How To Decide Whether To Sell Or Hold Real Estate

Posted by Joe Manausa on Monday, May 10th, 2010 at 12:43pm.

Deciding to sell or hold real estate can be performed with an ROI analysis that helps one remove emotion and the consideration of sunk costs.

Recently, a long-time reader from out of State (Robert) contacted me to ask for help. Robert had purchased a residential lot in Tallahassee with the intent of relocating to Tallahassee and building a home. With the turn of the economy, Robert believes that he might not be able to move here for another 3 to 5 years, so he asked me if he should sell or hold his real estate.

My initial reaction was to ask if he thought he would ever move here. Robert indicated that with family in the area, he would still like to move here, but will have to wait for better economic times. I told Robert that I would take a look at the lot but believed that he was going to be better of just holding it until he was ready to build.

The following case study demonstrates the process that I would encourage Robert (and anybody in Robert's situation) to use in deciding whether to hold or to sell a lot in Tallahassee.

Tallahassee Historical Lot Sales

When we look at historical lot sales in Tallahassee, we see prices jump up more than 300% from 2000 through 2007, only to see them drop back down dramatically ever since. So why such crazy behavior?

Real Estate Graph of Tallahassee Lot Sales

I believe it has a lot to due with the Florida Comprehensive Land Use Plan which was enacted in the 1980s. The "Comp Plan" created a glut of residential lots available and thus there was no real appreciation throughout the 1990s. By 2000, the glut was consumed and normal market conditions resumed. The cost of development had skyrocketed and now residential lots were selling for significantly more money.

All of this coincided with a national real estate market explosion, so land prices shot through the roof. More developments were created and more lots were brought to the market in order to keep pace with the frantic demand. Unfortunately, the explosion is over and we are left with another glut of residential lots for sale in Tallahassee.

Future Lot Values In Tallahassee

In order to determine the realistic path residential lot values will take, one must study residential supply and demand in Tallahassee. With our 12.5 months of supply of homes, as well as the mounting shadow inventory, it is likely Tallahassee will not need any new homes built for growth for the next 3 to 5 years.

When we plot expected lot sales on the graph, we see the following disturbing image:

Residential Lot Sales Graph In Tallahassee

In the real estate graph above, everything to the left of the vertical orange line has occurred, while everything to the right is projected. Note how we project a period of several years where lot values hardly move at all, but once the inventory is consumed, we see values shoot up to a level that is consistent with the expected cost to bring them to market.

Tallahassee Lot Sales Case Study

When we look at the specifics of Robert's situation, we know that he purchased his lot in 2007 at a price that was just below the average lot price at that time. We will assume that if sold at any time in the future, it will sell below the current average lot price. The following graph shows that we should expect Robert's lot to return to its acquisition value in 2019!

Tallahassee Lot Sales Graph

So how do you decide what to do with your residential lot in Tallahassee? In order to complete our case study, we need to make some assumptions for Robert's specific situation. For the purpose of our analysis, I will assume that:

  • Robert financed 80% of the acquisition with a 15 year loan at 6.5%
  • Monthly mortgage payment is roughly $600
  • His annual principal reduction is $3,000
  • His annual property tax bill is $940
  • He has no Home Owner Association Fees (this could be way off!)

Using these assumptions, we know that Robert is paying roughly $5,000 each year to own a lot in Tallahassee ($8,000 in payments less $3,000 in principal reduction). Simply put, it costs him a net of $5K each year. He could sell it this year (most likely) for roughly $40K. He would still owe $60K on the note so with closing costs, a sale this year would require Robert to bring a check of about $24K to sell the lot.

He would need to hold the lot until roughly 2014 to be able to sell it and bring no money to closing (but that is after investing $8K per year for the next four years).

Surprising Recommendation For Tallahassee Lot Owner

After running some simple numbers, we are able to create the following two tables. The first is a equity analysis over time should Robert decide to hold the lot, the second is an equity analysis should Robert decide to sell the lot, but continue to make the same annual payments to an investment that yields 5% per year.

Keep The Lot

Date Value Debt Equity Investment ROI
May-10 $40,000 $59,392 -$24,192 $41,000 -159%
May-11 $35,000 $56,046 -$25,246 $49,000 -152%
May-12 $35,000 $52,476 -$21,676 $57,000 -138%
May-13 $35,000 $48,666 -$17,866 $65,000 -127%
May-14 $70,000 $44,602 $16,998 $73,000 -77%
May-15 $72,800 $40,265 $23,799 $81,000 -71%
May-16 $75,712 $35,638 $30,989 $89,000 -65%
May-17 $78,740 $30,700 $38,591 $97,000 -60%
May-18 $81,890 $25,433 $46,631 $105,000 -56%
May-19 $85,166 $19,812 $55,134 $113,000 -51%
May-20 $88,572 $13,815 $64,129 $121,000 -47%
May-21 $92,115 $7,416 $73,645 $129,000 -43%
May-22 $95,800 $589 $83,715 $129,940 -36%
May-23 $99,632 $0 $87,676 $130,880 -33%
May-24 $103,617 $0 $91,183 $131,820 -31%
May-25 $107,762 $0 $94,830 $132,760 -29%
May-26 $112,072 $0 $98,624 $133,700 -26%
May-27 $116,555 $0 $102,569 $134,640 -24%
May-28 $121,217 $0 $106,671 $135,580 -21%
May-29 $126,066 $0 $110,938 $136,520 -19%
May-30 $131,109 $0 $115,376 $137,460 -16%
May-31 $136,353 $0 $119,991 $138,400 -13%
May-32 $141,807 $0 $124,790 $139,340 -10%
May-33 $147,479 $0 $129,782 $140,280 -7%
May-34 $153,379 $0 $134,973 $141,220 -4%
May-35 $159,514 $0 $140,372 $142,160 -1%
May-36 $165,894 $1 $145,986 $143,100 2%

Sell The Lot

Date Investment Equity
May-10 $24,192 $0
May-11 $8,000 $8,000
May-12 $8,000 $16,400
May-13 $8,000 $25,220
May-14 $8,000 $34,481
May-15 $8,000 $44,205
May-16 $8,000 $54,415
May-17 $8,000 $65,136
May-18 $8,000 $76,393
May-19 $8,000 $88,213
May-20 $8,000 $100,623
May-21 $8,000 $113,654
May-22 $8,000 $127,337
May-23 $8,000 $141,704
May-24 $8,000 $156,789
May-25 $8,000 $172,629
May-26 $8,000 $189,260
May-27 $8,000 $206,723
May-28 $8,000 $225,059
May-29 $8,000 $244,312
May-30 $8,000 $264,528
May-31 $8,000 $285,754
May-32 $8,000 $308,042
May-33 $8,000 $331,444
May-34 $8,000 $356,016
May-35 $8,000 $381,817
May-36 $8,000 $408,908
May-37 $8,000 $437,353

Tallahassee Lot Sales Case Study Conclusion

I think the simplest way for Robert to evaluate his best course of action is to acknowledge that he has a decision to make. He should view each choice as a decision on how to invest $24K.

If he invests the money by keeping the lot (the $24K he would need to bring to closing will be kept invested in the lot), then the first table shows how his investment will grow. If he decides to sell the lot and bring $24K to closing, then the 2nd table shows how his investment will grow in the future).

Were this only a financial decision, the choice is clear and he should sell. His $8,000 per year investment in this lot is not wise. But if he plans on moving here in the next couple of years, keeping the lot makes sense. Why go through the expense of selling and then buying again in just a few short years. But once we get beyond two or three years, he would be smarter to sell the lot, and then later buy one like it when he is ready to build.

The money being spent to own the lot adds up quickly, so my instinctive advice was off base. Holding the lot will most likely yield worse returns then taking his loss today and investing wisely in the future.

Joe Manausa, MBA is a 26 year veteran of real estate brokerage in Tallahassee, Florida and has owned and managed his own company since 1992. He is a daily blogger with content that focuses on real estate analytics and providing his clients with a tactical advantage in today's challenging market.

4 Responses to "How To Decide Whether To Sell Or Hold Real Estate"

Linda wrote: very interesting; can you do the same for houses? let's say taking homes between $200,ooo - $400,000

Posted on Tuesday, May 11th, 2010 at 12:37pm.

Martin Hudson wrote: Joe,
Always enjoy your blogs.
It seems property developers, especially those whose still own the majority of lots, have lowered prices.
But I think size restrictions are worsening the sales rate. Buyer decisions have changed in the last couple of years. "Needs" in 2005, may not be "needs" today. After all, how many 2+2 families really "need" 2800sf or 3200sf homes?
My guess is these developers are going to have to continue to lower prices because buyers can't justify lot+build versus just buying existing homes.
Thanks for letting readers comment..
Martin

Posted on Tuesday, May 11th, 2010 at 1:08pm.

Joe Manausa, MBA wrote: Yes Linda, it would be very similar with houses, except that you would add rental income for the home during the hold time.

Posted on Tuesday, May 11th, 2010 at 1:37pm.

Joe Manausa, MBA wrote: Hey Martin, you are right. Buyers are much more focused on values... but developers owe money on the lots so many are not in a position to lower prices. We still have years' to work through this.

Posted on Tuesday, May 11th, 2010 at 1:39pm.

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