After 40 years of managing apartments in the upper Midwest, one owner ponders retirement over real estate management.
Imagine a new independent rental owner (IRO) who has just purchased his first apartment building. It’s probably a small building with no more than one half-dozen units, or possibly a duplex. For him or her, these are exciting times as they are now truly born into the business world. They set their sights on making money and eventually retiring comfortably—this is the American way, you might say. Full of optimism, they set out to prosper through their real estate investment.
But the owner struggles with the challenges of being a rental property owner. They don’t take full advantage of the resources and networking opportunities available through their peers in their local apartment association. The property’s performance struggles, and this owner doesn’t get past first base as a real estate investor. It doesn’t have to be this way.
The ‘Millionaire Next Door’
There are three stages to a real estate investment career: establishment (day one), growth (all the days in between) and divestment (the last day). Each stage offers its own set of challenges. IROs need to be successful at all three to fully achieve their goals.
Entering the real estate management industry with that initial purchase signifies the first stage. And for many determined people, learning the real estate investment game is based on their first investment property.
As for the second stage, the even more ambitious owners aim to leverage their time, talent and money into growing their portfolio. They can become “the millionaire next door” because after several years, if they make the right decisions, they may own and operate 50 to 100 units. These properties at retirement time may be free and clear, or they may still have a mortgage and could include approximately 50 percent equity.
In any case, do the math. Fifty units valued at $50,000 per unit make the property worth $2.5 million. Even by holding just 50 percent equity on that property, they are sitting on $1.25 million. Some IROs will run faster and longer still and ultimately own much more. They can add one, two or three zeroes to each of those numbers. Growing their portfolio to as many as 5,000 units or more is not uncommon. And by working with the resources and networking opportunities presented by the local apartment association as well as NAA, their growth stage is even more prosperous. These owners/investors effectively turn time into money. Now what?
Turning Money Into Time
The last stage of an investment career can be the trickiest task of all. Here, owners and investors try to turn “money into time.” This “time” represents retirement, which comes through divestment.
Given the potential complications from the nuances involved with timing, dealing with taxes, paperwork and negotiations, this crucial process can become complicated and could require skills as demanding as those needed to land a large plane.
Ask any pilot and they will tell you that there is probably more skill needed to land a plane compared to taking off or flying. Pilots don’t care where they are, but rather, want to be certain about what is 50 miles ahead of them because they will be there in three minutes. Apartment management for outgoing owners is a lot like this.
One resource that is helpful is a “pre-due diligence list” such as the one prepared
by IRO Frank Barefield, Chairman of NAA’s Independent Rental Owners Committee and owner and operator of 8,000 apartment homes in the Southeast and Southwest (see right).
This list may appear daunting to owners who are accustomed to doing things the “normal” or quick-and-easy way of the recent past. But our economy is now in the “new normal,” where buyers, and particularly bankers, appraisers and regulators are expecting and demanding a lot more information before considering and signing off on real estate transactions.
And for buy-and-hold investors and those who did 1031-Exchanges along the way, not being on the hook for taxes has been a relief. But with divestment, all those taxes come back to the owner through 15 percent capital gains tax and 25 percent recapture taxes. To complicate matters, the current tax rates extend only through December 2012. So for owners such as myself and my wife, we have depreciation taken 40 years ago looking back at us.
Who’s the Buyer?
Options for divestment are unique and based on each individual’s situation. In my case, our properties have performed well. But, like for us, family succession is not an option because my two children are making a living in the music industry in another part of the country. Furthermore, our community’s management structure is not set up to succeed our involvement. In other words, we’re the ones who rent the apartments, keep the books, handle repairs, shovel snow, plant the flowers and perform most other general day-to-day property upkeep.
Another option is finding someone with a combination of time, talent, and money to buy our properties. That may be easy to do in some parts of the country, but it is not that simple in central Wisconsin. Here, we are into the third year of “this economy,” living on Main Street Mid-America. Property is not really moving very fast, even with these historically low interest rates available.
One strategy left to consider is selling fractional shares of our ownership LLCs to a trusted person who has time, talent and money. This could help to spread tax liability over several years and possibly involve a next generation in ownership and management. Even still, that ultimately could become a touchy balancing act between risk and benefit.
Our divestment may take a couple years. The job for us now is to lean into the business, constantly try to upgrade our residents’ profile, increase cash flow and avoid deferred maintenance.
Here is the hardest part. We have been managing apartment property for more than 40 years. We must now re-focus our approach and look at our business through the eyes of future generations. Our peers are not our potential buyers. There is a new breed of owner and new ways to effectively manage and market apartment buildings. Consider that my first computer was a 32K TRS 80 Model I. Don’t laugh. And today, I am supposed to rent apartments using Facebook? So many new challenges. So many new opportunities.
Rich Sommer is an Independent Rental Owner based in Stevens Point, Wis.
Pre-Due Diligence Checklist
Following are items to include when considering selling your rental assets.
1. Two previous year-end operating statements
2. Current operating statement
3. Current rent roll with security deposit liability listed and any delinquent rents
4. Unit mix and current market rents
5. Delinquent/pre-paid report
6. Copies of all contracts in place
7. Copy of most recent termite bonds and inspections
8. Copy of insurance policy
9. List of insurance loss runs for the past three years
10. Copies of property tax bills
11. List of all employees and compensation, including apartments
12. Personal property inventory
13. Copies of all drawings, plans, specs, engineering report and environment reports
14. Access to all units, occupied and vacant units
15. Access to all lease files
16. Copies of existing survey and site plan
17. Copy of current lease
18. Brochure and floor plans
19. Copies of all legal action pending
20. Latest market survey and list of your comps
21. List of all vendors
22. Copy of the resident qualification standards
23. Copy of the most recent resident profile
Courtesy owner Frank Barefield and NAA Community Site