How to invest money from the sale of a ranch – part three
This article is the third of a three-part series on how to invest proceeds from the sale of a ranch. While the first two articles discussed investing in the stock and bond market, this article is on investing sale proceeds in real estate.
Investing sale proceeds
If one plans to use a 1031 exchange to defer tax on the sale of their property, they must exchange their land into other real estate. Fortunately, land can be exchanged into many different types of investment property such as apartment complexes, office buildings, retail strip malls and rental houses.
The goal for most families who have sold their farm or ranch, and are transitioning into retirement, is to generate income. Most families want secure income producing real estate investments they do not have to personally manage.
While land may offer good appreciation potential, the cash flow returns offered through other types of commercial and residential property are often double and triple what producers can achieve with land.
One of the first decisions those who sell ranches face when considering the different types of income-producing real estate to invest in is deciding whether to invest in commercial or residential real estate. While there are pros and cons with each property type, commercial properties offer some significant advantages over residential properties. If anyone is considering investing in commercial property, it is best to work with a real estate broker who specializes in commercial property.
Investing outside hometowns
I have known agricultural families who have exchanged their land into properties located in the towns closest to their farm or ranch. While it is nice to have a property close to where they live from a management perspective, properties located in a rural area or a small city may not offer the income potential, appreciation potential and financial security a similar property located in a strong market might offer.
Producers should not limit their property search to areas near their home which may have poor demographics and limited potential for growth. By working with a broker who can search properties nationwide and by working with a property management firm, one can invest in properties outside the immediate geographic area.
Evaluating real estate investments
Effectively analyzing income properties can be very complex and is something best left to professionals. A commercial real estate investment professional can help identify and evaluate income producing real estate investments.
With this said, it is helpful if one becomes familiar with some of the approaches used to evaluate income properties.
Location, supply and demand and good demographics are important factors in evaluating real estate investments. However, when it comes to investing in cash flow real estate, one is mainly interested in buying the income stream the property offers.
Therefore, the most important factor for evaluating income producing real estate investments are the numbers.
Net operating income
Net operating income (NOI) is the annual income generated by an income-producing property after taking into account all income collected from operations and deducting all expenses from operations. NOI helps income producing real estate investors evaluate investment properties.
Operating expenses are those costs required to run and maintain a building and the ground it is located on. Operating expenses include items such as insurance, property taxes, advertising, property management fees, landscaping, snow removal, utilities, repairs and janitorial fees.
NOI is a before-tax figure. It also excludes principal and interest payments on loans, capital expenditures, depreciation and amortization.
Several ratios are used to analyze income producing real estate investments. The most commonly used ratio to estimate the value of income producing properties is the capitalization rate. To calculate the capitalization rate of a property, divide the net operating income by the sales price or value of a property.
To estimate a property’s value, divide the NOI by the cap rate. For example, if an office building has a NOI of $140,000 and the asking price is $2 million, the capitalization rate equals seven percent. In another example, if an office building has a NOI of $150,000 and capitalization rates in the area for this type of property are eight percent, the estimated property value is $1,875,000.
The money one receives from selling their property represents years of blood, sweat and tears. With this in mind, anyone selling their property should take time to educate themself on how to invest the sale proceeds so they can enjoy the retirement income they deserve and pass on sufficient wealth to their heirs.
While an individual may be tempted to invest in things they are comfortable with, such as land and certificate of deposits, much better options exist for creating passive retirement income. Acquiring the services of a reputable registered investment advisor and/or real estate broker are critically important decisions.
Make sure to do homework and obtain client references.
Chris Nolt is an independent registered investment advisor and the owner of Solid Rock Wealth Management, Inc. and Solid Rock Realty Advisors, LLC, sister companies dedicated to working with families around the country who are selling a farm or ranch and transitioning into retirement. To order a copy of Chris’s new book Financial Strategies for Selling a Farm or Ranch, visit amazon.com or call 800-517-1031.
For more information, visit solidrockproperty.com and solidrockwealth.com.