What happens if you inherited property with a long-term lease?
Q: I’m writing about your recent column that dealt with a family inquiring about an inherited property with a long-term lease.
I know of a similar situation where a family leased one of the best locations in town to a large burger franchise restaurant decades ago under a 50-year lease. Apparently neither they nor their attorney knew of cost of living (COLA) clauses and they were sadly stuck with a tragically underperforming lease for decades.
Heirs don’t always get to change the terms of inherited property with a long-term lease
That may have happened here. If so, I think the children should feel sorry for their parents (and themselves) rather than angry with them.
A: Thanks for your comment. Not every financial decision is good – and sometimes there are valid reasons for not wringing every last dollar out of a deal. The adult children in your example, and those that we wrote about, may not enjoy the fruits of a fabulous deal. But they do have the benefit of some future income.
Long-term leases eventually get renegotiated
And that’s not all. Their children still own the property. When the lease is up, they’ll have the ability to renegotiate that deal. Hopefully, they’ll be able to get a market rate for the rental. So it’s not all bad. It’s just not great for this period of time.
But, this raises a larger issue: the number of complaints we get from family members who feel financially “cheated” by the decisions made by their parents or other relatives. We frequently receive questions from children about the choices their parents make regarding their own commercial and residential real estate. These adult children have concerns about the impact their parents’ decisions will have on their wallets and their lives. Many are upset that their parents want to spend their money while they’re alive, rather than leave it to them as an inheritance.
Heirs should appreciate cash-flow properties that deliver revenue
From where we sit, this is a lot of whining about nothing. It’s the parents’ real estate. Their money. They have the right to make their own decisions about how to deal with their money and property. That includes deciding who should inherit what, and how much. If anything. If you have $1 million, we think you should decide how to spend it. You can save it, invest it, stuff it in your mattress, or buy a jet share. Sure, we’d love to see you make a smart financial move for yourself. And, if it happens to build generational wealth, and benefit your children also, great.
So what does this mean in the context of your comment?
Often, owners of residential or commercial property enter into long term deals with people or businesses. We don’t know what they’re thinking, or if they’ve thought about what unintended consequences a decades-long deal might generate. Probably, these parents thought they were signing a good deal. They turned out to be wrong. That happens more often than you’d think.
Long-term leases can deliver annuity-like results
Let’s say you own a rental property, farm, store or other piece of property. And let’s say you agree to rent out for 20 or 30 years. You see the stream of income that the property will generate for you over that time. You’re happy about it when you sign the deal. It’s sort of like buying an annuity or bond that will pay you a certain amount every month without much work.
You’re happy with that because at the time, you got top dollar. In 1970. Fifty years later, prices escalated, inflation rose significantly and the value of that long-term investment eroded.
Try to add cost of living adjustments (COLA) to long-term leases
Many leases include either a cost of living adjustment (COLA) or an adjustment to market rents when they renew. So, if you have a 20- or 30-year lease, you can bump up what you get in rent over that time by the rate of inflation or by knowing what market rents go for in a certain area. The cost of living increase can be tied to the Consumer Price Index or other indexes. Some indexes follow specific states or geographic areas while others follow larger trends across the county.
These adjustments allow the owner of the property to receive increases in the rent depending on how the lease document is drafted. The increases could come annually or periodically, say every five or 10 years. But the end result is good. As long as the tenant remains in the property, the rent may rise according to the index to which it is pegged. That’s how a landlord avoids getting stuck with a long-term tenant paying the same amount over 30 years or so.
In a different context, a parent can give a lease to a relative to live in a home for the rest of their life rent free. At the end of the lease term, the property ends up back with the family and the family can choose to sell the property, renew the lease, or use it as they wish. And, we can see some economic value to parents who skip a generation and give the property to their grandchildren.
Financial decisions about inheritances, including real estate, can be complicated. Especially when that decision was made half a century ago.
Read more about what to do with inherited property that’s leased
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©2023 by Ilyce Glink and Samuel J. Tamkin. Distributed by Tribune Content Agency.