Ensuring those who inherit your real estate property don't inherit a headache means having a plan in place.
"A real estate succession plan is one piece of a bigger estate planning strategy," said Cory Hensley, manager of the specialty assets group at BOK Financial®. "It helps protect assets, maintains or increases cash flow for future generations, and yields more effective and flexible tax strategies. A real estate succession plan plays an important part in helping you achieve your goals and investment objectives."
If someone passes away without a plan in place, things like what to do with inherited real estate are left to chance.
"Over the years, I've seen clients inherit real estate and the first thing that jumps to their mind is 'let's sell it!' before they even know what they have," said Brad Nelson, a senior specialty asset manager for BOK Financial. "They typically don't have the expertise to take on the role of a real estate professional. Without the real estate expertise, the beneficiaries end up selling the assets without knowing the potential value of what they have inherited."
Nelson said in many cases real estate property may be re-developed into something bigger or more valuable than the original zoning, all of which could make it a more favorable investment.
He said having a plan in place can also help eliminate unnecessary and unexpected family conflict that arises from an under-qualified individual being left to manage the asset.
When it comes to the creation of a real estate succession plan, they suggest keeping a few things in mind.
Analyze family conditions
"This involves taking a thorough look at family dynamics and the relationships with one another," said Hensley. "It also takes into account stages of life of everyone involved, which can have an impact on peoples' needs and how the plan moves forward."
He said this step involves determining to whom and how the asset will be transferred, and who will be managing the real estate assets.
"In each case, it's important to consider if those being named as inheritors or managers are qualified to manage this type of asset," said Hensley. "Do they have the appropriate licenses or experiences? Could this cause additional contention or division amongst other family members? These are important questions to ask at this phase."
Dan Bartell, president of Bartell and Company Real Estate Wealth Management, said the ages of everyone involved also matters. Their season of life will affect the lens they use to view things like assets and income, so these are important considerations to keep in mind.
"For example, I recently worked with a 74-year-old man and his family. He has a long history of successful real estate experience and wanted to keep his feet in the investment world without too much personal involvement," said Bartell. "He wanted to be involved, but he didn't want to subject his wealth to undue risk. His sons—citing the stable economy and growing market in their area as the reason—wanted to push the envelope and do more."
Father and sons were seeing the situation from different walks of life, with different goals and experiences. Bartell helped the two generations find common ground and share in the appropriate risk and potential reward, rather than investing and developing simply because they could.
Have frank discussions
Nelson said having frank discussions is where people tend to struggle the most.
"Sometimes people are reluctant, but it is important to have honest and open conversations with your estate attorney and wealth management advisor regarding the future of the family," said Nelson. "It's best to be open about goals and obstacles that could arise down the road."
Knee-jerk responses to dramatic life events can yield irrational investment behavior, Bartell added. "Making assumptions about an individual's intrinsic motivation and perception of the situation can yield seismic negative results."
Asking the parties not only what they need out of real estate, but also why having the real estate itself is meaningful, is sometimes difficult—but often cathartic. Asking this type of question smooths the course, maintains positive relationships, and often has a positive impact on the health of the investment, he said.
Evaluate the asset's performance
"People don't always take the time to look closely at a real estate asset and evaluate if it's performing as well as it could under different circumstances," said Nelson.
He suggests partnering with a real estate professional to have an analytics report completed on the asset to understand past, present and future forecasting performance.
He said the performance analysis should include the following:
- Investment objectives
- Debt service coverage analysis
- Asset basis
- Cash on cash returns
- Current condition of the property
- Internal rate of return
- Cash flow
- Cash reserve analysis
"The analysis should really look at what strategies can be implemented to maximize cash flow while adding value, as well determining if the asset is underutilized or underperforming," Nelson said.
Understand the risk
"It's important to get a full understanding of what your real estate assets are and how they might perform in the context of today's world, considering future uncertainties and risks," said Hensley.
In working to understand the risk, he said there are some key questions to consider:
- Are there any environmental issues?
- How is the asset currently titled?
- Has an insurance valuation been performed to ensure adequate coverage?
- Are the returns acceptable as it relates to the overall risk?
"When it comes to a real estate succession plan, or an estate plan, it isn't one and done," said Hensley. "Family dynamics, situations and values change, so this is something that will need to be revisited along with those ongoing conversations."
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