Commercial Investment Real Estate May/June 2019 | Page 18

INVESTMENT
A N A LYSIS
Setting Up an
Investment Base Camp
How to build a model for the hold-versus-dispose decision.
by Joseph A. Fisher, CCIM
16
May | June 2019
Investment Base for Hold Alternatives
The investment base of the continue to “hold as is” alternative is
the sale proceeds after tax realized if the property were sold for
cash at the decision point.
This investment base is calculated as follows:
Sale Price
– Cost of Sale
– Mortgage Balance
= Sale Proceeds Before Tax
Sale Proceeds Before Tax
– Tax on Sale
= Sale Proceeds After Tax
(Investment Base in
“hold as is” Alternative)
The money left invested becomes the cash flow for the end
of year zero. Both the projected annual cash flows after tax and
the projected sales proceeds after tax at the end of the holding
period are the future after-tax benefits received from continuing
to own the property. The investment performance of the “hold as
is” alternative can then be measured by calculating the after-tax
internal rate of return (IRR).
Another hold alternative is to retain the investment but
to refinance and place some or all the refinance proceeds in
another investment. This would reduce the investment base in
the “hold and refinance” alternative.
–
=
–
=
New Loan
Existing Loan
Gross Loan Proceeds
Loan Costs
Net Loan Proceeds
Investment Base of
“Hold as is” Alternative
– Net Loan Proceeds
= Investment Base of
“Hold and Refinance” Alternative
This figure is calculated as follows:
The money left invested after pulling out the net loan pro-
ceeds of the refinance becomes initial investment. The after-tax
benefits received are: 1) the projected annual cash flows after tax
with the new loan in place and 2) the projected after-tax sales
proceeds once the new loan balance is paid off at the end of the
holding period. The investment performance of the “hold and
refinance” alternative can then be measured by calculating the
after-tax IRR.
COMMERCIAL INVESTMENT REAL ESTATE
A
real estate investor, after acquiring an asset, must
constantly make decisions during its ownership
cycle. Issues such as property management, ten-
ancy, and capital expenditures require attention and
careful consideration.
Throughout ownership, an investor must always weigh the
benefits, costs, and opportunities of holding onto or disposing
of a property. Saying “buy low and sell high” sounds like a recipe
for success, but it’s nearly impossible to time the market to sell an
asset in its most favorable conditions.
There is a process, however, that can help investors create a
decision matrix to fully understand hold and dispose alternatives,
along with the benefits of each avenue.
First, the investor must understand what is foregone by hold-
ing an investment. In other words, if the investor sells for cash,
how much could then be placed elsewhere? This cash flow is the
investment that remains in the decision to hold rather than sell
the investment. To accurately judge its performance from this
point forward, the investor must consider this amount as the
initial investment.
Investors often make the mistake of judging a property based
on its original investment, without consideration for the change
in value over time. For example, say an investor acquired a tract of
land for $500,000 cash 10 years ago that is now worth $3 million.
The investor must consider the sale proceeds after tax from a cash
disposition as the amount invested when deciding whether or not
to continue owning that asset. Rather than having $500,000 in
the land, the investor should make decisions based on $2.5 mil-
lion as the investment amount. This calculation is the sale price
minus the taxes on the long-term capital gain.
This alternative-use money is called the “investment base,”
because it is used to examine your options to sell the property.
Every investment alternative has an investment base. To quantify
it, ask the question, “If someone chooses this alternative, how
much money is that investor giving up the right to use in another
investment?” This investment base can then be used to measure
an investment’s performance from that moment forward.