Holding a commercial real estate property for the long term is a strategically wiser investment compared to selling. Some industry professionals believe in selling and reinvesting in larger more recently constructed buildings; however, my experience has taught me to hold for the long term.
A tenant recently gave notice to move after 14 years of leasing my building that was built in 1979. The building was purchased in 2000 as a result of a 1031 Exchange. A 1031 Exchange allows an investor to sell a property reinvest the proceeds in a new property and defer all capital gain taxes. However, this property does not compete very well with the newer and better designed developments.
The building was purchased at a very low price and as a result the real estate taxes are very low. Therefore, the property can be leased for lower rent than more recently constructed commercial properties. Newer buildings cost more to construct, and taxes can be as much as three times higher in some cases.
The concept of adding value or Value Add to an old building makes it more marketable and is much more rewarding for the investor. A good architect and real estate broker can provide a strategy to make an older building more competitive to newer better constructed buildings.
For example, the exterior of some older buildings can be changed with new architectural treatments. In addition, demolishing portions of the building to create more parking or better loading access can make it more appealing. Adding interior treatments and dividing the building into smaller units can make the property more marketable and obtain higher rents. This concept is especially popular with the high tech industry in Los Angeles right now.
All of the changes mentioned do not come cheap; however, they create more value for the property. My company is working on modifying a portfolio of properties built over 50 years earlier. By Los Angeles standards, they are old buildings. These buildings have character which would be very expensive to duplicate in new buildings. We are able to double the rents by adding some of the modifications mentioned.
The lower tax base means that we can still be more competitive to the tenant with lower rents compared to newer buildings. The longer the investor holds onto the buildings the mortgage is reduced or eliminated resulting in a higher cash flow. This is why I advise investors to hold for the long term.
