Should You Ever Sell Good Income Producing Assets

 

I recently was faced with a decision to sell an income producing commercial building owned in a partnership of 20+ owners. We had not thought about selling the building, but an interested party approached us with a viable offer.

We were all suddenly faced with making a decision to sell or keep the investment. We had owned this investment for almost two decades and it has been spinning off good passive income returns. Our current annual cash return is equal to 34% of our original investment and we have also experiences an increase in equity. Should we sell? Let’s look deeper into this question.

At the time we made the initial investment, all of the investors were practicing physicians. Now we fast forward two decades and most of us have retired from medicine, died, or moved out of the area. Our interests in the use of our money have evolved. In the beginning, we all had the same position, working physicians wanting to add new passive business income.  Now the group is no longer homogenous. Some want to sell and use the capital for other purposes. Some want to keep getting the passive income cash flow. Some see a chance to cash in on the property for big profits.

Let’s take a look at what happens when you own an income property for a long time. Initially we put in enough money for the down payment of the property. The remainder of the purchase price was paid by taking out a large mortgage. Our equity in the building was only what we put into it, the amount of the down payment. We had leveraged our investment.

Over time, the value of the property has increased, the rental income has increased, and the monthly mortgage payments have been paying down the principal each month. Now we are only eleven months from having the mortgage paid off. That means our equity in the property has grown substantially though the years. My initial investment of $40,000 is now worth $225,000 if we sell today. That is a 562% return. Which works out to about 9.2% per year in equity increase. That doesn’t include all the cash flow we received those 19 years. It has been a very good investment.

We face a tough question though; is now the time to get out of the investment, end our partnership, and individually invest our money elsewhere?

The fact that we will have the mortgage paid off in just eleven more months is an important factor in making this decision. Next year, our cash flow will double and we will be getting about a 70% return each year on our original investment. The age old question was upon us: Do we keep a good annual cash flow of 70% return every year (starting in eleven months) or do we sell and get a lump sum capital gain of 562%, and invest or spend the money to meet our current situation?

During our discussions, some interesting points came up. If we keep this investment, just eight years after the mortgage is paid off our distributions will add up to the same amount of money that we will get from this sale, and we will still own the building.

We also looked at the return we would need to get from the sale proceeds to equal our after mortgage passive income. If my portion of the sale profit is $225,000 and I pay capital gains tax of 20%, I will be left with $180,000 to spend or reinvest. To match my post mortgage annual cash flow of $27,200, I would need to make 15.1% on the $180,000. That means, if we sell, I would need to find an investment that would return at least 15.1% in cash flow to equal what I already earn by keeping the building. That will be a hard investment to find.

For some of the owners, if we sell now, they will spend the money and not invest it. Many of them are now retired and living on their investments so this might be a chance to cash in and do some playing and not really affect their retirement income. Some of them will spend part of the money and reinvest a portion of it. This type of thinking keeps many young doctors from becoming wealthy. They sell income producing, appreciating assets, to buy stuff that not only doesn’t produce any income, but costs money to maintain and decreases in value.

I remember having a discussion with my father when he retired many years ago. I suggested he sell his house and purchase a nice motorhome and travel around the country. This was his chance to see the world. He asked me if I thought it was a good idea to sell an appreciating asset, his house, and buy a depreciating asset, the motorhome. I had never thought of it that way. Over the years, one of those methods, owning appreciating assets, leads to amassing wealth. The other method, owning depreciating assets, lead to poverty. I later read about this same concept in the book, Rich Dad, Poor Dad, which reinforced that lesson I learned from my dad.

Another factor that might influence the decision to sell a commercial building is the quality of the tenant. In this case, the tenant is doing well and has five years remaining on their lease. Next year we will pay off the mortgage. Even if the tenant were to leave at that time, we would not have the issue of trying to pay the mortgage without any rent coming in. Partner capital calls never go over very well. Once the mortgage is paid off, a vacancy would only create a loss of income, not a major expense to cover. That will make this investment extremely safe and secure and unlikely to generate a capital call.

So what should I decide to do? We had an offer on the table and a decision to accept the offer or turn it down must be made. Should I vote to turn down the offer and keep a $27,200 a year cash flow? Or do I vote to accept the offer, sell the building and cash a check for $225,000.  It’s not often one sees a check that large. Keep in mind that both of these figures are before taxes.

What would you do? Is there another angle I have not discussed that would help in the decision? Would reading my book The Doctors Guide to Eliminating Debt influence the decision? What if I were selling the building to use the money to pay off debt and become debt free? Would it be worth the trade? Is this the chance to get that awesome motorhome or beach house?

Comment below and tell us what you would choose and why.

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10 thoughts on “Should You Ever Sell Good Income Producing Assets

  1. Okay I am extremely biased. But positive cash flow RE would always be my dream investment. I read that you already have plenty with your other apartment buildings but positive cash flow RE is still awesome! It is much harder to find and manage these investments. If you already have such a great one why cash it out? Plus this one is commercial and could serve to diversify the residential apartments.

    Either way though, I think any option is great at this point for you Dr. Fawcett.

    • You are right, Dr. MB. I knew a doctor who had rental apartment buildings in Utah while practicing medicine in California. At least, if she had to quit her job, she has some kind of income to fall back on. You can’t say that for most of us; otherwise, we would not be taking garbage from our bosses.

  2. your answer is in the question. Do you want to take the time out of your busy schedule of travel and fun to do what you would have to do to find another investment that would do what this one has done? You talked a few weeks ago about being content in an example of buying a car. This is not the same but similar . I wouldnt want to go through the hassel of finding something as good or better and maybe not really get the same or better results.

  3. This is something exactly what my partners and I are dealing with right now. I own part of the building my multispecialty group practice is (70+ docs). It has been by far my best investment, I calculated that it has a blended gain of 575% since I originally bought it in 2006. It spits off pretty reliable dividends ($17,850/yr) which based on current assessed value is very low (little over 3%) but from initial investment put in the yield is great (22% or so).
    The reason why now it is so low is because our charge for rent was way lower than market (and kept that way for 10 yrs with us now finally increasing it to still slightly below market).

    The view of the majority of owners basically wanted to make sure the other partners didn’t have massive overhead and help retain partners which lowered general overhead that way.

    However we have had a recent unsolicited offer that is almost 2x our last April 2018 appraisal. Original investors could literally walk away with nearly 20x their investment value.

    The great debate is if we sell, those people would profit, but the clinic may self implode as the new buyer would not do what we did and actually run it as a business for profit and bring rates across the board to market value.

    I have a colleague in Florida that apparently had the same situation happen, they sold, rents became high, overhead caused those operating on thin margins to leave, and thus remaining partners shouldered more overhead and the death spiral began.

    Curious on how you would approach this dilemma. I’m near the tail end of my career so honestly the selfish part of me wants to cash in while the market is hot (who knows if this property will ever be worth the offer in future)

    • Nice story Xrayvsn. It does sound like mine. Everyone who has owned an income property for a long time will face this dilemma at some point. Frankly, I could go either way. I have a good use for the money if we sell and I would love spending the cash flow if we keep it. Decisions, decisions.

  4. I agree with Jereal and your dad. Keep the cash flowing. This investment is a great success and has at least 5 years of continuing. Maybe the remaining partners could buy out those who want to sell.

  5. I love passive income from real estate. Based just on the investment I would sit tight. If my partners really wanted to sell, I would consider our relationship and do the right thing. If I did sell, I would consider a 1031 exchange and not pay the tax.
    Nice “problem” to have either way. Congratulations!

    • Wealthy Doc, I love passive income from real estate also. It is the main reason I was able to give up my surgeon’s income. It is important that all the partners keep in good grace with each other. If we start fighting over this, it will not turn out well. It has been a good run, and likely will continue.

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