When you own one or a few self storage properties, deciding when to sell your property can be daunting. However, understanding the time value of money (TVM) can help clarify why selling your current property and reinvesting in another can maximize your portfolio’s value over the long term.
What is the Time Value of Money?
The time value of money is a financial concept that states a dollar today is worth more than a dollar in the future due to its potential earning capacity. This principle is crucial in real estate, where property values and rental incomes typically appreciate over time.
Why Sell Your Current Property?
- Capitalize on Appreciation: If you’ve owned your property for several years, it has likely appreciated. By selling now, you can unlock this increased value and use it to invest in another property with even greater potential.
- Diversify Your Portfolio: Selling allows you to diversify. Instead of having all your capital tied up in one property, you can spread it across multiple properties or markets, reducing risk and potentially increasing returns.
- Leverage Tax Benefits: Using a 1031 exchange, you can defer capital gains taxes by reinvesting the proceeds from your sale into a new property. This deferral can significantly increase your purchasing power.
- Accelerated Depreciation: By purchasing new properties and conducting cost segregation studies, you can benefit from accelerated depreciation. This strategy can lower your personal taxable income by allowing you to write off larger depreciation expenses sooner.
The Power of Reinvestment: A Case Study
Let’s look at a simplified example to illustrate the impact of reinvestment. Assume you have a stabilized self-storage facility valued at $3 million, capitalized with $1 million of equity and $2 million of debt, generating an annual net income of $100,000 (a 10% return).
Scenario 1: Hold the Property
If you hold the property for another 10 years, assuming a modest 3% annual appreciation in property value and a steady income increasing by 3% per year, and then sell at the end of 10 years, you will have $3.28 million ($1.15 million in income, $1.13 million in appreciation and mortgage paydown less sale costs, and $1 million in initial equity). This delivers a 10-year internal rate of return of 16.3%.
Scenario 2: Sell and Reinvest in a Value-Add Property
If you sell the property now for $3 million and reinvest in a value-add storage property, you can potentially achieve an 18% internal rate of return on that new investment. Let’s also assume you utilize a 1031 exchange to defer taxes. Your new property’s value and income might look something like this:
- Sell current property for $3 million, paying off the $2 million mortgage and 3% in sale costs, with net proceeds to reinvest of $910,000.
- Year 1: Purchase a replacement property with a value of $3.5 million, assuming ~75% loan-to-cost financing and a 6% purchase cap rate ($210,000 per year of net operating income). After mortgage payments, your first year cashflow would be $41,650.
- Year 10: Assuming you find a property where there are opportunities to increase the cashflow through filling vacant units, revenue management, cost-cutting, or other measures, your new property value at the end of 10 years would be $5.74 million. Your total income over 10 years would be $4.32 million ($0.90 million in income, $2.50 million in appreciation and mortgage paydown less sale costs, and $0.91 million in initial equity).
- This scenario delivers an 18.0% internal rate of return.
Comparing the two scenarios:
- Holding: End value = $2.26 million; Total income = $2.28 million.
- Reinvesting: End value = $3.55 million; Total income = $3.32 million.
Making the Decision
While every situation is unique, the time value of money demonstrates that reinvesting your capital can often lead to greater overall returns. Here are a few tips to help you decide:
- Evaluate Market Conditions: Look at local and macro real estate trends. If your property is stabilized and in a market that has peaked, selling might be a smart move.
- Consider Your Goals: Are you looking for steady income, capital appreciation, or both? Your goals will influence your decision.
- Consult with Experts: Speak with your Marcus & Millichap broker and your financial advisors to get a professional opinion tailored to your specific situation.
Selling your self-storage property and reinvesting can be a strategic move to maximize your portfolio’s value. By understanding the time value of money and leveraging opportunities in the market, you can ensure your investments are working as hard as you are.
Feel free to reach out if you have any questions or need further guidance on making the most of your real estate investments. Happy investing!