Investors sell property when they change their strategy.
Real estate is usually a long-term investment, whether it's a primary residence or a rental property. The decision to sell an investment property can be much different compared to selling a home, particularly when it comes to capital gains and other financial implications. But sometimes personal decisions can influence when an investment property owner wants to sell, says Doug Imber, president and co-founder of Essex Realty Group in Chicago. "Everyone has their own unique reasons to sell, but generally speaking, there are some similar reasons why someone might sell," Imber says. Here are eight reasons why owners should sell their investment property.
There are tax code advantages.
Imber says real estate investors who want to sell can take advantage of IRC Section 1031, which is a tax-deferred exchange. This allows investors to sell one property and buy another, temporarily avoiding capital gains taxes on the rental property. The taxes on that sale can be deferred indefinitely. There are restrictions, such as investors need to find another property to buy in 45 days, and then buy that property within another 135 days, for a total of 180 days. "People sell because they want to move capital from one opportunity to another. And in real estate, it's often (that) they use Section 1031 as part of that strategy," he says.
The loan term may be ending.
Many real estate investors use some level of debt, and many use term loans that won't be fully amortized, unlike residential mortgages. Investors may borrow money for five to 10 years, and at the end of the loan term they need to decide to sell or refinance. Investment loans have high prepayment penalties, discouraging debtors from paying off the loan early to sell the property. That means investors may sit on a property before selling. "A lot of times, people don't want to give away the prepayment penalty, and they'll wait until the end of the loan term to sell," Imber says.
Market conditions are strong.
When prices are high, it encourages selling. Imber says strong values may spur some people to sell even if they hadn't planned because they don't want to wait for the next market cycle. When the condominium market was hot between 2006 and 2007, some people sold, but others waited. In some instances, people who waited went through the Great Recession and had to wait had to wait at least five years or more, depending on their local market, before prices rebounded. "Investors who don't have the longest investment horizon, who only want to do this for another five or 10 years may not want to wait and see when the next cycle comes," he says.
Other real estate sectors look cheap.
Investors can claim building depreciation on tax returns, says Mark Brodson, president of Resource Commercial Advisors, and some sophisticated investors may dedicate part of their real estate portfolio to depreciation in order to reduce tax liability. "In that case it makes more sense for them to sell those assets and buy new to turn back the clock on depreciation," he says. Normally real estate assets depreciate over a few decades, but there are some complicated ways to speed that up, such as using cost segregation studies to depreciate certain interior parts in as little as five years, he says.
Taxes are increasing.
When municipalities increase assessed values for buildings, the higher property taxes can be an incentive to sell. "Local taxes play a huge role," Brodson says. In a gross lease, landlords are on the hook for paying taxes out of rental income they receive, meaning the extra taxes eat into the owner's net operating income if they don't raise rents. In other lease types, such as triple net leases, known as NNNs, the taxes are passed through to the tenants and the renters are directly responsible for the higher costs. Either way it can make it more expensive to be an owner, he says.
Rental income is stagnant.
Kelly Crane, chief investment officer of Napa Valley Wealth Management, says building owners need to look at how much of the building's return comes from rental income versus property value growth. In places where property values are high, it's difficult to generate a lot of net rental income. For example, if rental income is about $20,000 a year on a property that's worth $1 million, it might be worth selling, unless the building owner is expecting further growth. "When I can get a better return in a tax-free municipal bond, which is a passive investment, that's a good time to sell," he says. A return on a tax-free muni bond can fetch about 5%.
Long-term tenants leave.
If long-term tenants leave a building, it's an ideal time to do strategic improvements that could add to the value of the property and make it much more salable at current market values, especially if the market cycle is strong, Crane says. "It's hard to do extensive repairs when the tenants are in there," he says. Whether a landlord sells or not after significant improvements depends on what the building owner can get for rental income after the upgrades. "Improvements can help you recognize top market sale value when the rental income in unimproved condition may be below market," he says.
Reasons to sell your investment property.
-- There are tax code advantages.
-- Loan terms may be ending.
-- Market conditions are strong.
-- Other real estate sectors look cheap.
-- Building has reached full depreciation.
-- Taxes may be increasing.
-- Rental income is stagnant.
-- Long-term tenants leave.
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