The Scanlon Report: Is it time to sell your investment real estate?
We are often asked by investors we work with whether it’s a good time to be selling. This question usually gets an “it depends” answer, because the particular facts and circumstances of each situation are so different that the answer could be yes for one investor but no for another.
Here are some factors that need to be considered in arriving at a judgment on this question:
• Hold period - If you have owned the asset for some time, you have used up a lot of the available depreciation (cost recovery), which is one factor that might make it advantageous to sell, since you have significantly reduced the annual deduction available to you.
• Life event - Life events such as death, disability, retirement, divorce, relocation and business partnership breakups often cause owners to think about selling. One never knows when these events will occur, but if you are experiencing any one of them, it could mean it’s time to sell. That can lead to peace of mind and less worry about management-intensive properties.
• CAP rates - For the past year or so, CAP rates have been climbing, putting downward pressure on prices. It’s conceivable that CAP rates could continue to climb, so if you have been thinking about selling, now could be the right time. In very general terms, the better the location and the better the tenant quality, the lower the CAP rate. There are buyers for every type of asset, but lately there has been more of a flight to quality, and such assets are easier to sell.
• Capital gains rates - Regardless of who becomes president, there is the possibility that capital gains rates will increase. Currently at 15 percent, they are due to automatically revert to 20 percent on Jan. 1, 2011. All of this raises the issue as to whether it makes sense to sell now and take the hit on capital gains. And remember, the tax on recapture of depreciation (cost recovery) is 25 percent. In New Hampshire, the business profits tax adds another layer of taxation.
• Interest rates - As with capital gains rates, no one has a crystal ball, but odds are that interest rates will climb, especially if inflation becomes more of a reality than it already is. We have seen some rate creep already, and lenders have tightened underwriting standards, making financing more difficult for many buyers who need leverage. This decreases the pool of potential buyers, and creates another reason to sell now. Also, if you have been thinking about refinancing rather than selling, it could be more challenging than in the past.
• Investment alternatives - If you sell and take the hit with capital gains, you can park the cash in less stressful financial instruments and wait out the current economic situation. Section 1031 is still available and remains one of the jewels of the tax code for investors. There has been a dramatic drop in the number of transactions that have taken place over the past year, and it is our view that there are fewer investment opportunities available, but they are there, often off-market.
For investors who would like to get out of direct management of investment real estate but still own high-quality property, one option is a tenant in common (TIC) interest. There are national sponsors who find and market interests in investment-grade properties, such as shopping centers, apartment complexes, office parks and industrial buildings all over the country.
These interests qualify for tax-deferral under Section 1031 and provide all of the benefits of real estate ownership. In general, returns have been in the 6.25 percent range, and TICs offer peace of mind to their investors, with monthly payments directly deposited to your checking account. As with any investment, advice should be obtained from experienced real estate, tax and financial advisers before buying these interests.
Dan Scanlon is a retail investment adviser with Grubb & Ellis|Coldstream Real Estate Advisors Inc., Bedford. He can be reached at 603-206-9605, or firstname.lastname@example.org