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Disclaimer: I am not an attorney and this article is not intended as a substitute for advice from the appropriate legal, zoning, financial, construction and/or tax professionals. This information is provided for educational purposes only and is made without warranties or representations
Many people around the world own commercial real estate. People also don’t have infinite lifespans, meaning when an individual passes, their property and properties pass on to their heirs unless otherwise specified. As one of those heirs, you’ve inherited commercial property, and you’re left with a question: what do you do with it?
The two options that immediately spring to mind are selling the property or keeping it and renting it out.
Which is the better choice?
There’s no correct answer here. It all depends on your specific circumstances and how you value the various pros and cons of each option. Let’s dig deeper and see what might influence your decision.
Selling an Inherited Commercial Property
Inheriting a commercial property can be a source of a hefty sum. If you don’t want to deal with the hassle of managing a property – or the expense and responsibility of working with a property manager to handle it – you can divest yourself of the asset entirely and walk away with money in your pocket.
As with all decisions in life, there are pros and cons to selling an inherited commercial property.
Some may be more relevant than others, so be sure to know the full scenario of your inheritance before you make a decision.
One of the most significant factors that can influence an inherited property is when there are multiple heirs.
If you have yet to inherit full ownership of the property, you may have close family to negotiate with, and they may not always be reasonable. Or they’ll be more than willing to play ball, offering you a better-than-market deal for their future gains. It all depends on your familial relationships, and there’s no way I can predict it in a blog post.
The Pros of Selling the Property
The most significant and obvious benefit to selling inherited commercial property is, of course, the money you get from the sale. Even small commercial properties are often valued in the high six or low seven figures, and as either a large portion of or the majority of your inheritance, it can be great to have that money to put into your own ventures.
You may not be interested in managing commercial property. That’s fine! Not everyone needs to follow in the footsteps of their parents. Being able to shift focus and get a start on something new with plenty of seed money can be a great boon.
Managing property is also a significant responsibility and not one that everyone wants to take on or has the skills to manage appropriately. Rather than learn a whole new skill set, selling the property lets you stay focused on what you really want to do.
The Cons of Selling the Property
Unfortunately, selling a commercial property can be challenging. If you’re not in a seller’s market – and there’s no way for you to control what kind of market you’re in – you may either be forced to sell for a lower-than-expected price or take a long time to find the right buyer. The longer it takes to sell, the more you have to do to keep up with the responsibility of owning the property.
Moreover, holding the property when you don’t want to be a property manager can mean ongoing costs.
While you’re certainly entitled to the rent generated by the property as you own it, some or all of that rent may be going towards the costs associated with ownership, and you may have to add more of your own money to keep it going before you can sell.
There are also all sorts of associations in inherited property that can skew your perspective.
Do you have personal attachments to the property that would make it hard to look at objectively? Maybe the parent who owned the property spent their life working to buy it; does selling it betray their memory, and is that important to you for sentimental reasons? Never discount the impact of emotions on your state of mind and decision-making process.
Determining a Sale Price for Your Inherited Property
The sale price is key information that will help you decide whether you should sell or keep an inherited property. So, you should know the property’s valuation before you decide to sell.
The question is, how do you find the value of inherited commercial property?
There are actually several different ways to calculate the value of a piece of commercial real estate.
- You can look at comparable properties in the area, see what they’ve sold for recently, and guess what the value of your property would be in the same situation, with modifiers for the differences between the comparable property and your property.
- You can use the cost approach, where you calculate what it would cost if you were to build the property as-is today (including the cost of materials, engineering, labor, and other fees) and consider that sum total (plus the value of the land it sits on) as the value of the property.
- You can use the income approach, where you identify a “capitalization rate” for the property, as well as the income it generates as-is, and calculate a value based on those factors.
- You can calculate the rent the property generates for you, multiply that by a “gross rent multiplier” calculated based on comparable properties, and decide on a sale price from there.
At the end of the day, though, the sale price of a property is “what someone will pay for it.” None of these calculations will give you a definitive price until someone pays that price.
Therefore, it’s important to know what a best-case, a typical, and a worst-case sale price point might be and a minimum you’d be comfortable selling for.
Then, you can make your decision. First, though, consider what life might be like if you keep and rent the property instead.
Renting an Inherited Commercial Property
The single biggest roadblock to success in commercial property investment is the substantial initial investment of buying a property to rent and manage. If you can’t afford to enter the market, you aren’t going to be able to participate. Right?
Inheriting a commercial property is a shortcut to commercial real estate investment. You skip the initial investment and can get right to the profitable part of owning commercial property.
If you’ve ever dreamed of having some level of passive income (even if commercial property investment isn’t truly passive), then inheriting a commercial property can be a significant windfall.
The Pros of Renting the Property
The biggest benefit, of course, is that you earn income from the rents you charge the tenants of your property. In an ideal world, your rents are enough to cover the recurring monthly expenses associated with maintenance and upkeep of the property, plus enough to set aside for occasional improvements and repairs (like the roof, HVAC, and other long-term maintenance), plus enough to profit.
Now, it’s not always going to be true that you’ll make that much from your tenants. The real estate market shifts a lot, and a desirable location can be made much less desirable due to anything from changing trends in a city to new construction elsewhere to even global factors like the pandemic.
While some situations may require you to sell before you drain too much of your own funds, you can often turn a property around and make a profit with the right investment. It might take some work – it might take a lot of work – but it can be done with virtually any commercial property.
There’s also the long-term benefit of appreciation in real estate. The real estate market tends to grow year over year, and even when the bubble bursts temporarily, it usually recovers. Holding onto the property even for a few years can increase its value more or less passively, and you can sell it for a higher price down the line.
The Cons of Renting the Property
Make no mistake: owning commercial property is a lot of work. Even if you find a property manager to handle most of the day-to-day tasks, you’re still going to be on call to address issues that they can’t, approve spending, and plan for the future. It can eat up a lot of your free time and take time away from your primary career, hobbies, family, or all of the above.
Owning a commercial property that you rent out and manage can also be a force tying you to a specific area.
It can be difficult to move to a different location if you need to address issues in person. There are ways around this, especially in our modern, connected world, but it’s still a significant consideration.
In some cases, the property may have been neglected by the previous owner. You may not want to think ill of the dead, but if they’ve left you with a property that requires a significant investment before it can turn a profit, that may be effort and money you don’t want to put into it.
Performing a Rental Analysis
As with valuing a property, determining the kinds of rents and income you can expect is also an important part of making the decision to rent or sell.
The easiest way to determine what kind of rent you’ll be getting out of the property is to look at the rent you’re getting from the property.
It’s pretty unlikely that your relative wasn’t renting it, after all. You can then compare those rents with what market-rate rents are for comparable properties and determine if you could safely raise rents to make it a better choice to hold onto the property.
Raising rents always comes with a cost, of course. If you drive away anchor tenants or long-term tenants, you might hurt the visibility or traffic to the property, sending it in a downward spiral until you can recover it or sell it so someone else can. On the other hand, if you keep rent increases reasonable, tenants will be happy to stick around, leaving you with a consistent and improving investment.
If you’re looking to calculate rents, either for unoccupied units or for hypothetical “ideal” tenants, you can make the calculation in various ways. Often, a simple price per square foot is used, which is both regional and determined by comparable properties. You can also determine an overall rent, subdivide it by unit, and divide it by month or year. As with valuation, rents are only important when you find a tenant willing to pay them, and there’s a lot that goes into that negotiation. Even that negotiation is a process you may not be interested in pursuing, and that’s a consideration as well.
Deciding to Sell? Looking to Lease?
If managing a commercial property isn’t in the cards for you, selling might be your best option.
If you’re looking to sell a commercial property you inherited in the southern California area, I’m your guy. Extensive experience, metric-driven focus, and my personable attitude combined to earn me the #1 SVN broker in California for two years running, and I intend to keep it going. If you want to guarantee you get the most out of your inheritance, I can do it with you.
On the other hand, if you’ve decided to keep the property but you want to offload most of the work of managing it, my firm is the exclusive landlord representative for over half a million square feet of commercial property throughout southern California. I’d be happy to add your investment to the list and provide the best possible representation, marketing, and returns you can get.
Or you haven’t made a decision yet, and you want to talk to an expert to get advice on what you would need to succeed in either venture. If so, feel free to reach out; my contact information is here for you.
Erik Egelko is a veteran of the commercial real estate business with a specialized focus on Investment Property Sales. In 2021 and 2022, Erik was the #1 ranked Broker in California for one of the largest CRE Firms as well as ranked in the Top 1% of brokers nationwide. He has extensive experience in a variety of asset types including: Retail Shopping Centers, Medical Office Buildings, Industrial Properties, and Multifamily Apartment Complexes. Over the course of his career, Erik has closed over $100,000,000 of commercial property sales throughout Southern California.