If you own a retail strip mall, or a small office building and have been receiving rents over the years, or have used it as your shop or office, you may have accumulated equity in that asset. That equity can be used to benefit you and your family in many ways. Are you examining them?
Is it time to move on or move up? If it is, you have several options that you can pursue. The easiest is to just sell the property, take your cash, and move to Hawaii. However, when the vicissitudes of life like unexpected medical bills, divorce, retirement pressures, or kids entering college disrupt your tranquility, you will be glad you invested years ago. Your challenge is to find the best resource that will analyze the value of your asset and work to generate the highest price for you.
As you have held your asset and paid the bank and the equity has increased and it can be leveraged to allow you to purchase another asset. This can “give” you two assets for the price of one, so to speak. Your first commercial purchase could buy your second one for you while still keeping the original in your portfolio.
A third option comes as a gift from the IRS. The IRS gives commercial real estate asset owners, or income producing asset owners, a break when they want to sell their property and buy a “like-kind” property of equal or greater value. The IRS allows you to postpone the payment of capital gains tax. Like everything with the IRS, there are rules and although they are not difficult to understand and to follow, a mistake can be costly.
Assume an investor sold a commercial property and realized a $400,000 gain and that he incurs a tax liability of $140,000, leaving him with $260,000 to invest in another property. If he gets a 25/75% loan-to-value ratio financing package, he then could purchase a $1,040,000 property. If, however, he were to do a 1031 Exchange with the same financing, he would be able to purchase a $1,600,000 with that $400,000 gain.
There are certain things one should not do and the following example illustrates some of them. An inexperienced investor built a building for which his wife’s medical practice would pay rent on 25% of the space. He hired a home builder to build the building and the resulting product looked like a very large home. Unfortunately for him, the site he had chosen was the center of an office park with 12-other small office buildings. The choice of this location was not thought out. They bought it because it was convenient for them and not necessarily for potential clients. They did not investigate the vacancy rates of the other buildings, the rent rate trends, the amenities required for the tenants (transportation, food, other commercial enterprises) and they had no understanding of the economic drivers of that area. Who was going there and for what purposes? What was the economic core of the site?
He should have hired a company to identify the best site for his objectives and then hired a firm to manage the property for him. The local competition was offering tenant improvements and free rent, items which he could not afford to offer. In addition, he failed to keep the building maintenance up-to-date.
The owner called and asked me to price the property for him. When I gave him my valuation, he declared that the price would not cover his mortgage.
There are some basic things you can and should do to minimize your risks.
First of all, understand your financial qualifications and the amount you want to invest. This will be driven by your net capital available, your level of risk tolerance, and your planning horizon. I believe it should be a minimum five to seven-years. Whatever it is, discuss it with your financial advisor. Rely upon an expert.
“I can get out if I need to…” is a bad investment strategy. Can you hold it “long enough?’
Second, understand how much work do you want to do .Do you prefer older assets that require a lot of remodeling investment, and more maintenance, or do you prefer a new asset? Do you prefer lower maintenance assets (offices, warehouses), or do you want to monitor and maintain high traffic, high wear and tear assets like apartment buildings?
Third, in my opinion, the investor should only be making financial decisions and should leave the rest up to a property manager. Give him a budget. Anything under that they handle. Any exceptions to the budget must be approved by you.
Fourth. Choose the right asset class. If you are a novice: start with an easy one. Industrial is easy or small multi-family.
Finally, just to offer you a fleeting glimpse into the obvious, and as our example above showed, location is important. Are there emerging commercial areas in established neighborhoods (Tennyson, South Gaylord)? Are there opportunities in newly developing areas (Arvada, Broomfield)? Is the demand for small warehouses in urban areas because of the “Amazon Effect” creating opportunities for new buildings in established areas (Wheat Ridge)? Where is the next ideal spot for small offices (West Colfax, Sheridan, Sloan Lake)?
- Understand why you prefer a certain asset type; compare that to investor trends
- Study the economic drivers behind investment sites; understand the competition and rent trends.
- Define what is your “long-term planning horizon”
- 1031 Exchanges are important; understand how they work. Get educated.
- Hire the correct resources to help
- Location remains important; make your insight work for you
Key Take Away
Don’t get caught in the same mistake as the gentleman in Ken Caryl. Don’t approach this lightly and don’t think of this as a hobby you can take care of on the side.
Do hire professionals to guide your sale and/or purchase. DO hire the proper leasing and management companies to make sure your asset performs. This is a lot different than an owner/user purchase. You won’t be there. Make sure it pays you and doesn’t cost you.
Call me so we can discuss you’re Denver commercial real estate plans. Let’s sit down for an hour over a cup of coffee. I’m buying.