Is This Finally the Time to Sell?

The answer depends on your unique circumstances

There are literally thousands of Orange County business owners out there who bought their industrial buildings when prices were just a small fraction of what they are today. If you are one of those with the foresight and courage to have done so, congratulations, you are a huge winner. Your property’s value has appreciated more than you ever thought possible. 

If you bought a 10,000-square-foot building in Anaheim in the early 1990s for $60 per square foot, you would have dismissed any broker as crazy or dishonest who told you that your building would be worth $400 per square foot in 2025. We certainly would not have told you that, as making such a claim would have been well outside our professional comfort zone.

Yet here we are today and the truth of that statement is a matter of public record. Even buildings purchased as late as 2011 are worth nearly 4 times as much today. Oh, sure, some buildings in that size range are worth a little less depending on condition and configuration, but some are worth even more. So, for the sake of this conversation and to make our point, let’s stick with $400. 

Let’s take a look at a simple example of a 10,000-square-foot building acquired in 1995 by the owner of a machine shop in Anaheim for $60 per square foot ($600,000) with a 15% down payment ($90,000). The $510,000 loan he took out was paid off years ago using the rent he charged his own company to use the space. He then sells the building in 2025 for $4,000,000, or $400 per square foot. Let’s assume he took 30 years of depreciation on the structure using a 70/30 building-to-land split and put $200,000 into capital improvements over time. That leaves him with an adjusted basis of $476,923 and a taxable capital gain of $3,323,077 after paying 5% in closing costs. After paying California state income tax, Federal Capital Gains tax of and Federal Depreciation Recapture tax totaling $1,112,769, he keeps $2,687,231 in after tax proceeds. That amounts to 29.86 times his original down payment—after all taxes are paid!

With that in mind, if you were this owner and someone offered to sign a contract on the day you acquired the building in 1995 to buy the property in 2025 at a price that would yield you 29.86 times your down payment, would you have accepted that offer? Your answer is probably yes because you would never have expected to get anything close to that return on your investment when you acquired it. That outcome would have been unfathomable at the time. Yet, this potential scenario is ubiquitous in Orange County today.

We know, things that sound too good to be true usually are, but these are unusual times. The prolific run-up in industrial property values was fueled by ridiculously low mortgage interest rates, the result of the loose monetary policy of our central bank. When the Fed finally raised rates to stop runaway inflation , mortgage rates spiked and industrial property values topped out in late 2022. Prices have been edging lower since then, but we have, until now, avoided a full-blown market correction. 

This leaves owners of highly appreciated assets in a conundrum. Do they sell and realize their massive gains, pay their taxes and ride off into the sunset with their saddlebags stuffed with cash, or hang on and wait for prices to go up again if and when mortgage rates come back down? For those with a long-term hold strategy or who are planning on passing their assets along to their heirs at a step-up in basis, staying the course makes reasonable sense. But, for those who own properties that figure into the funding of their retirement, today’s conditions send a clear message to sell and reduce the risk of a loss in equity in the event of a correction. It is important to note that during the last two market corrections industrial property values fell by 40% or more, depending on submarket and building quality. A 40% correction takes a $400-per-square-foot building down to $240. Not a pleasant prospect.

So, why aren’t more owners of highly appreciated assets heading for the exit? Two of the most common reasons we hear are 1) the tax consequences of a sale and, 2) not knowing what to reinvest the proceeds in. 

As to the first reason, it’s easy to understand that no one wants to write seven-figure checks to the IRS and the FTB. That would be a painful experience no matter how big the gain is. But, watching equity erode during a correction is no fun either. Even after a 20% market correction, the owner of a highly-appreciated asset will still have a substantial tax bill to pay on top of suffering the loss in equity, which just adds insult to injury.

As to the second reason, there are many other investment vehicles to invest in, many of them that don’t include the ongoing risk associated with owning real estate. Even four-week US T-bills will yield 4.25% these days, and they are completely liquid and widely regarded as risk free. Depending on your unique circumstances and your appetite for risk, there are numerous options available. Some of them just might surprise you in a good way. More on that in our next post. Stay tuned.