Dale is an investor in a local real estate investment group here. in Chicago, Illinois. It is his turn to speak this evening about his path to finding real estate and his passions. Let’s listen.

One Investor’s Tale About Providing Peace In Probate

I have been in this business for a long time and we all have a moment in our career that has challenged us and is searching for answers. The one obstacle in my career that has also defined my career is the story of George Fordham and the inherited property.
To begin our story about George and why this situation was career-defining for me, we have to provide some background on investors and liquidity. As Investors, we like to remind people that we choose investment property based on two factors: yields and liquidity. While yields create revenue and cash flow during ownership, liquidity determines how successful the investor will be upon exiting the project and it is also good to point out that liquidity is an important aspect of any real estate investment.

The Liquidity Factor

The next point to bring up is what exactly is liquidity and why is important to the real estate market? Liquidity determines whether assets will be sold quickly or slowly and if the price will be above or below market value. Property that is easy to sell and purchased at market value is liquid. Conversely, assets that are harder to sell and transact for a discounted price are considered illiquid.

To give an example of why liquidity is something to always keep in mind, we analyze the state of Detroit over the years, Detroit became known as America’s failed automotive capital and for a high number of foreclosed homes that were known to sell for $5,000. These assets are illiquid: so difficult to sell that they require a more-than-substantial discount to find buyers. If these
properties were advertised for $30,000–40,000, buyers would take years to appear. To further explain what is liquidity, let’s also look at what types of liquidity are considered the best and which is not considered the best. In retrospect, any asset that can be exchanged for money has a certain level of liquidity. Money is the most liquid asset because it is the fastest to exchange for other assets. Securities known as stocks, bonds, etc. are also deemed liquid because of their low acquisition costs, lack of complex legal arrangements, and ease of transaction.

Unfortunately, Real estate is one of the most illiquid assets because it requires more capital to buy than securities or precious metals for example. It also takes longer to sell property, both to find a buyer and complete the transaction process. Property assets are also limited to their current location (immobile) and affected by changes to the local market. It’s also common for buyers to request a discounted price in exchange for a faster transaction.

Three factors increase liquidity: high demand from a wide audience of potential buyers, high product, and how easy it is to estimate the value. Real estate lacks that final element. The relatively low liquidity of real estate, compared to securities, can be attributed to the difficulty in its evaluation rather than lower demand. It’s hard to create a system that can accurately and quickly evaluate price considering the wild variety of properties on the market. Imagine how simple it would be if Paris had only 10 types of flats and land were the same price everywhere — it would be much easier and faster to figure out the price and to sell.

There are few benefits when looking at real estate and liquidity. Property location, condition, and local market dynamics also affect liquidity. Here are the questions and factors that can help an investor evaluate a potential purchase. Now, one thing to remember is that some property types are better than others when it comes to liquidity.

Real estate liquidity also depends on the type of property. Generally speaking, residential property has better liquidity than commercial property because:

• It requires less due diligence and incurs fewer transaction fees.
• Residential property is more immune to national or regional economic fluctuations: people always need somewhere to live.

Now to put it into further perspective In general, large and expensive property is less liquid, which is why apartment units are easier to sell than whole commercial apartment buildings. Offices sell more quickly than office blocks and high street stores faster than shopping centers. Shopping centers and large hotels are the hardest to sell because due diligence takes time, resources, and costs more.

High-yield property is harder to sell, which affects the overall value of the investment. Investors often need to give a substantial discount if they want to sell quickly. I recommend buying quality property in central locations so it will always be in demand with local and international investors like in Chicago and its suburbs.

A Case Study Of Probate Problems

Let’s examine George’s situation. His family had set up an estate plan that left him with the property. The family had instituted a will before their death and had not fully thought about the consequences of leaving everything unorganized. His family had the best intentions in writing a last will & testament but never explicitly enumerated the properties held within. They never thought about how messy life can be, and children fight, and not all is fair in love and probate.

To divulge further, he and his siblings have left property that was equally split in his family’s estate plan. As part of their estate, they owned land, timber, and mineral rights that his family felt were valued at approximately $5 million. The family member decided to leave this portion of their estate to George while leaving their liquid assets (their investment accounts valued at $4 million at the time the estate plan was written) to George’s siblings.

At your passing, the appraisal of your assets is completed. The property left to your son now has a value of $11 million. Under today’s tax laws, there will be an estate tax due; and it must be paid in cash within nine months of your date of death. Since all liquid assets were left to your daughter, what can your son do to pay his portion of the estate tax? Some of his choices are better than others, but none are perfect.

We have two different options that George can handle this inherited property:

In the first option, George can use his illiquid assets that will have to be sold at the current market value to pay the tax. This could lead to a large capital gain, or he could be forced to sell at a loss. He could choose to sell his home, the land he inherited, or his collection of firearms. But remember, the estate tax must be paid within nine months of your passing, and selling his home, or the inherited land or even his gun collection could take much longer than nine months because they are illiquid.

In the second option, due to the time deadline, George decides to use his investments as collateral. The investment value, a cumulation of stocks and bonds, totaled over $2 million, which was plenty to cover the estate tax. In the end, his investments sold for $3.5 million. So, he now has the cash to pay the estate taxes however will also owe taxes on the capital gains he recognized when he liquidated his investments, which could be as much as $300,000.

Both options outlined above have a significant downside. So what can I suggest to my future clients to prevent this from happening with their estate? Here are just a few suggestions to discuss with your financial advisor:

• Place your illiquid assets into a trust before you die;
• Buy life insurance that will pay out enough to cover the estate taxes; or
• Your son could take out a loan when the estate taxes are due using his home or investments as collateral

Of course, these are only a few choices. There may be others based on your situation. Advanced planning and honest family discussions are pivotal to discern the best path. Consult your advisor to determine a strategy that fits your needs. He/she will also be able to help you acquire a more current, accurate value on all your illiquid assets.

Conclusion

Dale felt blessed and knowledgeable to be able to assist George in his time of need. He said this is where his passion for real estate originally stemmed from, making a difference. There are always options. A difficult real estate situation requires a team of experts backing you who have been there before and understand the different strategies to help you through any tough time