Strategy: Hold vs. Sell

[Mike S.]

I would like to get everyone’s thoughts on hold vs. sell.

I have a property that generates a 20% CoC currently that I bought 2 years ago. Over the same time the property appreciated 30% and I can sell it and make a 2.3x on my initial investment.

How should I think through this? Would appreciate your thoughts!

[James Storey]

Hello @Mike S.

To decide whether to continue to hold an investment or to dispose of it, you must know the amount of money you could potentially extracted from the investment at the time the decision is being considered. This is not the same as the dollars originally put into the investment at acquisition or during the holding period. It is the amount of after-tax dollars that you could take out of the investment at the decision time "if" the investment was sold. This is considered your opportunity cost of holding the property as is because you are giving up selling the property if you decide to hold it. Anything invested in the property in the past when acquired or improved is a sunk cost and should not be considered in sell vs hold alternatives.

For example, an investor who purchased 20 acres of land five years ago for $50,000 per acre paid $1,000,000 cash. The amount of dollars in the land today, the decision time, is no longer $1,000,000. It is the sale proceeds after tax from an all-cash sale. Had the property appreciated to $2,000,000 during the five-year holding period, this would be $1,800,000 ($2,000,000 less the tax on the $1,800,000 long-term capital gain at 20 percent). The $1,800,000 is the amount against which the investor should measure future cash flow benefits when deciding whether to hold the land or to dispose of it. This is called the investment base, which is the amount the investor will forgo using in another investment by continuing to own the land. If the land was leased and cash flowed $180,000 a year, then the land would have a CoC of 10% if held today ($180,000/$1,800,000 = 10%). Conversely, if the investor took the $1,800,000 from the property and put it into a new property that had a cash flow of 15% ($270,000 cash flow), then selling the land might be a good option.

That being said, is the 20% CoC you are calculating based on what you originally paid for the property? If so, you can't make an accurate comparison to a replacement property if you are trying to sell and purchase a new investment like most would. If the 20% CoC return is based on what the opportunity cost of selling the property and taking the cash after taxes (assuming you don't 1031 exchange) i.e. Cashflow/Opportunity Cost = Hold As Is CoC, then you would have to ask yourself if the new property or investment you can buy with your proceeds would beat that 20% return. If for some reason you are able to find something that yields a 30% CoC return, then you have a chance of increasing your cash flow by 50%.

As you can see, the growth in appreciation get's consideration in the calculation of your opportunity cost (investment base) of selling the property. A lot of investors get wrapped up in what they have put into the investment as a dollar amount but all of that is sunk cost since it is in the past and cannot be changed.

James Storey, CCIM