Buy a Real Estate

I cannot keep track of how many times people tell me that they were thrilled to sell a property at a handsome profit, and then a few years later recoiled with total remorse when they realized that the property had doubled or trebled in value yet again. That doubling or trebling in value, if they had kept the property, would
have come at the expense of very little marginal effort. There would have been no contracts to study, no due diligence to perform, no finance applications to make—none of the activities normally associated with buying a property. In fact, by not selling the property, they would have saved all the contractual work associated with a sale.

There are, to be sure, extenuating circumstances when there may be some legitimate reasons to sell. For instance, with the restaurant premises that I bought for $120,000 discussed earlier, I had a succession of tenants, and then the building ended up being vacant. After many months of applying all my techniques to attract a tenant, I finally got a call from a couple in Switzerland who were keen to sign up as tenants. I was all excited at the prospect of having the premises leased once more. Then, just before they were going to sign the lease, they contacted me to say that after a lot of thinking, they decided that they would only proceed with their dream of opening their own restaurant if they could own the freehold of the property. I was faced with two options: Hold out for the gamble of a new tenant (which could take a long time), or sell the entire property to the Swiss couple at a handsome profit. It was an easy decision.

At public events I cajole the audience into coming up with valid reasons to sell a property. Few of the reasons proffered are truly valid. The most common reason given is to take the profit out of an existing investment, and then to use this profit to invest in another property. There are two arguments against this.

First, when you sell, as we have seen, you will pay capital gains tax and depreciation recapture tax. Second, while you may release the equity in a property by selling, you could release that same equity by refinancing the property and still retaining it.

For example, imagine you bought a property for $500,000 with a mortgage for $500,000 (you bought it vacant, but with a tenant in place it went up in value and the bank was willing to fund the entire purchase price). Assume it is now worth $2 million. You do not need to sell it to release the $1.5 million of equity. You could achieve the same result by simply refinancing with your existing bank or a new bank. You simply get a new appraisal and submit a new proposal for finance. Now admittedly, if the bank will only go up to a 70 percent loan to value (LTV), then they will only lend you $1.4 million, which is only $900,000 more than your present loan.

However, if you sold the property, you would lose perhaps 6 percent in selling commission ($120,000) and at least 15 percent of the capital gain to tax ($225,000), more to depreciation recapture tax, and even more to selling costs, leaving you with perhaps barely a million in net, after-tax profit. Which would you rather have, a million dollars in cash, or equity of $1.5 million (from which you could easily borrow another $900,000), secured against an asset worth $2 million, and rental income for life? The property only has to go up by 5 percent for you to make yet another $100,000 (which would be tax-free so long as you continue not to sell).