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For about five years, a close relative and I have co-managed jointly owned rental properties together in California. We each have a 50% share and make joint decisions on everything together. This relative now has increasing demands on their time and is looking to divest or reallocate their ownership. They are looking either to be bought out, or to own their share outright rather than co-own.

I'm looking to canvas what some options here might be. Right now we have two LLCs, each of which contains a property. Property one is roughly 35% of the total portfolio value; property two is the other 65%.

I'm wary that trying to carve 15% out of property two is going to be a mess of valuation attempts, and that it's going to be very hard to split the two properties evenly both in terms of legality and logistics, such as insurance and other collective costs.

What are my options here? I'm thinking about possibly taking a mortgage on the second rental property for the 15% differential, ceding the first property to my relative and buying them out of the second. I'm concerned, however, that this is going to be a very large mortgage that is going to dramatically impact my cash flow in the second property.

What are my best options here?

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    How mortgaged are you both now? Are both properties mortgaged 100%, 95%, 80%, etc.? Or are you free and clear now? Are both properties equally paid off? Or have you paid off e.g. 50% of the 35% property mortgage and 20% of the 65% property? – Brythan Feb 23 '17 at 15:27
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I think the first step is to be thankful that your relationship with this person has not degenerated into lawsuits and bickering. That would greatly affect your cash flow and valuations! It also seems that this person is open to a variety of solutions. This truly is a gift.

I see two options without taking a mortgage or fronting cash:

  • You take the 35% property, and receive 15% in cash.
  • You liquidate the 65% property, provide the 15%, and buy new rental properties with the 50%. The down side here is the cost of transacting real estate.

The key here is if the 65% property already has a mortgage. Does it have enough equity to provide 15% cash out, and cover the existing mortgage? What is the interest rate? Can you get a lower rate that will reduce the impact of a higher mortgage payment will have on your income? Can you have your partner finance the 15%?

In the end there really isn't a way to divest this company without impacting your income.

  • Thanks, this is good advice. What might be standard practice if I wanted to simply take over all responsibilities for both properties? Should my relative expect to be partially bought out for this? Would I be in line if I charged them a management fee? – fox Feb 23 '17 at 14:15
  • That is a great option that I did not think of, very creative. I'd advise to treat such a situation as different entities/transactions. The two LLCs could decide to hire a management company. You could hire Joe's company to do it, and the LLCs would pay the fees prior to receiving profits. Or you could hire Fox's (your) rental company. It would receive fees from the LLCs. In order to keep good will with your relative I would advise a deep discount. – Pete B. Feb 23 '17 at 14:21
  • @PeteB.You're suggesting that the LLC's pay OP as property manager, then split the profits? That's not a bad idea, but the LLC's should also make sure they fund a reserve which will pay any expenses. Mainly to ensure that they never have to have the conversation, "How do we split up this expense." If that reserve is allowed to grow, eventually it could be used to fund the purchase of more property. Assuming a 10% property management rate in the area, I'd say 10% after operating costs to reserve. Then 10% for the managing partner, and 90% split between them. 10/40.5/49.5 is final split. – Xalorous Feb 23 '17 at 22:29
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Figure out how much you own

You say that one property is 65% of the value of the two properties and the other is 35%. But how much of that do the two of you actually own? If you have co-signed mortgages on both properties, then your equity is going to be lower. If you sold both properties, then your take away would be just half of that equity. And while the 35% property may be less valuable, if you bought it first, it may actually have more equity.

It's the equity that matters here, not the value of the property. With a mortgage, the bank is more of an owner than you are until you've paid down most of the loan.

You may find that the bank won't agree to a single-owner refinance. A co-signed mortgage is a lot easier for them to collect, as they can hold either of you responsible for the entire loan.

Consider selling the 65% property

If you sell the 65% property, then you can pay off any mortgage on that property and use the equity payout from that to buy out your relative on the 35% property. If you currently have no mortgage, you'd even have cash back. This is your fewest strings option.

15% mortgage

Let's say that you have no mortgage now. So this mortgage would be the only mortgage on the property. It's not so much, as 15:65 is 3:13 or 18.75% of the value of the property. That's more of a home equity loan than a mortgage. You should be able to get a good rate. It might reduce your short term profit, but it should be survivable if you have other income.

If you don't have other income, then seriously consider selling the 65% property and diversifying the payout into something else. E.g. stocks and bonds.

Private mortgage

Perhaps your relative would be willing to float you the loan. That would save you bank fees and closing costs. Write up a contract and agree to take assignment of the title at payoff. You'll need to pay a lawyer to write up the contract (paying a modest amount now to cover the various future possibilities), but that should still be cheaper.

There's a certain amount of trust required on both sides, but this gives you some separation. And of course it takes your relative out of the day-to-day management entirely. Perhaps the steady flow of cash would provide what they need.

Management fees

If your relative is willing to remain that involved, that can work. Note that they may not want to do this, so don't get too attached to the idea. Be prepared for a no. This would be a great option for you, as you pretty much get everything you have now. They get back the time meeting with you to make decisions, but they also give up control over those decisions. Some people would not like that tradeoff.

The one time I was involved with a professional managing a property for me, the fee was around 7% of the rent. If that fits your area, you might reasonably charge 5%. That gives a discount for family and not being a professional.

There's a relatively easy way to find out what fits your area. Look around and see what companies offer multiple listings. Call until you find a couple that will do management for you. Get quotes for managing your properties. Now you'll know the amounts.

The big failing though is that this may not describe the issue that your relative has. If the real problem is that the two of you have different approaches to property management, then making you the only decision maker may be the wrong direction. This is certainly financially feasible, but it still may not be the right solution for your relationship.

If you get a no on this, I'd recommend moving on to other solutions immediately. This may simply be too favorable to you.

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