Real Estate Q&A: Hedge Funds Buying Homes and Inheriting Property
Each month, past San Diego State University lecturer and Zillow Blog contributor Leonard Baron answers two questions from readers regarding buying, selling and investing. Have a question? Send it to Leonard@ProfessorBaron.com
Hedge funds crowding out real estate buyers
Hi Leonard — We are first-time buyers in Phoenix and can’t purchase because many hedge funds seem to be buying all the properties we want. We’re really frustrated and have started offering on properties that are not our top picks, just in hopes to at least buy something. But we are also considering just holding off for a while and staying renters. How long do you think it will be until the hedge funds stop ruining the market for all of us? Maria P., Phoenix, AZ
Well Maria, you’re not alone. In fact, many markets are short on inventory. The real bummer for buyers like yourself is that both prices and interest rates are up. However, don’t rush to buy property. You should buy the right property for you, for all the right reasons that are important to you. Don’t buy a property if you don’t “love” it. So even with the increasing prices and interest rates, you’re probably best off to keep searching for a great-fit property that you will own for a long time instead of buying something that’s not right for you.
Many hedge funds are learning that owning and managing individual rental properties is not as easy nor as profitable as they’d hoped. The problem for buyers is that the hedge fund managers make money lining up investors and buying the properties (think acquisition fees, management fees, asset management fees, etc.), and they get those fees regardless of how good or bad the investment actually works out for their investors.
So that’s not much of an incentive for them to stop buying, even though the returns can’t be all that good. However, in the next few years most of those funds will probably realize that individual properties are not the great investments they originally penciled out and will probably start dumping properties so individuals like you can buy them.
Tax guidance: Grandparent gifting property
Hi Professor — My grandfather is getting very old, and he is going to give/gift an investment rental property he’s owned forever to me in the next couple of weeks as he’s unfortunately going into hospice. I don’t know much about the tax issues and inheritance issues, but Grandpa has instructed me to get guidance, and I’m wondering if I need to do something before he passes. Joshua N., Arlington, TX
Hi Joshua — First and foremost I’m sorry to hear about your grandfather’s condition, but hopefully he’s lived a good life and is in comfortable surroundings. Also, always get professional tax advice; my guidance is just general information.
Yes, you absolutely need to contact a certified public accountant or lawyer ASAP. There are several issues, from the property income tax basis and depreciation amounts, to inheritance taxes and maybe even Texas property tax issues. And there are possibly probate court issues too.
One major issue is that if the transfer occurs before his passing, the current federal income tax basis on the property will transfer to you. That means if you sell the property in the next few years, you’ll probably have a huge tax bill. If you inherit the property after he passes, your federal income tax basis will be the “stepped up” current market value, so if you sell the property, the tax impacts should be minimal. Also, if you inherit the property, you can start taking depreciation expense on the new “stepped up” basis, which you won’t be able to do if he gifts you the property before death. And that could be a lot of tax savings to you for decades.
There may also be state property tax issues that should be addressed related to the transfer. And there could be state and/or federal inheritance tax issues that need to be addressed.
Also, does he have a revocable living trust (so his assets can pass to his beneficiaries outside of probate court)? This keeps the distribution of assets private and probably saves on court costs, so you want to address that issue with a lawyer, as it may take a week or two to set up a trust and transfer assets (cost should be $2,000 to $3,000).
There are lots of issues related to the transfer of any assets before and/or upon death. Spending a little money on competent guidance could save you tens or hundreds of thousands of dollars in income taxes, property taxes and court fees over time. Grandpa is trying to help you one last time. Now follow his wishes and get on it!
- Real Estate Q&A: Revocable Trusts and Wrap-Around Mortgages
- Tax Savings: Rental Property Depreciation Explained
- Rental Property Investing 101
Leonard Baron, MBA, is America’s Real Estate Professor®. His unbiased, neutral and inexpensive “Real Estate Ownership, Investment and Due Diligence 101” textbook teaches real estate owners how to make smart and safe purchase decisions.
Note: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinion or position of Zillow.