If you are like most of our investor clients you, from time to time, consider the prospect of selling your commercial property to cash out or move on to another investment.
So, you do a little research on your own and then talk to your broker about the current market value of the property. Then you pick up the phone and call your accountant to see what the tax consequences will be. After you hear the jaw-dropping number over the phone, the whole idea seems silly.
Then you may consider exchanging into another asset to improve your chances for appreciation or avoid spending money on deferred maintenance. After looking at the premium price you’d have to pay to improve your position, exchanging seems as silly as selling outright. So, you shelve the whole idea of a disposition and decide to hold the property and hope the wind stays at your back.
This is a scenario we hear over and over again. Our prime takeaway from those conversations is that investors are willing to take on a lot of additional risk over time to avoid writing those checks to the IRS and the Franchise Tax Board. It is quite understandable, as taxes due on a straight sale for most industrial assets add up to roughly one-third of the overall gain. We wrote a post on the topic last year called Tail Wags Dog.
After adding the fact that industrial property values have been on the rise for ten years, it’s easy to understand why investors may be content to keep rolling the same set of dice. This is one of the main reasons supply of industrial buildings for sale remains as tight as it has ever been. Most buildings that do make it to the market for sale attract multiple offers and are gone within days or weeks, even during the current pandemic. Buyers are not deterred by rising prices, as the numbers still make sense to them due to rock-bottom interest rates and 90% of purchase price loans. As counterintuitive as it might sound, both parties score a win on every sale, and right in the middle of a massive economic shock!
Savvy investors consider all their options, compare asset classes, underwrite risk and assess overall economic conditions before they make a decision to acquire or dispose of assets. That process complete, they choose the best alternative for themselves, based on their unique circumstances. It’s not a one-size-fits-all decision, and it could mean that selling outright, paying the taxes and padding a bank account with cash is the best option.
And, that is our point today. Whatever you decide to do with your property should reflect your position in life from both a quantitative and qualitative point of view. Maybe what’s best for you is to bite the bullet and pay the taxes on your massive capital gain. Maybe it’s not. But, it’s always worth looking into and making prudent changes to your investment strategy when called for. We’ve been around long enough to understand that real estate markets are cyclical. Where you are in life is important to consider relative to the real estate cycle.
President-Elect Biden is proposing numerous tax hikes that will directly impact the value of commercial real estate. If you follow our blog, you are aware of our level of concern over his plan to overhaul the tax code. If just one of his tax proposals becomes law, it would be very disruptive to the real estate market. The impact of any combination of two or more would be exponential. Should we expect the 1031 exchange to go the way of the do-do bird? Would a President Biden actually pull the trigger on eliminating the step-up rule? Would he actually sign a law that taxes capital gains at ordinary rates? We don’t know at this point if he will have the political clout to make any of those things happen, but he campaigned on a promise to do all three along with a few more. The senate races in Georgia will tell us a lot about the political balance of power after January 20th.
Regardless of that outcome, this is a good time to take a hard look at your investment strategy. As a property owner, you have multiple options and it is your interest to know how each one could impact the quality of your life and the safety of your hard-earned money.