Knowing when it’s time to sell a commercial property can be a difficult decision. Many experts agree that it’s part art, part science. As a result, much of the information on commercial property analysis focuses on what conditions need to be met before purchasing an asset.
Still, it is just as important (if not more important) to analyze the property’s sale price—a critical factor affecting investment returns.
While there is no failproof equation, there are several major considerations in a sale decision. Here’s what you need to think about to figure out if it’s the right time to sell your commercial building:
- Time of the year
There certainly seems to be ‘popular’ seasons for selling homes. But is there such a thing when it comes to selling a commercial real estate asset? The answer is both yes and no.
Commercial property buyers and sellers are generally agnostic about seasons, focusing on investment decisions and fundamental financials when purchasing or disposing of CRE assets.
That said, there is wisdom in not selling during vacation months—which is August (before school starts) and December (when school’s out).
Many deals still get done during this time, but it’s much harder to locate and get in touch with people when they’re on holiday, so it might take longer to market and negotiate a commercial property. This is true even in this age when people are using smartphones to do deals 24/7.
- Market timing
It’s important to determine ‘where’ the market is in the boom or bust cycle when making sale decisions. To do this, find and read evaluations done by economists and commercial real estate analysts. The most popularly used index is the Federal Reserve Economic Data, which you can access online.
Understanding market timing certainly involves looking at liquidity and interest rates at a macro level—but it doesn’t stop there. You also have to analyze sub-index factors, including product type and location.
Check the recent sales of similar commercial properties. Is the cap rate trend showing upward/downward pressure, or has it remained flat?
Don’t forget to look at the building type and local market. Examine the vacancy rates and the location of the property for that asset class. Is it trending higher? How are the rental growth rates? Are they showing an upward or downward trend?
While it’s almost impossible to predict market cycles perfectly, you can make an informed decision by interpreting key metrics, including local market fundamentals and cap rate trends.
- Investment timing
The financial fundamentals of a commercial real estate property ultimately determine whether or not it’s time to sell it. There are four metrics to evaluate: the loan maturity, future capital expenses, upcoming tenant lease expirations, and investment goals.
- Is the loan maturity date quickly approaching? This means that interested buyers have to consider a refinancing event. Whether or not it’s easy to refinance or restructure a loan depends on the current capital environment.
- You also have to think about capital expenses, which can drastically affect a building’s value. Have you deferred large maintenance items such as parking lot, elevator, or roof repairs? Is there a need to address structural things such as the building’s foundation or façade? As a seller, you need to decide if you are willing to pay for these expenses before putting the property on the market.
- A third metric to consider is if there are any upcoming lease expirations. As you probably already know, near-term lease expirations mean uncertainty for potential buyers. You as a seller might also need to shoulder leasing commissions and improvements for new tenants.
- Lastly, don’t forget to think about your investment goals for the commercial property. Will the sale meet your return objectives, including the cash flow that’s already been realized and the projected sale price? It makes sense to take these expected investment returns and analyze this alongside other assets in your portfolio to see if it’s the right time to sell.
- The proforma
Like any commercial real estate investor, you probably spent a lot of time building a financial projection (proforma) of the property’s operating expenses, cash flow, income, and net operating income before purchasing it.
Go back to these projections and ask yourself: Does the contemplated sales price compare favorably to the proforma point? If it does, then consider selling.
If not, it might be better to hold on to the property until a better opportunity comes along.
- Potential for future returns
Selling a property means missing out on potential returns it may make in the future if you continue holding onto it. So ask yourself: How much in potential returns will you miss if you sell now?
Let’s say you require a 15% minimum annual return on your commercial apartment building. However, the market is up, and competition is fierce, with many new apartment buildings being advertised online.
Because of this, you estimate a yearly return of 9%, which is significantly less than your 15% requirement. Therefore, it might make sense to sell the property in this case because your expected future returns are substantially less than your requirement.
On the other hand, if you conclude that your current tenants will stay and rents will rise, it might be better to hold on to the property.
There are many other ways to estimate potential future returns that you might earn from holding an asset, including looking at new income opportunities, the property’s value relative to new supply, and debt availability at current interest rates. You can also analyze how similar assets are performing.
In addition, some experts recommend comparing new market value returns concerning what it might cost to acquire a new asset. Try to analyze if lower turns today may turn out to be better risk-adjusted returns, in the long run, considering the transaction costs, individual tax treatment, and execution risk involved in acquiring a new asset.
- A pool of available buyers
Lastly, it’s important to think about who your potential buyers could be and their motivations.
In general, larger and well-funded institutional buyers with access to low-cost capital (as in the case of REITS) can afford to pay significantly more than regional buyers or local business owners.
In addition, individual buyers who have to execute a 1031 Exchange Money on a tight deadline may also be willing to pay more than a buyer looking for commercial property as a long-term investment.
If these factors indicate a profitable sale, then it’s certainly worth considering disposing of your commercial real estate asset.
Your ‘sell’ analysis should be just as rigorous as your pre-purchase due diligence if you want the best possible outcome. Take your time and don’t decide based on emotions.