3 Reasons to Stabilize a Rental Property Before Selling

When you’ve invested significant time and money into developing or renovating a rental property, it can be tempting to sell as soon as construction is complete. At that point, you’re probably excited to recoup your investment and (assuming everything went well) a tidy profit! But not so fast…

If you want to maximize return potential, there’s another phase to complete: stabilization. 

Stabilization is when your units are fully occupied and generating stable recurring income. Yes, it can take some time to market your newly developed/renovated units for rent, screen for qualified tenants, and get everyone moved in. But the benefits can’t be ignored. 

So let’s look at those benefits to explain why adding the stabilization phase is likely to pay off.   

Here are the top three advantages of leasing up your new units before selling your completed rental property. 

Vacant buildings appeal to a very small number of opportunistic investor-buyers. Without renters, a building (even a newly constructed or renovated one) may be viewed as speculative. The buyer assumes the risk in filling units and establishing an income history. This can also make it more difficult for buyers to secure the financing needed to complete the purchase, as lenders may be less willing to assume some of the risk.

But once the property has proven occupancy and documented rent rolls, it’s considered a performing asset, which typically attracts more buyers (and their lenders). Most investors, including institutional investors, passive investors, and 1031 exchange buyers, prefer stabilized assets because they offer immediate, predictable cash flow. 

Additionally, by stabilizing the property, you can lean on the income approach to valuation when setting the asking price. This approach uses the rental income generated by the property to establish its current market value. In many cases, the income approach offers a higher value than the market approach (which relies on recent sales of comparable properties and can be tricky for unique properties without many comps) or the cost approach (which calculates the current land value plus the cost to replace the structure).   

So you have two factors working in your favor to earn you a higher sales price: increased demand plus a higher valuation, driven by proven rental income. 

One of the biggest financial advantages of stabilizing your property before selling is the potential to lower your capital gains tax. In the US, profits from assets held in service as a rental for less than a year are taxed as short-term capital gains, which are subject to your ordinary income tax rate, potentially as high as 37%, depending on your tax bracket. But properties held in service as rentals for more than 12 months qualify for long-term capital gains tax rates, typically ranging from 0% to 20% depending on your taxable income level.

Let’s say you invest $800,000 to purchase and renovate a small duplex, and then sell it ten months after acquisition for $1,000,000. That $200,000 profit would be taxed as short-term capital gains, which are treated as ordinary income because you held the asset for less than a year. If this gain falls into the 35% tax bracket, you’d owe $70,000 in taxes, leaving you with an after-tax profit of $130,000. Not bad for ten months of work! But what if you hold and stabilize the duplex for at least 12 months before selling?

Even if the sales price were to be the same (which is unlikely because the increased buyer pool and income-based valuation would likely drive the price up, but we’re focusing on just the taxes with this example), your $200,000 profit would be taxed at the lower long-term capital gains rates. At a 15% tax rate, your after-tax profit would be $170,000. That’s a $40,000 difference simply for holding and stabilizing the property before selling. Plus, you have rental income during the hold period, which should cover holding costs while creating passive income!

Finally, a stabilized property gives you breathing room. With tenants in place and cash flow coming in, you’re not under pressure to accept the first offer that comes along. You can afford to wait for the right buyer. 

That steady passive income stream creates a more flexible exit strategy. You can sell when market conditions are favorable rather than when your budget forces your hand. Even if the market temporarily dips (always be prepared, right?), you can simply hold and continue earning rental income until the market rebounds. You could even refinance the stabilized property to pull out equity while retaining ownership, as is a staple of the BRRRR method.

Gatsby’s multi-family built-to-rent investments use these advantages of stabilization to benefit our investors. Once development is complete, the property is stabilized through at least 12 months of in-service rental, so that you, as an investor, get the benefits of a higher sales price, lower capital gains tax rates, and potential rental income while we search for the right buyer.  

By investing in one of our syndicated real estate deals, you don’t have to worry about investing any of your own time or effort into the project. We handle every detail for you, using our experience, proprietary systems, and local connections to boost your profit margins. Plus, with low investment minimums, investing in unique real estate deals is hyper accessible to all accredited investors.    

Explore Gatsby’s available investment opportunities online or schedule a call with a dedicated investor relations specialist to discuss your financial goals today!