6 Reasons You May Want to Consider Selling Your Commercial Real Estate This Year
As a real estate investor, you have three possible courses of action for your asset(s): buy, sell, or hold. The majority of property owners act according to a specific strategy put in place upon the initial acquisition that they use to manage their portfolio. It is the foundation and informs their decisions about what actions to take and when to take them. Having a strategy is important, but flexibility matters, too, and with unpredictable market fluctuations, plans often must change. Today, many long-term investors are facing uncertainty and are being forced to reconsider their 2022 strategy.
Transitioning to A Sell Strategy
A large majority of Orange County real estate investors utilize a buy-and-hold strategy: That is, they buy their real estate with the intent to hold onto their property for the long term. The benefits of such a strategy are plentiful: Investors can leverage debt to build equity and profit from numerous tax advantages such as depreciation. Then, they build wealth via appreciation of the asset.
But, just like in every other part of life, change happens. And often these changes prompt a shift in an investor’s strategy. Let’s look at the top six common reasons investors with a long-term hold mindset should consider selling – Especially in today’s commercial real estate landscape.
Top Reasons to Shift from a Buy-and-Hold Strategy to a Sell Strategy
1. Renovation and re-tenanting costs exceed the cost of purchasing an already stable asset.
Re-tenanting properties can come at a cost. From the cost of marketing the vacant space to the expenses associated with tenant improvements, property owners can often experience financial setbacks during these times, especially if the loss of the tenant was unexpected or represents a significant portion of the revenue.
For example, during COVID, CRE trends shifted, impacting investors’ initial investment plans. Many tenants had to vacate their space due to lost income from government shut-downs, resulting in declining property revenue.
As a result, landlords have to decide whether to re-tenant or sell. In this case, although selling was not the initial strategy, it may be the best solution for an investor hoping to recapture any losses incurred by the pandemic.
2. A property tenant’s lease expiration has dropped to only 5 to 10 years out.
Investors are often looking at their long-term return. They are drawn to leases that have multiple years remaining. For example, office investors often want tenant lease terms to have over 5 years, while single-tenant retail investors seek properties whose tenant lease terms exceed 10 years. This is a direct result of the reduced risk associated with a longer-term lease. Therefore, to maximize on one’s return, the best strategy is to sell properties when they meet the sweet spot for long-term investors. As an investor yourself, you can then trade into an asset with an even longer-term lease, repeating the strategy to preserve equity. As an additional benefit, properties with longer term leases are much easier to finance at lower costs.
3. An investor has more than 50% equity in their property.
Leveraging debt is the most optimal way to get into a real estate asset. With minimal money down (typically 20% to 30%), investors can purchase a real estate asset and utilize the income from their tenants to pay down their debt. Once an investor builds more than 50% equity in their property, they can then sell to trade into a higher income-producing asset. This strategy can be continued, promoting ongoing financial growth for an investor.
4. A vacant building will sell above market value.
A tenanted property is typically worth more than a vacant property. This is simply because the vacant property is associated with risk and requires more work to make it profitable. In rare cases though, a property may be deemed more valuable when vacant. For example, a strongly located development opportunity may drive a higher value due to the pro-forma returns of the site. Or, an owner/user may find personal value in the site and be willing to pay above-market rates. If a buyer has offered an above-market price for a vacant building, by accepting the offer, an investor can increase their return not only by the offer but also due to the saved costs associated with re-tenanting the property. Given historically low interest rates and excellent SBA loan terms, the current market should be considered a Seller’s market, as the scarcity of buying opportunities, coupled with favorable financing have shifted the market to favor Sellers.
5. An investor receives an offer above market value.
Many investors never plan on selling, until one day, they receive an offer way above the current market value. When inventory is limited, this is often seen in competitive markets. Whatever the reason, property owners who receive an above market offer should consider selling; this may be a rare opportunity for Sellers to maximize on their initial investment.
6. An investor finds a property that can give them a greater return with less risk.
All capital/equity investing comes with some level of risk. Commercial real estate investing has varying levels of risk as well. However, some assets present more risk than others, and typically, the higher the risk, the higher the return. If an investor identifies an opportunity to earn the same return on a less risky asset, they can improve their position by trading from one asset to another. The bonus in this situation is that an investor can defer paying capital gains taxes by utilizing a 1031 exchange. This has historically been a great strategy for investors to facilitate growing their real estate portfolio.
Preparing to Sell in 2022
Since 2019, the commercial real estate landscape has drastically changed. Investors who have always stuck to buy-and-hold strategies are now evaluating the benefits of trading out of their California real estate.
Some are motivated to sell their real estate and invest their capital elsewhere; some are moving their capital out of state; and others are simply trading asset types to ensure long-term security.
Whatever the reason for change, the recent shift in the commercial real estate environment has caused an uptick in investor activity. If you are an investor who owns CRE in Orange County, it may be time to strategize ways of ensuring your investment portfolio remains secure through the ongoing uncertainty. Reach out to a professional today to learn more.