What Would You Do #7?

Mar 5, 2014 by

dice with question marksAs noted here a few weeks ago, my mother passed away January 31. When a loved one leaves this earth, distractions that occupy the mind can be helpful. Though I rarely write about my, not especially blog-worthy, life on these pages, I’d be interested to learn your perspective on a particular distraction I’ve been puzzling over and analyzing since my Mom’s passing.

Background: My Family’s Illinois Farm

On September 10, 1853, my great great great grandfather, Alvah Preston Coffeen, purchased 280 acres of farmland in Champaign County, Illinois for $2,000. (That land today would be valued at perhaps $3.5 million.) After many split inheritances spanning several generations and some sales to “outsiders,” my mother became owner when her father died of 80 acres of the original 280. And when my mother died, two of my brothers and I became owners of these same 80 acres.

I don’t know exactly when, but at some point in time 2 acres of the 80 were carved out and a farmhouse built. Additions were made to the house on at least a couple of occasions I think, but I believe the original structure is well over 100 years old. When I attended the University of Illinois in nearby Champaign-Urbana, I would sometimes visit Max and his wife Lou Taylor who lived in the house. Max and his son Tim farmed my family’s cropland under a tenant farming arrangement. Over the past 25 years, my Mom liked to visit the house on occasion, and she enjoyed the financial luxury of choosing to leave the house unrented for the past several years while she furnished and decorated it to her liking, a project she enjoyed.

Here’s What I’m Puzzling Over

Renting the house to improve the property’s cash flow may seem like a no-brainer. But I wonder.

The house is old, and it’s serviced by a well and septic system. These factors have the potential to translate to bigger-than-average maintenance costs. Also, since the house has been unoccupied for several years, we don’t really know its current condition and what maintenance might be required to make the house rentable.

Instead of renting the house, why not demolish it and convert the 2 acres back to cropland?

The Numbers

I’ve done a one-year snapshot cash flow estimate if the house were rented:

farmhouse cash flow

This assumes $750 monthly rent, which I’m fairly confident is within +/-10% of what the market will bear in the area. The other numbers have a low margin of uncertainty, except maintenance & improvements, which necessarily is a guess. I think $2,500 is conservative for this particular property, but I’d be interested to hear your comments on that.

None of the owners lives near this property, so we’ll need to hire a property manager to deal with tenants, handle maintenance, and so on. Also at least one of us will make an annual trip to the property. Those costs underlie the $2,000 per year management expense.

Here’s a cash flow estimate if the 2 acres were cropland:

cropland cash flow

So about $1,500 per year difference in favor of renting the house.

The Intangibles

Few business decisions reduce purely to dollars and cents, and this one is no exception. Here’s how I’d summarize the intangible factors:

  1. If we rent the house, I’m guessing that 98% of the time and decisions related to owning the 80 acres will be tied to the 2 acres, the house and its tenants. And with multiple owners, each decision has the potential to be especially time-consuming and problematic.
  2. Liability vulnerability for the business as a whole would be mostly tied to the house.
  3. One or two big house maintenance items every five or ten years would likely wipe out the cash flow advantage I’ve estimated above. If that happens, then you really start wondering, because of intangible #1, whether the rent-the-house model makes sense.
  4. I suspect there are tax advantages related to the house that are not captured by my pre-tax cash flow analysis. Any comments on this?
  5. As a family heritage asset, I’m instinctively resistant to the idea of demolishing the house.
  6. This is a tangible for which I could get an estimate, but I have no idea of the cost of demolishing the house and converting the 2 acres to cropland.
  7. To establish a capital gain tax basis, we’ve hired a guy to appraise the entire property as of the date of my Mom’s death. While discussing the property on the phone with the appraiser, he asked me whether there was a house on the property. When I said yes and suggested how he could gain access, he asked me whether the house was one of those old farmhouses. After I confirmed that it was, he said “it’s probably not worth anything.” That surprised me. The assessed value of the house is about $100,000.

What Would You Do?

For starters, I think we’re going to have the farmhouse inspected so we better understand where we stand with respect to maintenance. If the inspection concludes tens of thousands of dollars of work needs to be done before the house could be rented, our decision may be made. But I’m not expecting that.

What are your suggestions for how to think about and work through this question of renting vs. demolishing the house?

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