at a fixed price of $1500. That attorney also recommended a CPA to help him get his EIN Number, prepare taxes and make sure he was getting 1099’s from the property manager and was in compliance with local and federal tax laws.
He felt prepared now that he had an LLC, but he was still very nervous. This was his first major investment. He had heard a lot of war stories. Mostly from people renting to brothers and sisters and friends and then getting back a property that had been completely destroyed. He knew he wanted the property manager to deal with this as an arm’s length transaction and not rent to friends.
He also knew that if he sold it in the first year of ownership, he’d have a short-term capital gains problem and that he would have to wait at least another year in order to have any proceeds taxed with a lower tax rate applying the long-term capital gains rules.
His goal was to hold on to the property for 10 years, take advantage of the appreciation, refinance then buy another house and then he’d have two rentals. He understood that typical expenses or approximately 40 to 50% of income so best case he’d be making about 1000 bucks a month.
He believed that he needed to have significant reserves for other repairs and tenant turns as time went on. It would take some time to save at least one to two years’ worth of reserves to offset additional operating expenses.
He was pleased that he found a good property manager who was going to send him monthly reports, be responsible for renting the house to tenants, choosing and selecting tenants and handling the midnight emergency calls. It meant that he could go back to school to finish his college education and create a revenue stream from his new investment once he finished college.
This created a jump start for him, to start studying some real estate investment techniques and finance and accounting so that he could be thoughtful as he made future investment decisions. Moreover, as a 25-year-old this gave him a head start on his retirement and his meeting his investment goals.
He called his mom and said “Mom I’ve hired a property manager. I’m renting the house, it looks great. You will be proud of me.” Of course, she agreed with him. His father was also pleased because it was an opportunity for him to start investing early and candidly make some mistakes with a small investment that he could use to form his decisions on larger real estate investments in the future.
Summary
The key things to learn from his story
Don’t be afraid – Many people are afraid of investing. They think they will make mistakes and lose a lot of money. In fact, this can happen, but if you go slow and easy and take reasonable risks you can build a real estate empire.
Start small to gain experience – starting with a house or a smaller property means that if you make a mistake in judgement, you make a smaller mistake and you can work your way though the financial or decision-making impact. You can learn from your mistakes and ensure you are not making the same mistakes as you grow your portfolio.
Real estate can be a profitable investment – figuring out how to make money in different economic environments as a small investor, tends to give you the confidence you need to grow your future portfolio.
One of the reasons his grandmother had left her house was to prepare him for inheriting a larger portfolio of properties from his parents in the far, far future. This was just getting him to first base.
Clifford A. Hockley, CPM, CCIM, MBA
Cliff is a Certified Property Manager® (CPM) and a Certified Commercial Investment Member (CCIM). Cliff joined Bluestone and Hockley Real Estate Services 1986 and successfully merged that company with Criteria Properties in 2021.
He has extensive experience representing property owners in the sale and purchase of warehouse, office, and retail properties, as well as mobile home parks and residential properties. Cliff’s clients include financial institutions, government agencies, private investors and nonprofit organizations. He is a Senior Advisor for SVN | Bluestone.
Cliff holds an MBA from Willamette University and a BS in Political Science from Claremont McKenna College. He is a frequent contributor to industry newsletters and served as adjunct professor at Portland State University, where he taught real estate-related topics. Cliff is the author of two books, 21 Fables and Successful Real Estate Investing; Invest Wisely Avoid Costly Mistakes and Make Money, books that help investors navigate the rough shoals of real estate ownership. He is the managing member of a real estate consulting practice, Cliff Hockley Consulting, LLC., designed to help investors and commercial brokerage owners successfully navigate their businesses. He can be reached at 503-267-1909 or Cliffhockley@gmail.com.
This article is based on a summary of real stories.
