Real Estate Issues

Investment Real Estate: The Hold, Sell, or Trade Decision

Like the stock market, investors in commercial real estate face what many have found to be the most challenging aspect of ownership: deciding when it's time to sell. Many years ago, owning investment real estate was limited to elite individuals and institutions, but that's given way to a wide spectrum of individuals who've seen the financial benefits and security of investment real estate.

In rare situations where a buyer will pay a substantial premium over the market, the decision to sell might be an easy one; but where the offer to buy is on par with the current market, the decision becomes more complicated. Many times, the decision is based on financial analysis, but more often, these are tempered by other non-financial considerations.

Financial Considerations

  • Tax consequences. Because the IRS allows for tax deferrals on exchanges, after-tax consequences must be considered when comparing hold, sell, or trade options. An exchange permits the use of pre-tax dollars as payment, but it imposes a penalty on the amount of depreciation that can be taken.
  • Determining the yield for the sale/hold decision. How long one has held an asset and what after-tax dollars remain will influence the hold decision. The next step is to realistically project what's likely to occur in the future. Compiling a pro forma for the next five or 10 years, an investor can make an educated guess of the future value of the asset. The following factors can improve the ongoing yield: increasing rental rates, decreasing capitalization rates, and declining interest rates. From these future assumptions, an investor can calculate the annual after-tax income and by using the internal rate of return, show what the yield would be. By adding the after-tax cash flow total to the net proceeds on resale, the amount of accumulated wealth can also be calculated.
  • Determining the yield for an exchange. To make a valid comparison between holding or selling and reinvesting, it's necessary to select an alternative property to be considered as a replacement property. The same measurements used to estimate the future yield of the existing property can be carried forward to determine whether the new property is a good replacement. Care should be given to the calculation of the new depreciation factor due to special IRS 1031 code rules about carry-over basis.

Non-Financial Considerations

Leaving the results of financial yield analysis, it isn't unusual to discover an initially well-suited investment is no longer a good fit five to 10 years later. To determine how well an investment still fits with current goals, the following can be considered:

  • Market area. Has the surrounding area improved, or is there still projected upside potential? Can the investor create or maintain values going forward?
  • Investment goals. What are your future goals for the property? If the decision is made to hold, are there ways to improve the viability of the investment? Is the market for this type of property escalating? Can income be increased, can vacancy rates be improved, and can operating expenses be trimmed? If not, the property may have reached a plateau in value.
  • Alternative properties. Are there good alternative properties to consider? New opportunities surface constantly for investors who actively seek them. The top commercial real estate brokers can contribute significantly to the location and analysis of alternative investment properties.
  • Changed goals. How have the investor's goals or needs changed since acquiring the property? How closely does the property's profile now fit the investor's lifestyle, current cash needs, and future investment goals?

What's the answer? After calculating relevant financial rates of return and reducing other issues down to a comparative figure, the investor should now be in a position to decide. Both results should point to a clear choice. If not, then seeking outside consultation and relying on personal experience and judgment may be the deciding factor. IBI