To sell or not to sell? This is a question that most property owners face at some point in their investment career.
In reality, a broker or agent is nothing more than an expert match maker….in the real estate market, of course!
We take the needs of one person and connect them with the needs of another person (a buyer and a seller.)
The key difference between traditional match making and connecting buyers and sellers in real estate is that there are not only personal reasons to buy and sell, but there are outside forces (like the economy) that influence this decision.
I sat down with my dad, and McDaniel and Company’s broker, Bill McDaniel, and we discussed some of the key points to review when a property owner is considering selling.
Before diving into these points, lets quickly look at 1031 Exchanges since it can play a key role in deciding to sell a piece of property.
Simply put, a 1031 Exchange allows for someone to defer capital gain taxes when selling one piece of property and buying another.
A capital gain in real estate is the increase in value that is realized at the sale of a property.
In other words, a property that was worth $25,000 in 1980 may be worth $150,000 today. That $125,000 increase in value plus accumulated depreciation is taxable when the property is sold.
I will leave 1031 Exchanges to the experts, but here’s the basics:
After a piece of property is sold, an individual has 30 days to identify a piece of like property and has six months to close on the property
By “like property”, I don’t mean that the property has to be in the same asset category. Someone could sell an office building and buy a restaurant building.
“Like property” refers to a property that is of greater than or equal to price and debt.
The capital gain is deferred until the new property is sold again, where another 1031 could be utilized to further delay capital gains tax.
The Main Point:
A 1031 Exchange is one of the top advantages of investing in real estate because it gives a property owner the option to sell property and be able to defer capital gain taxes until a later date.
A 1031 Exchange can significantly increase an individual’s cash flow and net worth.
There are several ways this can occur
An individual can take a non-income producing asset and then invest that money into an income producing asset.
Someone could sell a tract of land (most likely, not income producing), and purchase a retail center to lease (income producing).
If a 1031 is utilized, no capital gain tax is paid on the sale of the land, and a new stream of income has been created from the retail center.
An individual can sell a nice piece of property they own and purchase a “fixer upper” piece of property
Someone could sell the fancy office building for a restaurant building that needs substantial remodeling.
Knowing the properties that could be identified for a 1031 Exchange will play a key role in determining when and if it is a good time to sell your property.
Now, here are some other factors that may impact your decision to sell a piece of property:
Needs change over time, needless to say.
The opportunity cost of time tends to vary significantly over time in a person’s life.
At one time, it made sense to own a property that required more time to maintain.
Someone may own a shopping center with multiple tenants that has a high turnover rate. Leases are negotiated often, the empty spaces have to be rent ready, etc. Owning a property like this can be time intensive.
As someone’s time becomes more valuable, they have more to lose by owning properties that take more time to maintain.
Consolidation of a Portfolio:
Related to the sake of time, it may be time to consolidate a portfolio of properties.
For someone who owns multiple properties, it may be more practical to sell several of the properties and use those funds to purchase one property (or fewer properties than before).
This method can allow a property owner to move up in asset classes. For example, someone could sell several class C buildings to purchase one class B building.
Since the pandemic, businesses have had to adapt to change at a substantial rate.
With the current supply chain issues and gas prices, the transportation costs of goods are actually a larger factor than the warehouse/storage prices.
Therefore, companies are being more strategic than ever in where they are placing sites for merchandise delivery.
This certainly has an impact on real estate in strategic locations.
On a more local level, areas and needs change over time for a company’s needs.
A pizza restaurant owner may realize their employees are driving across town for most deliveries and decide that it makes more sense to move closer to their core customers to improve efficiency and cut down on transportation costs.
And the List Just Keeps Going….
Of course, there are a variety of personal reasons why it may be time to sell a property.
Perhaps you have a major change in life, need to free up some cash for another use, or just don’t to own the property anymore.
Highest and Best Use
If you are thinking about selling a piece of property, determine if its current use is still the highest and best use.
A car repair business on a street with high end retail and restaurants could most likely make a profit from selling its existing location to be developed and moving someplace else.
Considering the economic climate may be the most important question to think about when considering selling a property.
Know (or connect with someone who knows) not only the overall economic conditions but also the local market and economy.
Ask questions such as:
What is the current supply/demand ratio for the asset class of property you are considering selling?
Do your research or connect with someone who knows their stats who can answer this question.
What have the trends for cap rates for a particular asset class been in the last year in the area?
A cap rate is a valuation tool in real estate that shows the return on investment of a property. This allows for an “apples to apples” comparison among multiple asset classes.
See my blog explaining cap rates here.
When cap rates are rising, this means prices are falling: There is less demand for your property.
When cap rates are falling, prices are rising: There is more demand for your property.
When contemplating if it makes sense to sell a piece of property, consider both the personal reasons and outside factors contributing to your decision.
The job of a traditional match maker is to learn the wants of individuals and then connect people if they appear to be a match.
A match maker in the marketplace essentially plays the same role but considers outside forces, such as economic conditions, that impacts all parties.
*Disclaimer: Please use professional tax advice for specific information related to your personal 1031 Exchange situation.