JF1821: How To Sell Your Apartment Syndication Deal Part 1 of 2 | Syndication School with Theo Hicks
Now that we’ve completed the business cycle with our apartment syndication deal, is it time to sell? Theo will cover what you need to look into with each deal before making that decision. It may make sense sometimes to sell early, other times it won’t. How do you know when is the best time? Hit play to find out. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!
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Joe Fairless: There needed to be a resource on apartment syndication that not only talked about each aspect of the syndication process, but how to actually do each of the things, and go into it in detail… And we thought “Hey, why not make it free, too?” That’s why we launched Syndication School.
Theo Hicks will go through a particular aspect of apartment syndication on today’s episode, and get into the details of how to do that particular thing. Enjoy this episode, and for more on apartment syndication and how to do things, go to apartmentsyndication.com, or to learn more about the Apartment Syndication School, go to syndicationschool.com, so you can listen to all the previous episodes.
Theo Hicks: Hi, Best Ever listeners. Welcome to another episode of the Syndication School series, a free resource focused on the how-to’s of apartment syndication. As always, I’m your host, Theo Hicks.
Each week we air two podcast and now video episodes that are typically a part of a larger podcast video series that’s focused on a specific aspect of the apartment syndication investment strategy. For the majority of these series we offer some sort of Microsoft Word document, Excel template, PowerPoint presentation, something for you to download for free, that accompanies that series. All of these free documents, as well as past Syndication School series can be found at SyndicationSchool.com.
This episode is going to be part one of what will likely be a two-part series entitled “How to sell your apartment syndication deal.” So we’re finally here, we’re finally at the end of the business plan on your first apartment syndication deal. Now it’s time to sell.
Again, this is most likely going to be two parts. In part one, which you’re listening to right now, we’re going to discuss the thought process of determining when to sell. We’ll get into that here in a second. Then tomorrow or in the next episode, in part two, we’re actually going to discuss the actual process of how to logistically sell your property at the end of the business plan.
One of the duties that we discussed for the asset manager is to frequently analyze the market that the apartment is located in. The purpose of analyzing the market is 1) to make sure you are staying up to date on some market rents, but secondarily, you are looking at properties that have recently sold, so that you can determine what you could potentially get if you were to sell your apartment community.
You don’t really care about the price that it sold at, it’s more what was the market cap rate the deal was sold at, because that is how you calculate the value of your property. You take a look at your current net operating income, you divide that by your market cap rate, and that is the current as-is value of your property. So that’s one way to determine the value.
A more formal way is to request a broker’s opinion of value; we’ll talk about a little bit more in tomorrow’s episode on how to actually do that… But essentially, you request an evaluation from your commercial real estate broker, and they will provide you with an opinion of what they believe the current value of your property is.
Now, you should be doing this, as I mentioned in the episodes about asset management – you should be evaluating the market in this capacity at least a few times a year, just so you know exactly what the value of your property is now, and you can determine what you could get if you sold the property, to see if it makes sense to sell early. However, the actual sales price, the amount of money you can get for the apartment is just one variable that you need to take into account when you are going through the process of determining whether or not you should sell your apartment community. There’s actually going to be six other variables, factors, whatever you wanna call them, that you should be looking at when you are, again, determining if you should sell your apartment deal, and that’s what we’re gonna focus on for the remainder of this episode. Obviously, one is the actual price that you can get.
Number two — before we go into this, the purpose of this is to determine if you should sell early. When you initially underwrote the deal, you stated to your investors your underwriting was based on a projected hold period. Maybe you determined that you were gonna hold on to that property for five years, and that’s what your projections are based off of. Or seven years, ten years. Whatever that number was, that is what your IRR, your cash-on-cash return calculations were based off of. So the purpose of this exercise is to determine if you should sell before the end of the hold period, before your projected sales date.
Something else you want to consider is the status of your loan. What type of loan did you initially secure on the property? A few things that you should consider about the loan is 1) the interest rate. Did you secure an interest-only loan? If you did, at this moment in time when you’re considering selling, how many more months or years are left on that interest-only portion? Because generally, during the interest-only portion of the loan your cashflow is going to be higher, because you’re not paying the principle. And it might make sense to wait until the end of the IO period to sell, because you can essentially get all that cashflow upfront, and then once you have to start paying down the principal and that cashflow is gone, or at least reduced, the principal that you’re paying to that lender that used to be cashflow is coming to you; once that’s gone, then you can consider selling your property.
Something else to think about is when this loan is actually due. You don’t ever wanna get forced to sell. We talked about this way back in the Syndication School series where we talked about the three immutable laws of real estate investing, with law number two being securing long-term debt, because you don’t want to get forced to sell or refinance the property.
So if you think it’s time to sell and your loan is going to be due pretty soon, then it might make sense to sell at that moment in time, rather than waiting until your loan is due and being forced to sell or refinance at that time… Because maybe the market turns from the time you decided that you wanted to sell, to when you actually do it, because you wanted to wait for your loan to expire, for some reason.
So overall, if your loan is due soon, then it might make sense to actually sell the deal early, to avoid being forced to sell or refinance. And then lastly, you wanna also know about the prepayment penalty on the loan. If there is a prepayment penalty, what is that amount going to be if you were to sell now, as opposed to selling a year from now or two years from now, and how much longer until the prepayment period expires. So if there is going to be a large prepayment penalty, or a prepayment penalty in general, you need to make sure you’re subtracting that from the sales proceeds. So when you’re doing your typical disposition analysis and determining how much money you’ll be left over after paying back your investors, paying the loan, paying the closing costs etc, you need to add in that prepayment penalty to that calculation, because you’re going to have to pay that.
If the prepayment penalty is expiring soon, or the prepayment penalty will negatively impact your returns, you wanna wait. If it’s vice-versa, if the prepayment penalty is not expiring for a long time and you paying it is not necessarily going to significantly decrease the returns, then it might make sense to sell.
So those are just three things to keep in mind about the loan – one will be the IO period, number two would be when the loan is due, and number three would be that prepayment penalty.
The next thing that you want to consider when you are determining to sell early is the status of your business plan. We are doing the Syndication School assuming that you are going to be a value-add investor, and all of the information we’ve provided is based on that specific business plan. If you’re doing a different business plan, the logic is still the same, it’s just the actual tactics are slightly different.
Assuming you’re doing the value-add business plan, that means you’re making physical improvements to the property in order to increase the income. So you’re upgrading interiors, you’re upgrading amenities, maybe adding in other amenities… Some sort of physical improvement to the actual property in order to get more money in rent and other income.
So each time you do one of these improvements, each time you renovate a unit and lease it up, each time you get a new amenity, the income at your property is going to be increasing. So if you haven’t completed your entire value-add business plan yet, you need to determine what you would be able to sell the property for if you were to wait and complete those value-add improvements.
So how many more units do you need to renovate, and how many more units could you renovate if you were to wait 6 months, 12 months, 18 months? And then based on that, what would be the overall returns to your investors if you waited to sell, once those units were renovated, 12 months, 18 months, 6 months? Just do a sensitivity analysis based on continuing your value-add business plan; maybe not to completion, but maybe it makes more sense to wait 12 months, because you can renovate 25% more of the units, the income is gonna go up by X, which means the value of the property is gonna go up by Y, and you could exceed your investors’ returns by even more.
If you’ve already completed your value-add business plan, then this point is not necessarily as important. But if you still have a large majority of units to renovate, it may make sense to capture that value first, and then selling the property at a later date, at a higher price.
A third thing to consider, outside of the actual sales price, is going to be the status of the market. The net operating income is only one of the factors that is used in the value calculation. The other is going to be the market cap rate. So you want to do some research to determine where the market and where the submarket is heading. This can be accomplished by analyzing a variety of research reports created by third-party companies like Marcus & Millichap, CBRE, places like that. Or you can have conversations with your team members, property management companies, mortgage brokers, to determine what the cap rate is now and where they think the cap rate is going to be trending.
Obviously, this is all a projection, this is all estimates, it’s not going to be guaranteed; but if you believe the market is just going to improve, which means that the cap rate is going to reduce, then you’re going to be able to sell the property at a higher price, at a later date.
Another way to look at it is that if the trends are better than what your projections were, so if the exit cap rate projection that you assumed when you underwrote the deal is a lot higher than the trends, then it may make sense to wait to sell. And then obviously vice-versa – if the trends are not as good, then you might want to sell now, before the market turns.
So the next one is going to be pretty simple, and that’s just the age of the property. If the date of construction is before 1980’s, so the property is 30, 40 years old, then you are going to want to consider the fact that capital expenditures and deferred maintenance are going to be an ongoing issue. So more than likely you’ve got a number budgeted for cap ex, you’ve got a number budgeted for reserves, a number budgeted for maintenance or repairs.
Keep in mind that the longer you hold on to the property, the more cashflow you’re going to lose to those items. So if your budget is a lot less than what’s actually going on – so you projected $100/unit, whereas in reality you’re spending $200/unit, then each year that goes on and you’re spending that extra $100/month or per year, that’s eating away at your investors’ returns, so it might make sense to sell early, so that you can give them their returns back at a higher number than if you were to wait and continue to bleed out money to those cap ex issues.
Number five is going to be your investors’ risk tolerance. When you initially underwrote the deal you had your cash-on-cash and IRR projection, or whatever return projections that you used. So let’s say you projected an 18% IRR, with a 5-year exit, but after three years you determine that if you were to sell the property now, the IRR would actually be 27%. Obviously, continue to do what I said before – look at the age of the property, status of the market, status of the business plan and status of the loan, and use all those things to determine what the IRR would be if you waited 6 months, 12 months, 18 months etc, depending on how much longer your hold period is… And then based on those IRR numbers perform a sensitivity analysis using a varying cap rate. So what would happen to those IRR numbers if the market got better, and what would happen to those IRR numbers if the market got worse?
Now, if you sensitize those IRRs, and even if the market gets significantly better, the IRRs are not significantly better than that 27% number, then you are risking the chance of the market either remaining the same or getting worse, and you not being able to hit that 27% number.
So most likely, since your investors are passively investing, they have a lower risk tolerance, or at least a relatively low risk tolerance, compared to maybe let’s say an active investor… So if you’re not confident that you’re gonna be able to achieve a significantly higher IRR selling later compared to selling now, or whatever return factor is important to your investors – it might not be IRR – then if you wait to sell, you’re putting your investors’ capital at risk, and they might not want that. They might be happy with you selling early, getting that higher return, rather than waiting and maybe getting them a return that’s a few percentage points higher, but also maybe a few percentage points (or a lot of percentage points) lower.
That brings us into point number six, which is you want to also understand your investors’ investment goals, which you should already know when you had a conversation with them… Because at the end of the day, the decision to sell or not to sell is based off of the returns you can provide to your actual investors. They’re the ones that are the number one priority here. So what are their goals? Are their goals to receive their money back and profits back pretty quickly, so within 3-7 years? Is IRR something that’s really important to them? Or are they more focused on a longer-term hold that cash-flows, and they just wanna donate their equity back after 10-12 years?
If they care more about getting their money back sooner rather than later, then the IRR is likely going to be that important measurement, because the IRR is a time-based return measurement. So all things being equal, if you sold the property for $100,000 profit today, that $100,000 is worth more than $100,000 a year from now, or two years from now, or three years from now. And the IRR factor actually takes the time value of money into account. So the longer you’re holding the deal, the lower the IRR is going to be, unless obviously you’re significantly adding value and increasing the income at the property.
And then vice-versa – the faster the equity is return, the higher the IRR is going to be. So if that’s what they care about, it might make sense to sell sooner rather than later.
On the other hand, if your investors are more focused on that long-term cashflow, then you might want to wait to sell, because they don’t necessarily care about getting the upside, they don’t care about getting the money back; they just want a place to park their capital, receive 5%-10% return, and then at the end of the projected hold period they get their capital back… Because maybe this is how they planned their money, and they planned on that money being in there for ten years; then getting it back early – they don’t necessarily know what to do with it. If they say they planned on hold on to it for ten years and you get it back to them after five years, I’m sure they could repurpose that money, but maybe that’s something that they actually don’t want to do.
Overall, if you are confident that selling the property now will get you the highest return for your investors, then you should sell. And each of the factors I discussed are what you can use to determine if it is truly the best time to sell, or if you have a better chance of getting better returns to your investors by waiting.
So let’s say you determine that right now is the time to sell. What are the next steps? That’s what we’re gonna talk about in part two. In part two we’re gonna focus on the actual eight-step process for selling your apartment community.
Until then, I recommend listening to the other Syndication School series. I believe this is series 21, so we’ve got 20 other Syndication School series that you can listen to, a bunch of free documents as well… All of those can be found at SyndicationSchool.com.
Thanks for listening, and we will talk to you tomorrow.Follow Me: