When is it time to sell?

Question

So I've owned a few properties now for several years - oldest 24, newest 5. A great time to exit was last year, but didn't pull the trigger for tax reasons - high priced 1031 exchange didn't seem like a great time. And I missed the opportunity to mortgage everything to the hilt and go shopping this year. Ugh.

2 questions:

1) Are there some heuristics for what ROE (return on equity) and expected appreciation indicates a sell position v. a hold?  From the news I'm seeing, it looks like prices will be flattish for a period, with some additional downside risk if the fed pushes rates into the 8% zone.  Of course, that also creates owner financing opportunities.

2) Any good posts or info on ownering financing?  Pluses and minuses?  Have found info online, but stories area always welcome.

Kevin Sobilo · Answer

Timing the market isn't really a "thing", just ask any stock professional about trying to time the stock market. Additionally, with real estate the market is LOCAL not national. There can be pervasive nationwide trends, but there will still be significant differences from market to market.

Not selling for tax reasons makes sense to me! Giving a large chunk to Uncle Sam is the last thing anyone wants to do.

Let's look at a 1031 exchange. I suspect you feel that even though you can sell for a good price, that you will have trouble finding replacement properties that are the kind of deals you would be excited about.

A few things to consider.

1. One property you have owned for 24 years. If its a residential property (1-4 units) you are almost out of depreciation deductions on it. So, that property in particular you want to consider selling or 1031 exchanging.

2. When buying a new deal, the deal isn't what's advertised. A deal is what YOU make of it. You can buy a 6 unit that barely cash-flows and improve it, raise rents, etc, or you might upgrade the heating system and reduce utilities putting money into your pocket. You also can negotiate a better price.

3. Marry the property, but date the rate! Interest rates are higher than we are used to from recent history. So, you would be buying a replacement property at that kind of rate, BUT that doesn't mean it will always be that way. You will likely have an opportunity in the future to refinance down to a lower rate.

4. DEPRECIATION! By buying MORE property, you will increase the depreciation deductions you get! In addition if a cost segregation study is feasible you can further reduce your taxes for the near future. In the end it doesn't matter how much a unit MAKES, its how much you get to KEEP! So, reducing taxes can sweeten a deal.

So, while buying replacement properties may not look exciting because nothing looks like a bargain on its face that doesn't mean you can't manage it into a better deal over time.

Dave Foster · Answer

@Nolan Marshall Jr, I like what @Trevor Richardson said about benefitting both seller and buyer.  The ripe times for owner financing are usually times of transition - early in a market when sellers still have a tough time selling and an owner finance opp can provide a buyer a reason.  Or late in a market when sellers have no problem selling but don't want to buy back into a heated market immediately.  But buyers are begging to buy properties.  And of course, times of interest rate movement when an owner finance option for a short term like Trevor mentions with a couple ofsight points lower interest can sway a hesitant buyer.

As far as hard matrics on when to sell that's tough.  There are few hard stops.  It's many times just a gut and spirit check as you saw last year.  The components of the IRR do not move in lock step.  For a while now appreciation has continued strong but amortization is hampered by higher interest rates.  For sure you're coming up on a hard sell sign for those properties that have the end of depreciation in sight.  You'll need to retrigger that with new depreciable basis or your IRR will plummet.  And I would also be concerned about looming cap ex on some of the older units.  Again, not a hard calculation.  Just a gut call.

It's just something to have in the back of your mind.  But I'd look at the whys of selling.  And not worry so much about what you'll be getting in a 1031 exchange replacement.  Good investors can always find deals.

The maddening thing is that the best time to sell and start a 1031 is the worst time to buy and end one (a sellers market).  But also the best time for the purchase in a 1031 exchange is the worst time to start one (a buyers market).  It may seem like all the properties around are "overpriced".  But don't forget you're benefitting from that as well.  You wouldn't be selling it for what you are.  So go back to the whys and count on going sideways on price.  Cap-Ex, Depreciation, change in neighborhood or tenants, desire to change classes of real estate, opportunity for better financing, desired change geographically or a move from active to passive.  These aren't necessarily heuristic science but rather art.

Trevor Richardson · Answer

Owner finance IMO really happens when it’s ideal for both buyer and seller. Not sure if market conditions push it, the seller has to initiate it by not wanting to cash out.

From the ones we have brokered the terms that are popular are 3-5 year balloon. Essentially serves as a bridge loan for the buyer and defers taxes for the seller.

To me long term doesn’t make sense unless you are a very high net worth person who wants mailbox money to pay for boat and Porsche fuel. I don’t know why someone working up the equity chain would want sleepy money for 10-15 or longer years…

Alex Olson · Answer

Often the reason investors can't find replacement properties for their potential 1031 exchange is due to 3 reasons.

1) an investor's obsession with Internet rates. As said above you date the rate. Rates change. They may go up for 5 more years they may drop next year. You can always refinance. If you put more money in your pocket with a better property in a better location, why not trade up?

2) you don't have a good buyers agent or buyer agent network. You may have an agent or two but tell them your current returns so they can help you find properties with better returns. Generic answers and "it doesn't fit my criteria" will not help you.

3) you are priced out of your home market and are too afraid to look outside because you don't know anyone. A lot of investors look to the Midwest. Of course I am partial to Kansas City because it is a growth market but there are likely others to consider.

Hope that helps!

Brian Wilson · Answer

@Nolan Marshall Jr As others here have already covered very good fundamentals from the objective side, here is my personal opinion on these decisions:

Tax Depreciation - How many years left do I have, does it make sense to keep the property even without the added tax benefits? For example - great location, future expanse opportunity, rare/scarcity component, etc.

ROE - is my current ROE meeting my investment criteria for other deals. If not is it an acceptable level of reduced return given the reduced risk (free and clear property)

Exposure - Am I exposed by having too much equity in one place. Would losing this property to a law suit hurt me severely financially?

Refinance - Is this property a good candidate for refinancing? - If in great location and want to buy something else while reducing risk and holding original property I can pull a good chunk of my equity out.

Cashflow - Does this property perform well? Would I purchase it as is today?

Nolan Marshall Jr · Answer

@Dave Foster, great points on end of depreciation up coming and pushing a change.  The oldest however was recapitalized and updated partially in Katrina, so I likely have more time than 25 straight years would indicate - 10+ years?  Also great points on the 1031 timing conundrum.  Main driver is looking at potentially better markets and concerns that Louisiana has some population shrinkage that may be leading to potential appreciation stall v other opportunities.  Gets to the gut call piece you mentioned.

Nolan Marshall Jr · Answer

@Kevin Sobilo - Thanks for that and much to consider in what you mentioned.  I haven’t really gone shopping for what other property might be of interest and what levers I could pull to spruce up a deal.  Will have to do some work in that space.

Louisiana time on market, from stats I’ve seen, is longest in August.  Not sure if that’s nationwide, but imagine it could be given it’s school start time.  So I may want to hang on another year and take the time to ID a good deal.

Dave Foster · Answer

@Kevin Sobilo, A jedi master response!  I should have had you write that chapter in my book!

When is it time to sell?

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