Does it make more sense to sell my commercial properties or keep earning monthly income off of them?
I have inherited 25 percent of five commercial properties which brings in $1,500 a month for me. If we sell the properties I could earn at least $500,000. By my calculations, it would take me more than 25 years to make that amount at $1,500 a month. The others want to keep the property for sentimental reasons, but I would rather have the cash. What would be the better thing to do?
You'll get this disclaimer from any fiduciary adviser: It all depends on a lot of other factors that would be uncovered with a comprehensive plan: your age, retirement time horizon, budget, risk tolerance, how you own the properties (in trust, partnerships, etc.), tax bracket, etc. But let's take a quick look at just the scenario you describe.
Suppose rather than spending the $1500/mo. you save it at 4% for 25 years. That would accumulate $772,000. Suppose also that you keep the property and it appreciates at 2.6%. That would equal $949,000 for the same period for a total of $1,732,319.
If you take the $500,000 you run the risk of frittering it away, losing some or even all of it to market risk, transaction costs & taxes. On the other hand, if you could invest that lump sum at 4% it would equal $1,332,978 in 25 years. At 6% it would grow to $2,145,935.
But to be fair, if we apply a 6% rate of return to the first scenario your total would be close to $2.0 mil. Scenario #1 also presumes rents would never increase. And the second option- selling at taking your $500,000 -doesn't take into account the income tax advantages of rental real estate: Approximately 2/3 of your rental income would be tax free.
Bottom line: This is a large enough asset to justify hiring a fiduciary planner to be sure that your ultimate choice makes sense.
Let's turn this problem around and look at it from the front. If you and your partners sell, you would pocket $500,000 and not owe much (if any) capital gains taxes since you just inherited.
So your challenge would be to invest that $500,000 to replicate a stream of $1,500 a month ($18,000 per year) in taxable income. That's 3.6% per year. Do you think you could do that? (I do.)
There is probably more than just a sentimental reason to hold on, though. Real estate appreciates over time. I have no idea how much your property might be worth in 10 years, but if it grew in value by a (modest) 3% per year, you would then have to make 6.6% per year with that $500,000 in order to match the total return on the property. This is the great unknown in your question. The average return to the stock market over the last 100 years or so is about 8%, before inflation and taxes; but as usual the short term is unpredictable.
Some of your decision will be based on other factors. Will you need access to a lot of money in case of an emergency? Do you and your partners (they sound like family members?) have disagreements that make you insecure about having all this value tied up and under their control? Is there a near-term prospect that the property might need major maintenance and thus wipe out your income for a few years? Would you rather not have your finances attached to those of other family members? Then you are better off not owning this partnership share. On the other hand, if you think the rental income is likely to rise over time and the location is such that it could grow in value, then you might be better off holding on.
The best thing to do is make a comparison to other investments. In order to do this you need to come up with a current yield on the property. $1,500 *12 = $18,000 a year in income. $18,000/$500,000 = 3.6%. 3.6% is a fairly low yield for commercial properties. In other words, if you can get the price you are looking for then these properties are priced attractively in your favor.
However, there are a lot of other things to consider before you sell the properties. Depending on how the properties are structured (trusts, LLC, Partnership) there will be a cost to unwinding these. Additionally, there will be other transactional costs as well. You will also want to do an analysis of the properties which would include how long the lease in place, credit quality of the tenants, if there is debt on the property etc.
With that being said, there are a number of different alternatives to simply selling the property outright or keeping it. I would suggest talking with an advisor about your options and coming up with the best plan for yourself and also the other beneficiaries.
There's much to consider in this decision. How is your 25% owned? What are your income needs currently and in the future? What is the cost basis in the property? Will the properties require any capital improvements or significant maintenance expense in the coming years? What percentage of your total net worth does your interest in the commercial properites represent? In and of itself, having income producing real estate of this type is a good portfolio diversifier. It's hard to give specific guidance without knowing more about your situation. One observation: keeping any investment solely for sentimental reasons isn't a smart strategy. Neither the building nor the market care one iota about your loyalty or sentiment.