Decision Making at the Tipping Point
- Aug 03, 2016
You hear it from investors all the time: “I would love to sell, but there is nothing to buy.” We all recognize that real estate values are cyclical and the market will have its ups and downs. Currently, prices are at an all-time high in almost every asset class. So while we don’t know when there will be a correction, we can all agree that where we are today is not sustainable.
What is important for investors to understand is that this is a tipping point, and they need to assess how that impacts their investment and wealth-creation strategy, especially in the net lease space.
There are many reasons people own real estate, but if the main reason is to build net worth then it’s important to look at risk mitigation. Unlike stocks, real estate assets don’t compound. The only way to achieve compounding is fairly consistent buying and selling. However, the investor that is concerned about high prices is not looking historically at real estate value and only looking at the short term.
Many investors lose sight of the big picture. They fixate on a number, deciding that they don’t want to buy at a 6 percent cap rate if they have to sell at a 6 percent cap rate. Instead, the investor should look to manage their risk and seek to acquire a more valuable asset.
The greatest risk in net lease is that the investor buys the property because it is “management free” and therefore a passive investment. The investor should look at the value they are trying to achieve, especially if they want to build cash flow. If the property is worth more, now is the time to move to another asset class or reallocate a single-property investment into two.
That is not to say “sell everything,” but if there is good appreciation in a few assets, reinvest that equity into a more credit-secure, higher-quality property, recognizing that the goal should be to improve a situation. If the investor holds onto the asset, then they need to be realistic about whether its value will hold for the next five to 10 years.
The bottom line is, if the choice is to sell for a lower return, there is still an opportunity to make more money overall, based on the value of the property today and the return achieved. The decision to delay in hopes of buying at a lower cap rate will ultimately deliver less money to spend. There is no way to make up the loss in dollars by not selling a property at the right time.
Now more than ever, the best way to manage real estate cycles and their impact on net lease property value is not with inaction due to fear of buying at the top of the market but in realizing there is greater value in the underlying real estate fundamentals.