Top Reasons to Sell Investment Properties
There are any number of reasons people sell their Commercial Real Estate Investments, but below are a few of the most common.
1. Take a Profit: Owners often sell to capitalize on favorable market conditions (like we’re currently experiencing) including high demand, low cap rates and availability of financing. I love this expression taught to me by an early mentor, “You can’t go broke taking a profit”. Many times it is a good idea to cash in on a favorable market, make a profit (and even pay taxes) and move on to the next deal.
2. Loan Coming Due: Based on the way many loans are structured (ie high entry costs, pre-payment penalties, stiff underwriting process) a loan coming due is an opportunity for the seller to evaluate whether they want to continue to own the current property OR go through the new loan process for a different property they would prefer to own AND that is a better fit with their investment goals.
3. Major Tenant Renewal: Whether the user is a “major” tenant because they create more than 25% of the rental income OR they are a significant traffic generator, the renewal of a major tenant lease will often times allow a seller to obtain maximum value and profit because a buyer (and the buyer’s lender) will be more confident in the security of the asset at this time.
4. Major Tenant Lease Expiration: Is the owner prepared to handle the issues that may result if their major tenant were to vacate? Could they handle the loss of rents, the potential tenant improvement costs, and the required sophistication to negotiate with a new corporate tenant? Trying to sell with 1 year left on a major tenant’s lease is usually very challenging, but selling with 2 to 5 years left, can many times be accomplished at a fair price to the seller.
5. Step-Up Basis Allows Sale: The passing of a long term owner who had a very low basis in a property frequently allows the heirs to sell the asset without a large tax liability. Often times, the party that died owned the asset for a very long time and may have neglected the asset due to age and a desire to maximize cash flow. The heirs can often benefit by selling the asset to a more capable buyer with fresh energy and capital and either cash-out or purchase an asset without these challenges.
6. Risk Outweighs Rewards: Many times if an owner looks at the potential upside of a property compared to the downside, it becomes obvious that a lot more could go wrong versus right. This is particularly true for the owner who has made a personal guaranty on a loan AND especially if there are partners who have not also personally guaranteed the loan.
7. When your cap rate is below the risk-free rate of return. Think of a cap rate as your net rental yield. The cap rate can be calculated as Net Operating Income / Value Of Property. NOI is calculated by subtracting all expenses from gross rental income. If the cap rate is below what you can earn in a risk-free 10-year Treasury bond doing nothing, you should consider selling because you’re not being adequately compensated for the risk you are taking.
8. Work Outweighs Rewards: The asset may not be risky, but might require a lot of effort. A multi-tenant center with a lot of lease turn-over, combined with an aging property, could make it the ideal time to let the property become someone else’s “opportunity”. This reason alone drives many parties to sell and exchange into single-tenant properties or much newer assets with higher credit tenants.
9. Seeking Better Long Term Rental Growth: One of the motivators for many single-tenant sellers is the long term leases with modest increases. For some investors, rental growth with additional risk and effort is better than long term leases with minimal growth.
10. Partnership Dissolution: Selling to dissolve a partnership is sometimes done for adversarial reasons, but frequently it is just because partners are at different places of life and recognize the benefit of selling and allowing the parties to go their separate ways.
11. Need/Want the Money: There is no crime in needing money. There are a lot of reasons an owner might need money. They may have another asset that requires a cash infusion to refinance, or they want the cash for a down payment on their dream home, or maybe they just want some financial reserves in anticipation of a market down-turn when they can purchase assets at much better prices.
12. More Depreciation Equals Lower Taxes: Larger properties allow for more depreciation. It is not unusual for an owner to sell a property that has greatly appreciated and purchase a much larger asset with much higher depreciation to help reduce their tax liability.
13. Fix a Bad Purchase: Not all acquisitions work out the way they were intended. Sometimes a buyer purchases a property that they thought was going to be a good acquisition and for many reasons, it just does not turn out that way. If the value has decreased significantly, it could make sense to take a loss to offset a gain.
14. Portfolio Rebalancing: An owner may have too much risk relative to a specific tenant, a certain geographic area or a specific product type. These are all factors that could unnecessarily increase an investor’s risk. A smart broker will help an owner look at their portfolio and point out the vulnerabilities.
15. Building Code Issues: The property may be older and re-tenanting the property might require substantial upgrades including ADA, sprinklers, seismic, energy, flood hazard, etc. These costs can be extremely high and yet doing the work creates very little immediate return. Many times properties needing these improvements are sold to an owner/user who is willing to make the investment because they intend to occupy the property for the long term.
16. Stuff Happens: Last but not least unforeseen “stuff happens”. Health problems, divorce, the need or desire to relocate to another part of the country can all be triggers for an owner becoming a seller.
Whether it’s personal, strictly business, or financially advisable, the decision to sell investment property is always a very important one. While these are all possible reasons an owner might sell, investors should also always seek the advice of professional legal and tax counsel before any acquisition or disposition of property.
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*Based on analysis for closed transactions between 7/1/2018 and 6/30/2019 for select U.S. markets comparing pricing achieved from Marcus & Millichap versus local, regional and national firms. Source: MNet and CoStar.