How do you determine the price at which it's better to sell this asset instead of renting it out?

Question

Let's say you own a parking space. You have two options:

1. You can rent out the parking space for $1,000/month. It seems fair to assume that the rent will keep pace with inflation, which we'll call 2% over the long term, but otherwise remain fixed in real terms. For the example, we'll also assume that it's always occupied (i.e. no vacancy) and that there is no tax owed on the income.

2. You can sell the space, and use the proceeds to pay down long term debt that you would would otherwise carry at 4.5% (again, ignore tax effects/deductions).

How would you go about determining the price at which it is preferable to sell the space instead of renting it out? I am looking to understand the specific math.

Answer 1

You refers to the owner of the hypothetical parking space.

You can make the adjustment by calculating the Net Present Value (NPV) of the rental business and compare it with the estimated sale proceeds of the property. If NPV is larger, then it's better to rent the property out. Otherwise, it's better to sell.

NPV Formula

The formula is, quoted from the linked page above:

sum of R_t / (1 + i)^t for t = 0 to N

• t: Time period.
• R_t: The net cash flow in Period t.
• i: The discount rate.
• N: The last period of the investment.

Estimate NPV

To estimate the NPV of the rental business, you need to estimate:

• Annual/Quarterly/Monthly cash flow. This includes revenues and expenses.
  • Revenues include the rent collected, plus maybe some auxiliary services should you provide any.
  • Expenses include property maintenance expenses, tax expenses, etc.
  • Renovation cost. Once in a while, you may need to renovate. Don't forget to account that.
  • The value of your time. This is also one expense if you do not hire a manager. You could have used the time spent on rental parking space management to make extra money by doing side gigs, or rest better to make career advancement (assuming parking space rental is not the main career).
• The length of the holding period.
• The sale proceeds at the end of the holding period.
• The discount rate. You can estimate the discount rate by asking yourself: If I sell this property today, what investment would I put the money into? What is the rate of return of this investment? What adjustment would you make to factor in the difference in risk? In the example of your case, it is 4.5%, plus number that represents a risk adjustment, since the rental business is likely more risky.

With the above information available, you can plug them into the formula of NPV and compare.

Many of the estimates above are subjective and require knowledge in property maintenance, tax, property transaction, and investment in general. Given the uncertainty and subjectivity, one can also try to make one conservative estimate, one optimistic estimate, and one expected estimate, and calculate their respective NPVs. The same goes for the discount rate: Adjust it up and down to play with the numbers.

Answer 2

Ignoring taxes is a really big deal. It changes all the numbers a lot. Also, by choosing a parking spot (which doesn't need maintenance the way a house would) and stipulating you never go without rent (certainly not true of houses, partly because of that maintenance), you're making the example less representative of most of them.

That said, if 4% of something a year is $1000 a month, or $12,000 a year, then 1% of that same something is $3,000 a year so "something" must be $300,000. I changed your interest rate to 4% so I could do the math in my head. You can use a calculator. This pays no attention to the net present value of all that rent, since getting the rent doesn't reduce your ownership of the parking spot at all. You could still sell it ten years from now if you wanted to, or leave it to someone.

The going up by 2% thing is usually handled by considering the return of an investment after taxes and inflation, and working in current dollars. This means you can reduce the 4.5% you're comparing to. After all, if you get a 2% a year raise in your job without having to do anything, the payments on that long term debt will get easier and easier to make. Lowering the 4.5% will lower the "amount to sell for" that gives the equivalent in savings, over time, to the income from the parking spot.

Answer 3

If your choice is between a "risky" (meaning the cash flows are not guaranteed) investment versus a "risk-free" investment (in this case, a loan in the other direction), then you need to choose a "rate of return" that accounts for the extra risk. That rate of return should be equal to other available investments of equal risk (which is not easy to quantify).

Once you decide on a "required" rate of return (which should be higher than the 4.5% cost of your debt), then a standard NPV analysis would be appropriate. Calculate the present value of all future cash flows, making sure taxes and other expenses are accounted for. That would be the price at which you'd be indifferent between keeping the lot and selling it, investing in something else with that same rate of return, or paying off debt and investing the remainder.

In your case, the cash inflow increases over time, which complicates the math slightly.

Say you get an offer that equates to a 6% rate of return for the lot. Are you satisfied with that? Or would you require a higher rate to sell out? Only you can answer that.

Answer 4

Nothing of what you said is really relevant to price setting. Price is set by the market demand.

You can determine that the price is not worth it for you given the criteria, but the criteria is not the price driver. The price to sell is the price at which someone else will want to buy. You determine that by using comparables and analyzing the market demand and supply.

Answer 5

Calculate probable net yearly income from rental, after subtracting all costs (including maintenance, taxes, the value on f your time managing it and/or the cost of having someone else do so, unoccupied periods between tenants, lawyers...). Many variables to approximate depending on where you are and details of the property.

Calculate probable price you could sell it for, and probable net income from investing that elsewhere (after taxes and fees and your time and possibly boom/bust periods and whatever).

Decide how confident you are of those numbers. Adjust until you feel comfortable with them.

Then compare those two results.

Then decide if you believe the answer, and/or whether there are non-financial reasons which have to be factored in somehow.