By Lee Y. Wheeler, III, CCIM, President of Wheeler Commercial
Commercial real estate values are at or near their historical peak in many markets. But even in cases where prices have yet to fully recover or simply remain flat, now could still be the right time to sell. The reality with this or any other market is that valuation should never be the sole driver of a decision to sell a commercial property. Instead, owners need to reflect on a range of factors to reach a fully-informed decision.
What points to a sale?
Valuation – and the risk that valuations could rise or fall – will no doubt be the key consideration in any sell-versus-hold analysis. But issues such as investment time horizons, occupancy prospects, maintenance circumstances, and taxation all play an important role. Key questions to ask include:
- What is the time horizon for your investment? A good starting point to consider is how you’re doing against the investment premise you had going in. Major real estate transactions are often driven by timing. For example, the owners may be part of a fund whose initial 5-7 year hold period is expiring. Alternatively, the investment could be part of a longer-term investment premise with no specified termination in mind. In either case, factors such as today’s relatively high valuations as well as remarkably low interest rates will play a role in any decision to sell.
- What are the occupancy characteristics? The property’s cash flow prospects are a particularly critical consideration, both to valuation and to the sell-versus-hold decision. Is the current lease about to expire and, if so, what is the likelihood of renewal – or renewal at a significantly higher rate with either the current or a potentially new tenant? The loss of a tenant could lead to significant expense, including vacancy or potential refurbishing costs to attract a new tenant. Alternatively, the prospect of signing a new tenant to a more valuable lease could lead to a higher overall valuation. To make an optimal decision, a seller needs to have a thorough understanding of both the property itself and the overall marketplace.
- Deferred maintenance: What is the condition of the property? Usage and the passage of time lead to potential maintenance issues. What is the condition of the roof – will it need refurbishing in the near future? How about the elevators, escalators, HVAC systems or parking lots? The expected timing of significant maintenance expenditures can have a significant impact on cash flow. A current owner may not want to commit additional capital and, as a result, would be more likely to sell.
- What are the tax implications on any potential sale? Before they can make a fully-informed decision, current owners need to consider possible tax losses or gains and have a reliable figure for their “basis” in the property — what was paid for the property plus what additional expenses can be added to this investment amount? Maintenance costs, improvements, and a wide range of professional fees increase this basis. The larger the better, as the difference between it and the eventual sales price will determine the capital gain on the transaction and thus the tax owed. And owners need to consider the extent timing could have on the tax impact of any sale. Potential capital gains or losses should be considered in the context of an owner’s overall tax position. Here, timing can be a critical component of any decision to sell. Gains or losses on commercial real estate can be used to offset gains or losses from other transactions, business operations, or personal actions or events (such as the establishment of trusts, inheritances, IRS liens, etc.). If a sale can be delayed beyond the end of the tax year, this can defer the tax liability. Alternatively, there will be cases where an owner will want to accelerate a sale as a means of optimizing overall tax costs. Overall, would-be sellers need to pay attention to timing not only in the market itself, but also in the tax arena.
- Are there any loan covenants or agreements that could add costs to the sale? Commercial real estate financing often comes with various fees for termination or early payoff. While such costs may not seem substantial in relation to the whole of any sale, by themselves they are not insignificant. Consequently, owners should take a look and be certain of the amount before agreeing on a selling price.
When the answer is “yes”:
If the answer to all of the above questions is yes, then the work really starts. In general, a seller will need to market the property. It starts with curb appeal, but whether that means updated landscaping, resurfacing the parking lot, or adding a new façade is up to the owners and how much additional capital they want to invest. Bear in mind that a little additional work can lead to a faster sale, a significant increase in the selling price, or both. Finally, owners should make sure they’re listing with a capable broker using both traditional as well as the latest digital tools. Working in close partnership with a broker leads to the best outcome.