Unwinding A Real Estate Rental Portfolio

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Hannibal Barca
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Unwinding A Real Estate Rental Portfolio

Post by Hannibal Barca »

Situation: I recently got married and so came into possession of a real estate rental property portfolio of ~$1M. It's comprised of 4 properties of roughly equal value. The real estate portfolio is managed way too conservatively (e.g., none of the properties have mortgages), and since it's managed by my in-laws that's not going to change. However, they're open to selling the portfolio off and reinvesting the proceeds in stocks. My wife and I would like to sell because (1) in this circumstance we think we can generate higher long term returns with stocks, and (2) this is way too much real estate concentration (~1/3 of the portfolio).

What can we do to limit our tax bill when we sell off the portfolio?

Some ideas I had:
-Sell one property a year to limit the gains subject to the higher tax rates
-Move into a rental property to get the $500k MFJ tax free capital gain at sale. I think we'd have to live there for two years

Other relevant data points:
-MFJ marginal income tax rate is 35% and LTCG rate is 15%
-We own our house; the mortgage at this point is ~35% LTV
-We have ~30 years until we expect to retire
-We have no desire to play landlord long term, but are OK doing it for a few years as we wind down the portfolio
Last edited by Hannibal Barca on Mon Sep 20, 2021 9:53 pm, edited 2 times in total.
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hand
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Re: Unwinding A Real Estate Rental Portfolio

Post by hand »

Are you committed to your current primary residence?

There may be a pathway to 1031 exchanging your rental properties into a new primary residence and eventually (5 yrs?) use the primary residence exemption....
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Re: Unwinding A Real Estate Rental Portfolio

Post by mtnlover »

I am surprised by the number of “I” statements in your post. If you recently married and this portfolio of properties is managed by your in-laws, I surmise the properties are owned not by you but by your spouse. Perhaps your spouse should be leading the decision-making on this, not you.
Piper59
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Re: Unwinding A Real Estate Rental Portfolio

Post by Piper59 »

Tread extremely carefully with your parents in law properties. This is coming from a Boglehead and Real Estate Investor.

Have they asked you to unwind the properties and liquidate?
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Re: Unwinding A Real Estate Rental Portfolio

Post by delamer »

grandmacassie wrote: Mon Sep 20, 2021 4:39 pm I am surprised by the number of “I” statements in your post. If you recently married and this portfolio of properties is managed by your in-laws, I surmise the properties are owned not by you but by your spouse. Perhaps your spouse should be leading the decision-making on this, not you.
My thoughts exactly.

Do any of these rentals actually belong to you?
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gclancer
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Re: Unwinding A Real Estate Rental Portfolio

Post by gclancer »

I would leave the in-laws business alone if I were you. They may be overly conservative for your taste, but they’ve managed to build a million dollar real estate portfolio so they must have some some financial savvy.
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Re: Unwinding A Real Estate Rental Portfolio

Post by 123 »

I would tread very carefully about properties owned by your spouse until you understand the full history of the properties. Were the properties individually selected and purchased by your spouse or were they gifted to or inherited by your spouse? There are a whole lot of family dynamics that I think you may be unaware of. Maintenance of family relationships can be one of the most difficult aspects of married life.
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Hannibal Barca
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Re: Unwinding A Real Estate Rental Portfolio

Post by Hannibal Barca »

hand wrote: Mon Sep 20, 2021 4:21 pm Are you committed to your current primary residence?

There may be a pathway to 1031 exchanging your rental properties into a new primary residence and eventually (5 yrs?) use the primary residence exemption....
I'd definitely like to learn more about this. Right now we live in a starter house to keep the overhead low, but we expect to eventually (call it in 3-6 years) move into a larger home. We don't have any great attachment to our current home.
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Hannibal Barca
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Re: Unwinding A Real Estate Rental Portfolio

Post by Hannibal Barca »

delamer wrote: Mon Sep 20, 2021 7:34 pm
grandmacassie wrote: Mon Sep 20, 2021 4:39 pm I am surprised by the number of “I” statements in your post. If you recently married and this portfolio of properties is managed by your in-laws, I surmise the properties are owned not by you but by your spouse. Perhaps your spouse should be leading the decision-making on this, not you.
My thoughts exactly.

Do any of these rentals actually belong to you?
They belonged to my wife going into the marriage. Since I have more experience (and frankly interest) with investing, I'm generally taking lead on this front. But we've spent a lot of time thinking over the real estate properties, the endowment bias, etc. Neither of us want to play landlord on the weekend.
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Hannibal Barca
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Re: Unwinding A Real Estate Rental Portfolio

Post by Hannibal Barca »

gclancer wrote: Mon Sep 20, 2021 7:51 pm I would leave the in-laws business alone if I were you. They may be overly conservative for your taste, but they’ve managed to build a million dollar real estate portfolio so they must have some some financial savvy.
Most of their success comes from a high savings rate rather than good investments unfortunately.

But to be clear, the in-laws have real estate properties in their name that I'm not messing with. I'm just focused on my properties my wife and I now own.
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Re: Unwinding A Real Estate Rental Portfolio

Post by Archimedes »

I like real estate because of the cash flow. And the paper deductions shelter the income from taxes. We use professional management for most of our RE portfolio. Properties without leverage earn stock like returns from cash flow and appreciation. Leveraged properties earn more than double typical stock market returns over time.
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Re: Unwinding A Real Estate Rental Portfolio

Post by Aged Maduro »

There's a lot to unpack here but what i what i would say is that your in-laws have essentially built a small business that is debt free and throwing off cash. That's nothing to sneezze at. I do not know what the exact returns are but i'm willing to bet that its a lot more than bonds are returning these days. It may seem too conservative for you but it's a steady income producing asset. Holding those rental properties will also have tax deductions and appreciation that have to be taken into consideration. Just selling them and dumping all of that money into the stock market is no guarantee that your yields will be better in the long run.

My portfolio is about 80% equities and 20% paid off rental real estate. I love paid off rental properties. What it means to me is that even if there is catastrophic stock market crash i will still have steady income flowing in. I do not want all of my eggs in the Wall Street basket. You may want to hold on to those properties for the same reason and build up your paper assets at the same time. Rental property is a great compliment to stocks and bonds because they are not correlated and it gives you brick and mortar diversification that you can control and it provides the tax benefits of owning a business. Also consider, that if you want to boost your real estate returns and avoid taxes you could sell those four properties and use a 1031 exchange to acquire a larger commercial property. You could take that one million in equity and use a "safe" amount of leverage, say 50%, to buy a two million dollar apartment building with one million down.
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Re: Unwinding A Real Estate Rental Portfolio

Post by Sandtrap »

Piper59 wrote: Mon Sep 20, 2021 7:16 pm Tread extremely carefully with your parents in law properties. This is coming from a Boglehead and Real Estate Investor.

Have they asked you to unwind the properties and liquidate?
Huge +1.

Tread carefully.
Make no assumptions.
Seek your own legal counsel if needed for advice, tips.

Human dynamic factors to consider: recently married, properties managed and "owned" by inlaws and/or (new wife), properties may have a long family history ie: accumulated by inlaws parent's with hard earned dollar by dollar savings and in the family for a long time (it's not just property and money), etc.

Assuming that fund investment can be either more reliable or return higher than self-owned R/E residential income property is incorrect. They are two different things. One is a "business" and "active investing", the other is "passive investing". Other differences as well, also tax advantage potential.

PM me as you wish.
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Sandtrap
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Re: Unwinding A Real Estate Rental Portfolio

Post by Sandtrap »

Hannibal Barca wrote: Mon Sep 20, 2021 3:49 pm Situation: I recently got married and so came into possession of a real estate rental property portfolio of ~$1M. It's comprised of 4 properties of roughly equal value. The real estate portfolio is managed way too conservatively (e.g., none of the properties have mortgages), and since it's managed by my in-laws that's not going to change. However, they're open to selling the portfolio off and reinvesting the proceeds in stocks. My wife and I would like to sell because (1) in this circumstance we think we can generate higher long term returns with stocks, and (2) this is way too much real estate concentration (~1/3 of the portfolio).

What can we do to limit our tax bill when we sell off the portfolio?

Some ideas I had:
-Sell one property a year to limit the gains subject to the higher tax rates
-Move into a rental property to get the $500k MFJ tax free capital gain at sale. I think we'd have to live there for two years

Other relevant data points:
-MFJ marginal income tax rate is 35% and LTCG rate is 15%
-We own our house; the mortgage at this point is ~35% LTV
-We have ~30 years until we expect to retire
-We have no desire to play landlord long term, but are OK doing it for a few years as we wind down the portfolio
Per your points specifically:

1. Yes. Sell off properties only at a rate that optimizes your tax liabilities.
2. Move into a rental property only if you want to move out of your current home. If you do this, what happens to your current home?
3. Not wanting to be a "landlord" or own rental properties. It's good that you know that. It's not for everyone regardless of pros or cons. Anyone can argue for or against R/E investing and renting. What's important is what "you" want to do. Not what others think. So, good.
4. Since you have no desire to be a landlord, or own rental properties, it makes no sense to compare returns vs market investing, or other comparisons.
5. Talk to a CPA or Tax Attorney so that you can get answers and actions specific "to you" vs opinonions from others. It will be well worth the fees.
6. This might be a good time for estate planning. Legal consult. (new marriage, financial changes, additional assets, human dynamics, etc).
7. If this is concurrent with dissolution of all of the properties, including those owned by inlaws (inseperable), then it gets complex.
8. Other estate and asset concerns (PM me as you wish).

Have been in your shoes.
PM me as you wish.
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harikaried
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Re: Unwinding A Real Estate Rental Portfolio

Post by harikaried »

Hannibal Barca wrote: Mon Sep 20, 2021 3:49 pmThe real estate portfolio is managed way too conservatively (e.g., none of the properties have mortgages)

-We own our house; the mortgage at this point is ~35% LTV
How do you think it could be managed better? Why have you paid down your mortgage so much? What's your asset allocation for liquid investments?
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Re: Unwinding A Real Estate Rental Portfolio

Post by tj »

Hannibal Barca wrote: Mon Sep 20, 2021 3:49 pm
-Move into a rental property to get the $500k MFJ tax free capital gain at sale. I think we'd have to live there for two years
That's not how it works.

See this comment:

viewtopic.php?f=2&t=174493#p2636844
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Re: Unwinding A Real Estate Rental Portfolio

Post by White Coat Investor »

If you think they would do better with more leverage, then leverage them up.

If you don't want to own them, then sell them.

But selling "because 1/3 of my portfolio in real estate is too much" is not something I'd agree with, especially if all new additions are going to stocks and bonds. Soon it'll only be 1/6 of your portfolio. Then 1/10th etc.
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Re: Unwinding A Real Estate Rental Portfolio

Post by eric321 »

I'd echo the advice of not selling the properties for the relationship value.

You're issues seem fixable - not enough leverage and no interest in being a landlord.

Hire a property manager (pay 6-10% of rents depending on market, and they take care of the landlording part and cut you a check).

Leverage - go to a bank and get a commercial or investment property mortgage. They are not at the same rates as a primary home, but you can take cash out and invest it in the stock market.

I personally like a levered real estate investment much better than a stock investment. Say you have $250k to invest. You could buy $1M of Real Estate and Finance the rest (75% LTV). Or buy $250k of VOO. Rising Rates. Inflation, Fed Tapering, all benefits borrowing money now and buying inflation protected assets.
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Re: Unwinding A Real Estate Rental Portfolio

Post by Hannibal Barca »

harikaried wrote: Tue Sep 21, 2021 12:17 pm
Hannibal Barca wrote: Mon Sep 20, 2021 3:49 pmThe real estate portfolio is managed way too conservatively (e.g., none of the properties have mortgages)

-We own our house; the mortgage at this point is ~35% LTV
How do you think it could be managed better? Why have you paid down your mortgage so much? What's your asset allocation for liquid investments?
A few things come to mind (these are all pre-pandemic):

1) Low rental yield: The rent yield isn't anywhere near the 1% rent / month rule of thumb. I think they were around 1% once upon a time, but when the cap rates fell the houses were never sold to reinvest in a better yielding property.
2) Lack of leverage: The ROAs are mediocre, but with leverage the equity returns (ROEs) could go up by a few points.
3) Poor management: They charge under market rent (reducing ROA), mostly because they don't want to deal with turnover. Also my in-laws are generally too nice to tenants when it comes to collecting on rent, which leads them (and my wife) to be taken advantage of, sometimes pretty egregiously.

In general, I think if someone is going to actively manage real estate, they need to do it right. Otherwise they might as well save the hassle and just index the market.


In terms of asset allocation, ~1/3 of our combined assets are this real estate, 60% is equity index funds, and the remainder is a mix bond index funds. Of that 2/3 that's not real estate, maybe 40% of it is in tax-advantaged accounts and the rest is taxable.
Last edited by Hannibal Barca on Tue Sep 21, 2021 2:44 pm, edited 1 time in total.
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Re: Unwinding A Real Estate Rental Portfolio

Post by mikejuss »

I'm confused: who, in fact, owns these properties: your wife or her parents? If your wife, in what sense do her parents "manage" the properties? Do they have recourse to block a sale of them?
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Re: Unwinding A Real Estate Rental Portfolio

Post by Hannibal Barca »

mikejuss wrote: Tue Sep 21, 2021 2:39 pm I'm confused: who, in fact, owns these properties: your wife or her parents? If your wife, in what sense do her parents "manage" the properties? Do they have recourse to block a sale of them?
My wife owns the four, the down payment and mortgage paydown was done with her cash. Her parents own their own properties that are separate of this. There's no corporate entity, LLC, or anything like that. But the parents do all the day-to-day collection and a lot of the repair work. My wife helps with picking tenants and sometimes on the repairs.

Without getting into details, one of my in-laws had a health scare recently, and my wife and I had to take a more active role (which we didn't enjoy). I think this opened everyone up to the idea of changing the status quo.
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Re: Unwinding A Real Estate Rental Portfolio

Post by mikejuss »

Hannibal Barca wrote: Tue Sep 21, 2021 2:51 pm
mikejuss wrote: Tue Sep 21, 2021 2:39 pm I'm confused: who, in fact, owns these properties: your wife or her parents? If your wife, in what sense do her parents "manage" the properties? Do they have recourse to block a sale of them?
My wife owns the four, the down payment and mortgage paydown was done with her cash. Her parents own their own properties that are separate of this. There's no corporate entity, LLC, or anything like that. But the parents do all the day-to-day collection and a lot of the repair work. My wife helps with picking tenants and sometimes on the repairs.

Without getting into details, one of my in-laws had a health scare recently, and my wife and I had to take a more active role (which we didn't enjoy). I think this opened everyone up to the idea of changing the status quo.
And may I ask one further question: why do your wife's parents "manage" her properties? Why did your wife purchase them? As with other commenters above, I'm afraid your in-laws will think you're stepping on their toes by selling, and I'm trying to get a sense of how this unusual arrangement came about. You mention about that your in-laws are "open to selling the portfolio off." That gives me pause, as they do not appear to own the portfolio.
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Re: Unwinding A Real Estate Rental Portfolio

Post by H-Town »

Hannibal Barca wrote: Mon Sep 20, 2021 3:49 pm Situation: I recently got married and so came into possession of a real estate rental property portfolio of ~$1M. It's comprised of 4 properties of roughly equal value. The real estate portfolio is managed way too conservatively (e.g., none of the properties have mortgages), and since it's managed by my in-laws that's not going to change. However, they're open to selling the portfolio off and reinvesting the proceeds in stocks. My wife and I would like to sell because (1) in this circumstance we think we can generate higher long term returns with stocks, and (2) this is way too much real estate concentration (~1/3 of the portfolio).

What can we do to limit our tax bill when we sell off the portfolio?

Some ideas I had:
-Sell one property a year to limit the gains subject to the higher tax rates
-Move into a rental property to get the $500k MFJ tax free capital gain at sale. I think we'd have to live there for two years

Other relevant data points:
-MFJ marginal income tax rate is 35% and LTCG rate is 15%
-We own our house; the mortgage at this point is ~35% LTV
-We have ~30 years until we expect to retire
-We have no desire to play landlord long term, but are OK doing it for a few years as we wind down the portfolio
+1 on other posters who mentioned tread carefully.

Was there any prenup? If yes, you may need to seek legal advice, etc.

If your LTCG is only 15% (or is it 20% if you include house sale proceeds?), do not let tax be the sole factor in decision making. One thing I learned from RE transactions, you need to sale when RE market is hot. And you need to hold when it is not. The profit margin sometimes would pay for the 15% LTCG.
Time is the ultimate currency.
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Re: Unwinding A Real Estate Rental Portfolio

Post by afan »

Sounds like the wife owns the properties. Selected and managed by her family. Absent some serious reason to mess with it, I would drop the subject. Not propose that SHE do anything different with HER real estate investment.

Definitely do not suggest or encourage her to sell, end one aspect of her ongoing relationship with her family, then put the proceeds, less taxes, into an overvalued stock market. Or even worse, into individual stocks. There is an excellent chance that this could blow up financially and the blow back could strain the marriage.

Settle into the marriage. Leave her money alone.

Perhaps revisit in 10 years. For now, build your own portfolio and stop thinking of it as your asset.
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Hannibal Barca
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Re: Unwinding A Real Estate Rental Portfolio

Post by Hannibal Barca »

afan wrote: Tue Sep 21, 2021 3:37 pm Sounds like the wife owns the properties. Selected and managed by her family. Absent some serious reason to mess with it, I would drop the subject. Not propose that SHE do anything different with HER real estate investment.

Definitely do not suggest or encourage her to sell, end one aspect of her ongoing relationship with her family, then put the proceeds, less taxes, into an overvalued stock market. Or even worse, into individual stocks. There is an excellent chance that this could blow up financially and the blow back could strain the marriage.

Settle into the marriage. Leave her money alone.

Perhaps revisit in 10 years. For now, build your own portfolio and stop thinking of it as your asset.
Frankly by the time we actually sell the portfolio (probably selling one property a year to manage the tax bracket creep), the stock market could look very different from today.
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Re: Unwinding A Real Estate Rental Portfolio

Post by afan »

Hannibal Barca wrote: Tue Sep 21, 2021 4:24 pm
Frankly by the time we actually sell the portfolio (probably selling one property a year to manage the tax bracket creep), the stock market could look very different from today.
It might. But I would not encourage your wife to sell her property for a long time. 10 years might be long enough to start considering it.
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Re: Unwinding A Real Estate Rental Portfolio

Post by tj »

Hannibal Barca wrote: Tue Sep 21, 2021 4:24 pm
afan wrote: Tue Sep 21, 2021 3:37 pm Sounds like the wife owns the properties. Selected and managed by her family. Absent some serious reason to mess with it, I would drop the subject. Not propose that SHE do anything different with HER real estate investment.

Definitely do not suggest or encourage her to sell, end one aspect of her ongoing relationship with her family, then put the proceeds, less taxes, into an overvalued stock market. Or even worse, into individual stocks. There is an excellent chance that this could blow up financially and the blow back could strain the marriage.

Settle into the marriage. Leave her money alone.

Perhaps revisit in 10 years. For now, build your own portfolio and stop thinking of it as your asset.
Frankly by the time we actually sell the portfolio (probably selling one property a year to manage the tax bracket creep), the stock market could look very different from today.

Your wife has 10 rental properties and you are trying to completely overhaul her investments? Why? She obviously felt these were good enough investments before she met you.
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Re: Unwinding A Real Estate Rental Portfolio

Post by Hannibal Barca »

I appreciate everyone’s feedback and realize that the family dynamic and relationship implications are important here. There’s more meat to the story, but I don’t really want to get into it in order to preserve my anonymity.

That said, IF we proceed with unwinding the portfolio, I’d love to learn more about how to manage this TAX EFFICIENTLY. Some ideas folks have already brought up:

-1031 exchange into a larger primary residence.
-Selling one property a year to minimize the amount of gains that hit the higher income tax brackets
-Converting the rental properties into primary residences

Are there other tax strategies out there that aren’t covered above?
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Re: Unwinding A Real Estate Rental Portfolio

Post by H-Town »

Hannibal Barca wrote: Wed Sep 22, 2021 7:46 am I appreciate everyone’s feedback and realize that the family dynamic and relationship implications are important here. There’s more meat to the story, but I don’t really want to get into it in order to preserve my anonymity.

That said, IF we proceed with unwinding the portfolio, I’d love to learn more about how to manage this TAX EFFICIENTLY. Some ideas folks have already brought up:

-1031 exchange into a larger primary residence.
-Selling one property a year to minimize the amount of gains that hit the higher income tax brackets
-Converting the rental properties into primary residences

Are there other tax strategies out there that aren’t covered above?
Maybe you just ignore this one: Don't let the tax tail wag the dog.

While you're busy exploring tax defer strategies, you'd miss out on selling at the market top, missing rent payments, and/or minimizing selling cost. Focus on your total gain, net after tax. Not just the tax amount.
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Re: Unwinding A Real Estate Rental Portfolio

Post by michaeljc70 »

If you decide to move into one of the properties to avoid capital gains, there are other tax issues you need to look out for. Mainly depreciation recapture.
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Re: Unwinding A Real Estate Rental Portfolio

Post by GibsonL6s »

What are the property types, I would assume single family homes rents out? One possibility is to do tax deferred exchanges into an apartment building and them hire a professional property manager to reduce your involvement. The caveat here is some needs to manage the manager and it can still be a lot of work.

The issue with influencing the decision is the regret factors if the market crashes and the family second guesses the decision, or leveraging and have cash flow issues in a downturn. I would only help if asked to help once your wife has decided independently to sell the assets.

Good luck
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Re: Unwinding A Real Estate Rental Portfolio

Post by Piper59 »

afan wrote: Tue Sep 21, 2021 3:37 pm Sounds like the wife owns the properties. Selected and managed by her family. Absent some serious reason to mess with it, I would drop the subject. Not propose that SHE do anything different with HER real estate investment.

Definitely do not suggest or encourage her to sell, end one aspect of her ongoing relationship with her family, then put the proceeds, less taxes, into an overvalued stock market. Or even worse, into individual stocks. There is an excellent chance that this could blow up financially and the blow back could strain the marriage.

Settle into the marriage. Leave her money alone.

Perhaps revisit in 10 years. For now, build your own portfolio and stop thinking of it as your asset.
Well said!! If the parents have been taking care of repairs and other - there is definitely a vested emotional interest.
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Re: Unwinding A Real Estate Rental Portfolio

Post by harikaried »

Hannibal Barca wrote: Mon Sep 20, 2021 3:49 pmThe real estate portfolio is managed way too conservatively (e.g., none of the properties have mortgages)
We own our house; the mortgage at this point is ~35% LTV
Hannibal Barca wrote: Tue Sep 21, 2021 2:33 pmLack of leverage: The ROAs are mediocre, but with leverage the equity returns (ROEs) could go up by a few points
~1/3 of our combined assets are this real estate, 60% is equity index funds, and the remainder is a mix bond index funds
You can look at your overall portfolio including real estate, debt and liquid investments. For example, there's debt on your house but none on the rentals, but overall if you want more debt for leverage, you should look for where it's cheapest, and that is potentially with your primary residence, so would you cash out refinance to have more leverage?

Similarly, the 40% remainder of your liquid asset allocation for bonds means on one hand, you're getting yields from bonds while also paying interest on your mortgage (and potentially any other debt you seem to want). Bonds could indeed be yielding more than debt interest payments, but it could be useful to realize what your actual net exposure to fixed income is. Getting more debt decreases your net fixed income, but making your liquid asset allocation more aggressive by selling bonds achieves a similar shift as well.

As others have mentioned, having paid off real estate means you should be getting a lot of cash flow (not reduced by mortgage), depreciation/tax benefits and appreciation. You can compare those to your passive liquid assets with a potential more active role in pushing for more cash flow, e.g., increasing rent and/or finding new tenants, to decide if maybe the current real estate situation is "good enough."
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Re: Unwinding A Real Estate Rental Portfolio

Post by Wanderingwheelz »

Hannibal Barca wrote: Mon Sep 20, 2021 9:49 pm
gclancer wrote: Mon Sep 20, 2021 7:51 pm I would leave the in-laws business alone if I were you. They may be overly conservative for your taste, but they’ve managed to build a million dollar real estate portfolio so they must have some some financial savvy.
Most of their success comes from a high savings rate rather than good investments unfortunately.

But to be clear, the in-laws have real estate properties in their name that I'm not messing with. I'm just focused on my properties my wife and I now own.
Almost every wealthy persons success came from a high savings rate.

I’d suggest focusing more on your savings rate and less on your wife’s assets. I’ve been married for a very long time and my wife owned a business when we met. She still owns 100% of the shares in her name only. I’ve never gotten involved beyond listening when she needs an ear.
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Re: Unwinding A Real Estate Rental Portfolio

Post by Californiastate »

This scenario reminds me of the movie Brewsters Millions. It's a test. Can you manage a profitable portfolio of RE without getting greedy?
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Re: Unwinding A Real Estate Rental Portfolio

Post by mecht3ach »

It's interesting seeing this thread resurrected from 8 months ago. I wonder what OP decided to do, and if they ended up selling one of the properties, how that shook out with investing in the market.
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Re: Unwinding A Real Estate Rental Portfolio

Post by Hannibal Barca »

Wanderingwheelz wrote: Mon May 30, 2022 11:54 am
Hannibal Barca wrote: Mon Sep 20, 2021 9:49 pm
gclancer wrote: Mon Sep 20, 2021 7:51 pm I would leave the in-laws business alone if I were you. They may be overly conservative for your taste, but they’ve managed to build a million dollar real estate portfolio so they must have some some financial savvy.
Most of their success comes from a high savings rate rather than good investments unfortunately.

But to be clear, the in-laws have real estate properties in their name that I'm not messing with. I'm just focused on my properties my wife and I now own.
Almost every wealthy persons success came from a high savings rate.

I’d suggest focusing more on your savings rate and less on your wife’s assets. I’ve been married for a very long time and my wife owned a business when we met. She still owns 100% of the shares in her name only. I’ve never gotten involved beyond listening when she needs an ear.
My mental model has three main levers of accelerating wealth creation, 1) increasing one's income, 2) increasing one's savings rate, and 3) increasing one's returns. I'm working towards a promotion which will help w (1). Our savings rate is 45-50% and given Uncle Sam gets ~30% there's not much more fat to cut before it starts to impact our quality of life. Increasing returns seems to be the easiest here; I think our real estate properties are making a ~4% unlevered return and I could get ~8% in equities long term; that's an extra $40k in year 1 and the dollar spread will grow over time.
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Re: Unwinding A Real Estate Rental Portfolio

Post by Californiastate »

What happened? Did you cash out your RE to invest at the height of the bull in equities?
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Re: Unwinding A Real Estate Rental Portfolio

Post by Hannibal Barca »

Californiastate wrote: Sat Jun 04, 2022 5:50 pm What happened? Did you cash out your RE to invest at the height of the bull in equities?
Nope. My wife dragged her feet and we still own the properties. They're still poorly managed, but we missed the negative stock returns YTD. Medium term, I'm considering doing 1031 exchanges into real estate syndications so that the tax benefits are retained but without the mismanagement. While there are meaningful fees that eat into return, we should still be able to do better than a 4% CAGR.
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Re: Unwinding A Real Estate Rental Portfolio

Post by abuss368 »

Hannibal Barca wrote: Mon Sep 20, 2021 3:49 pm Situation: I recently got married and so came into possession of a real estate rental property portfolio of ~$1M. It's comprised of 4 properties of roughly equal value. The real estate portfolio is managed way too conservatively (e.g., none of the properties have mortgages), and since it's managed by my in-laws that's not going to change. However, they're open to selling the portfolio off and reinvesting the proceeds in stocks. My wife and I would like to sell because (1) in this circumstance we think we can generate higher long term returns with stocks, and (2) this is way too much real estate concentration (~1/3 of the portfolio).

What can we do to limit our tax bill when we sell off the portfolio?

Some ideas I had:
-Sell one property a year to limit the gains subject to the higher tax rates
-Move into a rental property to get the $500k MFJ tax free capital gain at sale. I think we'd have to live there for two years

Other relevant data points:
-MFJ marginal income tax rate is 35% and LTCG rate is 15%
-We own our house; the mortgage at this point is ~35% LTV
-We have ~30 years until we expect to retire
-We have no desire to play landlord long term, but are OK doing it for a few years as we wind down the portfolio
In my opinion you may be making a multiple mistakes.

There is history here with your spouse and in-laws. Too much change too soon.

The cash flow from 4 paid off properties must be material and provide additional security in the event of job loss or other needs.

As additional investments are made in the years ahead, and compound over time, the percentage of the overall picture to real estate will continue to decline.

Hire a property management company of you dont want to be involved before selling.

Best.
Tony
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Re: Unwinding A Real Estate Rental Portfolio

Post by illumination »

I hope your wife/in-laws set up a separate trust for all of this.
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Re: Unwinding A Real Estate Rental Portfolio

Post by like2read »

Hannibal Barca wrote: Sat Jun 04, 2022 5:55 pm
Californiastate wrote: Sat Jun 04, 2022 5:50 pm What happened? Did you cash out your RE to invest at the height of the bull in equities?
Nope. My wife dragged her feet and we still own the properties.
Sounds like she may be trying to tell you something.

I think I counted 18 suggestions above recommending that you think carefully about who the properties really belong to.

l2r
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Re: Unwinding A Real Estate Rental Portfolio

Post by Hannibal Barca »

like2read wrote: Sat Jun 04, 2022 7:12 pm
Hannibal Barca wrote: Sat Jun 04, 2022 5:55 pm
Californiastate wrote: Sat Jun 04, 2022 5:50 pm What happened? Did you cash out your RE to invest at the height of the bull in equities?
Nope. My wife dragged her feet and we still own the properties.
Sounds like she may be trying to tell you something.

I think I counted 18 suggestions above recommending that you think carefully about who the properties really belong to.

l2r
I'm very aware of those suggestions. They're not entirely wrong, but not entirely right either. There's also a lot of inertia and endowment bias at play, it's not just risk appetite.

There's also a lot of value to unlock. $1M invested at 8% for 30 years is $10M, vs $3.3M @ 4%, so there's a lot of money to leave on the table in the name of avoiding difficult conversations.
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Re: Unwinding A Real Estate Rental Portfolio

Post by Firemenot »

Hannibal Barca wrote: Sat Jun 04, 2022 8:14 pm
like2read wrote: Sat Jun 04, 2022 7:12 pm
Hannibal Barca wrote: Sat Jun 04, 2022 5:55 pm
Californiastate wrote: Sat Jun 04, 2022 5:50 pm What happened? Did you cash out your RE to invest at the height of the bull in equities?
Nope. My wife dragged her feet and we still own the properties.
Sounds like she may be trying to tell you something.

I think I counted 18 suggestions above recommending that you think carefully about who the properties really belong to.

l2r
I'm very aware of those suggestions. They're not entirely wrong, but not entirely right either. There's also a lot of inertia and endowment bias at play, it's not just risk appetite.

There's also a lot of value to unlock. $1M invested at 8% for 30 years is $10M, vs $3.3M @ 4%, so there's a lot of money to leave on the table in the name of avoiding difficult conversations.
Something about your tone seems kind of off for being newly married into a family that has probably sacrificed a lot of time and money to build up a sizable real estate portfolio. I hope you’re not so dismissive with them, as regardless of the forward looking CAGR they’ve accomplished a lot. Perhaps split the baby. Tap equity and put it in the market.
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Re: Unwinding A Real Estate Rental Portfolio

Post by sphinx2020 »

Be careful here, you’re comparing apples and oranges. That 8% return will only materialize by taking on greater risk and stocks are not guaranteed to provide high returns over the long run (this statement is controversial, but given the family/marital dynamics this needs to be kept in mind). Does your wife and her family have the tolerance for 100% equity risk?

The 4% return the properties are generating should grow at inflation or greater over the long term as long as the properties are in good locations in a desirable city.

I’ve seen academic research that concluded residential real estate provides returns slightly better than bonds, but less than equities (equivalent to a 25% equity / 75% bond portfolio). The $1.0MM real estate portfolio is equivalent to a portfolio that is 25% stocks and 75% bonds.

If we assume stocks provide a real return of 5% and TIPS yield a real return of 1%, a 25/75 mix would provide a real return of 2.0%. For the same amount of risk, you’re earning twice the return (4% vs. 2%) while avoiding the day-to-day volatility in the stock market.

On a risk adjusted basis you’re actually doing quite well, and professional management could push that 4% real return even higher.
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Re: Unwinding A Real Estate Rental Portfolio

Post by Californiastate »

Where are these properties? How are they being mismanaged?
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Re: Unwinding A Real Estate Rental Portfolio

Post by michaelsieg »

I also think you don't look at the "total return", but only at the cash flow side of these rentals. Real estate in general keeps up in value with inflation. You have to consider capital appreciation too. Recently, real estate was appreciating faster than other consumer prices - so that 1M real estate portfolio likely is worth 10%-15% more now than it was a year ago - it almost certainly outperformed equity markets. I think 1/3 of portfolio holdings in real estate is a great diversifier (I have about the same amount in my AA). For your mental accounting, I put real estate in an own category but more on the fixed income side. Currently, your real estate return is almost guaranteed to be higher than bonds (with the exception of ibonds with a nominal return of about 9%, but a real return of 0%).
Also, consider that you have no work to do with property management, as your inlaws manage the portfolio - it does not get much better than this! Rentals can be a lot of work, even with a property manager! I assume you have about 40k in cashflow coming in, which with a depreciation of 3.636% per year this is almost tax free - another advantage over bonds.
As others have said, I would hold my horses and if you want to proof your inlaws wrong, invest your own money and show them how much better your return is over the next 10 years - I think with a well diversified portfolio you might get a similar return, but not much higher. By the way, 8% real return of equity markets is an unrealistic expectation with the current valuations and it is very likely that it will be lower.
Good luck!
Michael
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Re: Unwinding A Real Estate Rental Portfolio

Post by mikejuss »

What makes you so sure that you can get an 8% return over 30 years by investing in stocks and bonds?
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Re: Unwinding A Real Estate Rental Portfolio

Post by AnnetteLouisan »

Hannibal Barca wrote: Mon Sep 20, 2021 3:49 pm Situation: I recently got married and so came into possession of a real estate rental property portfolio of ~$1M. It's comprised of 4 properties of roughly equal value. The real estate portfolio is managed way too conservatively (e.g., none of the properties have mortgages), and since it's managed by my in-laws that's not going to change. However, they're open to selling the portfolio off and reinvesting the proceeds in stocks. My wife and I would like to sell because (1) in this circumstance we think we can generate higher long term returns with stocks, and (2) this is way too much real estate concentration (~1/3 of the portfolio).

What can we do to limit our tax bill when we sell off the portfolio?

Some ideas I had:
-Sell one property a year to limit the gains subject to the higher tax rates
-Move into a rental property to get the $500k MFJ tax free capital gain at sale. I think we'd have to live there for two years

Other relevant data points:
-MFJ marginal income tax rate is 35% and LTCG rate is 15%
-We own our house; the mortgage at this point is ~35% LTV
-We have ~30 years until we expect to retire
-We have no desire to play landlord long term, but are OK doing it for a few years as we wind down the portfolio
Congratulations on getting married. I don’t understand your statement that the rentals are way too conservatively managed because they don’t have mortgages. Isn’t that a good thing?
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Re: Unwinding A Real Estate Rental Portfolio

Post by j9j »

sphinx2020 wrote: Sat Jun 04, 2022 9:23 pm Be careful here, you’re comparing apples and oranges. That 8% return will only materialize by taking on greater risk and stocks are not guaranteed to provide high returns over the long run (this statement is controversial, but given the family/marital dynamics this needs to be kept in mind). Does your wife and her family have the tolerance for 100% equity risk?

The 4% return the properties are generating should grow at inflation or greater over the long term as long as the properties are in good locations in a desirable city.

I’ve seen academic research that concluded residential real estate provides returns slightly better than bonds, but less than equities (equivalent to a 25% equity / 75% bond portfolio). The $1.0MM real estate portfolio is equivalent to a portfolio that is 25% stocks and 75% bonds.

If we assume stocks provide a real return of 5% and TIPS yield a real return of 1%, a 25/75 mix would provide a real return of 2.0%. For the same amount of risk, you’re earning twice the return (4% vs. 2%) while avoiding the day-to-day volatility in the stock market.

On a risk adjusted basis you’re actually doing quite well, and professional management could push that 4% real return even higher.
This is really good viewpoint on the risk breakdown. Although not sure ‘professional’ management would really help.
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