Owning and living in a small apartment building may not put you on a fast track to becoming a millionaire, but it can be a sure route to building some equity and defraying housing costs.
Emerson and Bob Nagel bought their 1912 two-flat in Chicago’s Magnolia Glen neighborhood because it was the only way they could afford to buy a home. “We were living in an apartment and had to have a tenant to afford costs,” Emerson says.
But, after five years, the couple felt the building had appreciated as much as it was going to. They also decided they could finally buy a single-family home close to the Evanston gardening shop they opened a year ago.
“We both have other jobs; I’m in banking and my husband is a graphic artist,” Emerson says. The garden shop “is our second career. Owning a building was our third and that’s one too many.”
The reasons for selling your building may differ from the Nagels’-perhaps you’re being transferred and can’t envision being an absentee landlord, or you’ve tired of fixing leaky toilets and busted pipes in the middle of the night. But the advice of the experts is the same: Before you list your building, know that selling an investment property is different from selling a traditional single-family home, condominium or cooperative apartment.
Following is a checklist to consider, based on advice from real estate agents, attorneys lenders and owners.
Is silence golden?
First, there’s the delicate matter of deciding when to tell your tenants that they’ll have a new landlord. Some landlords prefer to spring the news well before the closing; others wait until right afterward. Both approaches have pros and cons, especially because tenants and resident landlords in small apartment buildings often develop friendships.
If you need to gain access to apartments to show them to prospective buyers-and in most cases you will-you can’t just pop in. Usually, you must inform tenants in advance. Such information is often stipulated in the lease or covered by a local ordinance, with specifics also provided regarding how much notice you must give and what time of day you can enter, says Susan Randhava, an agent with Mitchell Bros. in Evanston who owns four apartment buildings.
In Evanston, Randhava says tenants must be given at least two days’ notice and then allow access only at “reasonable times.” What constitutes reasonable is not spelled out, however. “I advise owners to treat tenants as they (themselves) want to be treated. Ideally, they’ll accommodate one another,” she says.
Conversely, the lease or ordinance usually dictates that tenants can’t withhold permission. For example, the Evanston ordinance states: “The tenant shall not unreasonably withhold consent to the landlord to . . . show the dwelling unit to prospective or actual purchasers, mortagees, tenants or workmen.”
Bill Moran, a Chicago real estate broker who owns several apartment buildings, likes to talk to his tenants in advance, tell them how a sale will affect them and include them in the selling process.
“That way I help them understand that if the property sells, the new owner assumes the leases and that they’re not going to be out on the street. A tenant’s attitude goes a long way in convincing-or discouraging-a prospective buyer,” Moran says.
Still another advantage to telling tenants upfront is that one of them may be interested in buying the building, says Fred Levy of Coldwell Banker’s First American office in Hyde Park.
Some owners, however, prefer to take the opposite tack and keep a potential sale hush-hush. “A lot of people have a fear of the unknown,” says Wilmette real estate attorney John Dugan, who recommends silence. “After telling, an owner may find their tenant decide to move because they’re worried they won’t have their lease renewed or will have their rent hiked when it comes up for renewal by the new owner.”
Dugan advises his clients who sell not to show a buyer the apartments immediately, but to write in the contract that a sale is contingent upon the buyer inspecting all units.
Fixing up
Before the selling process begins may be the best time to decide on your policy toward the tenants, but it’s not the time to embark on major remodeling projects. You’re unlikely to recoup such costs before you move, experts advise. Instead, concentrate on being sure all systems are in good working order and that there’s no asbestos, lead paint, faulty wiring, or other structural defects: New disclosure laws hold the seller responsible, Dugan says.
Also, focus on making the building “market ready,” or presentable and competitive with other area properties, suggests Don Verson Sr., president of Columbia National Bank in Chicago.
That means making basic cosmetic improvements so that prospective buyers see a building that looks professionally managed when they walk in-fresh paint, clean carpet, a working buzzer and lock, advises Mark Gerb, an owner of several buildings. Gerb isn’t above “bribing” tenants to keep their apartments clean, or hiring a cleaning service to do so for tenants before units are shown.
Be careful, however, not to go overboard, advises Dale Kleszynski, an appraiser with Associated Property Counselors in south suburban Lansing. “A lot should depend on timing of the leases and the sale. If you recently painted a new tenant’s apartment, there’s no need to paint it again,” he says.
Marketing
Whether you try to be your own real estate agent or list your property with a professional, be sure to target the right audience by pricing and advertising the property competitively and offering a “reasonable possession date,” says Linda Christmas, an agent with Re/Max All Services Realtors in Hyde Park.
Currently, the market for selling small apartment buildings is healthy, though more so for those in the under-$500,000 category, where there’s still room for appreciation, says Allyn Rawling, an agent with Mitchell Bros. “In the last five years, there hasn’t been a lot of appreciation in the general market, except for condominiums priced inexpensively,” she says.
Those who’ve shown the most interest in buying small apartment buildings tend to be young professionals trying to build equity and who may not have a sufficient down payment for a single-family house; double-income-no-kids-couples (DINKs) and empty-nesters, both of whom don’t require a lot of space and who may be looking to stretch their incomes; and extended families who want to live under the same roof.
Other good news is that sales of small buildings tend to be less seasonal than those of single-family homes, which fall off during the holidays and summer months.
Paperwork
Besides getting your building physically ready for sale, you’ll need to get your records in shape. Buyers will want to see tax bills and several years’ worth of income and expense reports to learn whether the building has generated a positive or negative cash flow and how much. “People own apartment buildings to make money,” says Stan Benes, a vice president, mortgage lending, at First Chicago Bank. Benes advises putting together copies of leases, security deposits and a payoff letter to your lender to get a lien released.
Be sure you add in a list of repairs made through the years, because many can be deducted for tax purposes, says Verson of Columbia National Bank.
You’ll also need to present proof of title insurance commitment, affadavit of title, plat of survey, utility disclosure letter, homeowner’s insurance, and a list of items not included in the transfer of ownership, such as appliances, fixtures and window treatments, says Laura Addelson, an attorney in Evanston.
The taxes
Before you sell, you’ll also want to calculate your tax savings and costs. Don’t expect to make a killing or let the tax tail wag the dog, advises Randy Abeles, director of taxes for the Chicagoland offices of McGladrey & Pullen, an accounting firm based in Schaumburg.
“The entire basis-the amount you spent to buy the building and fix it up-can’t be depreciated. You can only deduct the square footage you didn’t live in,” Abeles says. “Taxes should factor in minimally to any purchase-and sale. The key thing should be attaining the value you seek and peace of mind.”
Your basis for computing your gain will have to be allocated between your space and that of your tenants, Abeles adds. Generally, you only pay tax on the gain allocable to the tenant portion, if you reinvest the money received for your residence in a new home.
