Why Sell Your Investment Property Now?
Lately many people I talk to about selling their commercial investment property have similar outlooks on selling. They usually say something like “Why would I sell; I don’t need the money. What would I do with the money if I sold? I’d just need to re-invest, and the market is so strong that finding good deals is difficult.”
In many cases I agree with these statements. If an investor is in the business of owning income property over the long-term and has capital either in-house or from investors to buy for cash and hold through market cycles, selling may not be to their advantage.
However, there are many situations where selling could be the right move, even in today’s robust market that offers limited choices for replacement properties. Investors should seriously consider selling now while the market is strong. Here are some reasons why you may want to consider selling now:
Values may not always be this strong:
There are major macro-level risks factors related to the overall economy and market cycles that could affect property values.
Interest rates and cap rates:
The target federal funds rate is currently 2.25 – 2.5%. To put this in context, the fed funds rate in June 2007 just prior to the global financial crisis was 5.25%, and 20 years ago in February 1999 was in the range of 4.75%. In the early 1980’s it peaked at a whopping 20%+, and 40 years ago in February 1979 it was 10%. So, interest rates are at nearly all-time lows, and can only go higher in the future. While real estate cap rates may not move in complete lockstep with interest rates, history shows that they’re highly correlated. Therefore, higher interest rates may lead to higher cap rates, which would in theory result in lower valuations for income real estate. Based on this data, now could be a good time to sell an investment property.
The economy is in its 10th year of expansion — its longest period of expansion ever. While no one knows when the cycle will end and what will cause it to end, history shows that there will be a downturn eventually, and it may be sooner rather than later. When the market stalls, market confidence turns to pessimism, funding from investors and lenders dries up, demand for investment properties decreases, and property values flatten or drop.
Your investment property value is a large proportion of your overall portfolio:
I’ve seen clients that have just one or two large properties in their portfolio and don’t have enough diversification. A rule of thumb in investing is to limit one investment position to 10% of your portfolio. If your entire portfolio is one single property, you may be exposing yourself to too much risk, and selling to diversify into multiple smaller properties or other types of investments may be wise
You owe money on your properties:
While debt is common in real estate, carrying debt is a risk. Eliminating debt, especially while we’re at the top of a market cycle could be a smart move. When the market turns down, values may decrease, but your debts won’t, and your equity could be wiped out. A debt-free, diversified portfolio of quality properties is the safest approach. Selling while values are high and paying off debts could be the way to go. If you’re carrying debt on other assets, such as your primary residence, a business, or any other type of debt, taking money off the table by selling now and paying off your debts could be your best move.
You have a business that could use the funding:
Many owners of commercial investment property also own businesses and other types of cash-intensive active investments, such as real estate developments, renovation projects, etc. Having cash tied up in stabilized income real estate that produces a return that is much lower than their business or other active investments can produce may hamper their overall performance. In this situation, selling their income property to fuel their business and active investments may make sense.
Some businesses are direct tenant-users of their own real estate, such as restaurant operators, automotive service shops, and many other types of businesses. It may not be best for these types of operators to tie up their capital in real estate while they’re trying to grow their businesses.
There are investment funds that offer business owners the opportunity to sell their real estate but remain in the property as a tenant and lease it back (known as a sale-leaseback). This allows the business operator to eliminate all the debt they may be carrying, and free up their equity to fuel their business. They also convert from paying non-deductible mortgage payments, to paying tax-deductible lease payments.
Your property value is trending downward:
It could be time to evaluate your specific property’s future. If your long-term lease from a national credit tenant is nearing its expiration, you could be at risk of a major drop-off in value if the tenant doesn’t renew and leaves you with a vacant building.
If the location of your property is trending in the wrong direction, it could be time to sell in order to move your money into a property with a better future.
Multiple properties leased to the same tenant:
In rare cases, and investor owns too many properties that are leased to the same tenant. A prime example of this is a developer who builds single-tenant net lease properties for a national retail company, such as a discount dollar store, auto parts store, or fast food chain. If the developer chooses to hold multiple completed projects upon completion rather than selling them, they could end up with a portfolio of multiple properties leased to a single company. This could be a huge risk. If their tenant runs into financial trouble and defaults on all the leases at the same time, the investor would end up with multiple empty buildings, a loss of a major portion of their income, and a major drop-off in portfolio value.
It’s a great time to sell. The world is awash in funding that is a result of central bank policy, loosening lending practices, and a hunt for yield by investment funds. No one knows what the future holds and it’s likely that we’ll eventually see another tightening that could affect property values.
If your portfolio is well-diversified, your properties are high-quality and trending upward, your world is debt-free, your other business ventures are not cash-strapped, and you’re willing to ride through market cycles, then you may be all set to hold the properties you currently own. But if any of these risk factors describe your portfolio or your properties, you may want to consider selling in order to strengthen your portfolio and eliminate risks.