With GDP shrinking the past two quarters, quibbles over whether we’re in a recession are fading. The commercial real estate traditional office market is already experiencing a pinch with metro Phoenix at 21% vacancy as companies downsize office space on the heels of the pandemic and continued remote working.
For business owners who also own their buildings, now is an excellent time to maximize returns by exiting at the height of the real estate cycle. Capitalization rates are currently low but will climb along with interest rates. Used to determine if the price offered is reasonable compared to other sales, cap rates reflect the risk and quality of an investment. Valuations decrease in response to rising cap rates, so it’s generally advisable to sell when they are low and buy when they are high.
Here are three ways you can maximize returns:
Some businesses may be reluctant to sell as they like their location and don’t want to vacate the property. Under a sale-leaseback, the owner sells a property to a real estate investor, then rents it from the new owner in a long-term agreement. It’s a win-win that minimizes stress for everyone involved: the seller enjoys an influx of cash to use in operating the business or purchasing another property, and the buyer has cash flow without having to find a new tenant.
Sale-leasebacks are particularly appealing when a property owner intends to retire in the next 10 years — selling while prices are high enables them to receive optimal value and when the lease expires, they can renew or vacate without concern for market conditions or finding a quality tenant.
The strategy is often used in the health care industry. A current trend is physician owners selling their practice to a private equity firm, then because the private equity firm doesn’t want the real estate, they sell the medical office building at max value to an investor and focus on their core competency of practicing medicine.
Alternatively, sale-leasebacks enable business owners to take the proceeds from one property and invest in others elsewhere. There are distinct tax advantages to this strategy. With a 1031 exchange, a sale-leaseback permits sellers to defer capital gains taxes indefinitely by rolling the proceeds into one or more properties. However, to qualify for tax-deferred treatment, properties purchased through a 1031 exchange should be held for at least a year or two.
Another advantage of a sale-leaseback in the ability to negotiate favorable lease terms. Sellers can write in important clauses ahead of time, including death and disability, assigning the lease from private equity, no relocation, signage rights and free parking.
Whether selling to generate cash flow or benefit from tax advantages, business owners should consult with their adviser who who is familiar with their investment goals. Doing so positions property owners to not only favorably counter short-term market uncertainty, but also benefit long term.
Trisha Talbot is managing principal at Scottsdale health care real estate investment services firm DocProperties.
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