There are countless articles online (this blog included) that provide advice on how to find deals, build a team, manage a deal, etc., but there isn’t much advice on what’s maybe the most important aspect of the deal – when to sell?
Jordan Fishfeld, who has decades of investing, development and sales experience in the real estate industry, has participated in the acquisition and sale of over $1 billion worth of real estate. In our recent conversation, he provided the three questions to ask yourself to determine if it’s best time to sell an asset.
Why Do Investors Have Difficulties Letting Go of Properties?
In Jordan’s experience, he has found that most investors suffer from what’s clinically called the endowment effect. Jordan defined the endowment effect as “basically, when you own something, you kind of want to keep owning it, even if it’s not in your best interest or fitting within your original model.”
A standard example would be you purchase a property for $100,000 at 25% down. Your original business plan is to hold the property for 5-years, receive a 10% cash on cash return each year – $12,500 overall. At year 5, the property appraises at $150,000. Rather than sell, since things are going great, you hold on to the property for another 5-years, continuing to receive the 10% cash on cash return, and now the property value is $175,000. For a novice to intermediate investor, that may look like an amazing deal. However, if you dig into the numbers, you could have received an even higher return if you sold in year 5, taken your original down payment and earnings, and reinvested your earnings into multiple $100,000 properties or a larger property, even at the same 10% cash on cash return.
This is a textbook example of the negative consequences of the endowment effect.
Jordan said, “the endowment effect problem is something that’s really hard to overcome. This isn’t an easy thing to do, to sell something you own that’s going well for you. It’s a very hard thing and I think that’s why it’s a great skill that is a learned skill. It is not a natural occurrence. It’s something that you have to learn and be good at and really stick to. I think people that do it well benefit tremendously from putting capital to the most efficient use possible at the most efficient time.”
How do you overcome the endowment effect and determine when is the right time to sell? Jordan said to ask yourself the following three questions:
- Would I buy the asset today at the price that I am looking to sell it at? If the answer is no, then you should probably sell. For example, if your initial goal was to receive a 15% cash on cash return, if you purchased the property today at the price you could sell if for, would you continue to receive a 15% return? If not, then you should probably sell, take your earnings, and invest in a similar or larger deal with 15% return.
- If I sell today, will the tax hit offset any gains I would achieve? Since when you buy a property, you aren’t hit with taxes, and when you sell, you are hit by taxes, make sure you are taking the tax bill into account when you consider selling.
- Is there a project that I can put my money in to satisfy my same goals? For example, if you sell this project where your initial target was 12% return over four years, which you achieved, and you know for the next four years you’re going to be making 8%. That reduces your overall project yield to 10% (approximately), can you find another deal that has a return greater than 10% in the current market at the same risk profile? If yes, sell. If not, keep.
Jordan recommends asking these three questions on a yearly basis. And to pull it all together, he said, “it still always depends on the investor individually and the projects individually and the opportunities available to that investor. But as opportunities explode with the online capital raising space, as information explodes all over with podcast and papers and books, and as yields compress, there’s a lot of different reasons why you should stay in and not stay in certain investments. But I think the skill of just doing a check-up on your investments and making that decision is very powerful.”
Related: How One Market Factor Can Tell You It’s Time to Invest or Sell
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Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action