The question all good investors must ask is, “When is the right time to sell my rental properties?” All markets, including commercial real estate, go through cycles. Riding a market when it’s on a strong upswing is truly a euphoric feeling.
Where are we on the Real Estate Market Cycle?
But where will the real estate market go from here? Shown below is a chart that shows the four phases of the real estate market cycle. I believe in 2016 the Pacific Northwest commercial real estate market moved from Phase II – Expansion to the beginning of Phase III – Hypersupply. Why? Because we are seeing for the very first time vacancy rates beginning to rise. Secondly, it’s all about rent growth. It’s still positive but rent increases are substantially less than they were a year ago. This puts us firmly in Phase III where rent growth is still positive but declining.
4 Questions Before You Decide
So is it time to divest of your real estate? Before making that decision, here are four questions to ask yourself:
- What is your time horizon? Are you at a point in life that it may be prudent to invest your money in lower risk investments? Or are you in it for the long haul come “hell or high water?”
- What is your risk tolerance? Can you afford to lose money if the real estate market goes in the tank?
- Do you need the equity in your real estate for other more important pursuits?
- How leveraged is your real estate? Or another way to answer that question, where is your property’s breakeven vacancy rate? If your property’s vacancy rate ballooned to 15% or more, would your property still generate a positive cash flow?
How you answer these four questions will largely determine the correct course of action for you to follow. Here are some other reasons that may help you decide if you should unload your rental property:
Good Reasons to Sell
- Sell when it’s still a seller’s market. The best time to dump your property is when the “herd” is buying. Or at the very least, get rid of it when the real estate market cycle is turning south, but well before the “herd” is aware of it.
- Sell when you’re running out of viable options to improve the value of your property. If there are no cost-effective capital improvements that will allow you to raise rents, then it might be time to sell.
- Sell when you’ve identified a replacement property for your 1031 exchange that has more upside than the property you currently own.
- Sell when interest rates are rising as cap rates will eventually follow. Cap rates are inextricably tied to interest rates. If you believe interest rates will be rising over the long term, then the value of your property will decline over the long term. If you think that is likely then sell, baby sell.
- Sell when you no longer enjoy owning real estate. If dealing with the day-to-day responsibilities of managing your real estate portfolio is beginning to cause undue stress, now’s the time to sell.
Good Reasons Not to Sell
- Don’t sell just because you see a downturn in the market coming. If you’ve got a modestly leveraged property that cash flows well and you’ve locked in a long term fixed rate loan at a low interest rate you should be able to successfully hunker down and weather the coming economic storm.
- Don’t unload your property when everybody else is selling. Fight the urge to follow the herd. Be contrarian. Don’t panic. Don’t be a lemming. Those who sell when everyone else is selling are the big losers.
- Don’t divest of your property when future improvements in county or city infrastructure will benefit your property.
- Don’t sell when the property’s neighborhood is in the path of growth. If your property is in a marginal neighborhood hold on until the path of growth envelopes it. Be patient.
- Unless you just want get out of real estate altogether, don’t sell until you find a replacement property. Do you really want to pay the capital gains taxes if you don’t have to?
- Don’t sell when the real estate market is trending upward. For all intents and purposes, you’re leaving money on the table if you do. Be patient.
- Don’t sell if you enjoy owning real estate. Life is good. Don’t sell if you don’t have to.
I believe that investing in commercial real estate is by far the best way to become wealthy in the United States today. It is certainly better than investing in any other investment vehicle – stocks, bonds, annuities, mutual funds, precious metals and other commodities. But there is a time and season for everything. And the decision of when to sell splits the knowledgeable and experienced investor from those who are not.