Should You Sell Your Apartment Syndication Deal Early?
As an apartment syndicator, one of your ongoing asset management duties is to frequently analyze the market to estimate the current as-is value of your property.
One way to calculate the current as-is value of the property is to determine the market cap rate based on recent sales and divide that by the current net operating income (value = net operating income / cap rate)
Another way to determine the current as-is value of your apartment is to request a broker’s opinion of value from your commercial real estate broker.
The purpose of estimating your apartment value at least a few times a year? – to determine if it makes financial sense to sell early.
In addition to the current as-is value of your property (i.e., the potential sales price), here are six other factors to consider to help you determine if it makes sense to sell your apartment deal before your initially projected sales date.
1. Status of the Loan
One thing to consider is the type of loan you secured. If you secured an interest-only loan, how many more months of I/O payments are remaining? Generally, you will receive a higher cash flow during the interest-only period, so it may make sense to wait to sell until you start paying down the principal.
Also, when is the loan due? You don’t ever want to get forced to sell, so if you think it is time to sell and your loan is due soon, it may make sense to sell now rather than waiting until the loan is due.
Lastly, if you were to sell now, would you be required to pay a prepayment penalty? If so, what is the amount and how much longer until that prepayment penalty clause expires? If there is a large prepayment penalty for selling early, you will need to subtract that amount from your projected sales proceeds. If the prepayment penalty clause expires soon or if paying the prepayment penalty results in returns that are less than or not significantly greater than your initial projections, it may make sense to wait to sell.
2. Status of the Business Plan
As value-add investors, we make physical improvements to the property via interior renovations and amenities upgrades in order to increase the income. Generally, every time you lease a newly renovated unit, the income increases. So, if you haven’t completed your value-add business plan, how many more units could you renovated if you held onto the property for another 12 months, 18 months, etc.? And what would the overall returns to your investors be if you waited to sell until you renovated those units in 12 months, 18 months, etc.?
If you’ve completed your value-add business plan, then this point isn’t important. But if you still have a large majority of units to renovate, it may make sense to capture that value first so that you can sell for a higher price at a later date.
3. Status of the Market
The income is only one of the factors that impacts your potential sales price. The other is the market cap rate. So, you need to think about where the market and submarket is heading. This is accomplished by analyzing the various reports created by third-party research companies, like Yardi Matrix, CBRE, Marcus and Millichap, etc., to determine the rental rate, occupancy rate, and market cap rate trends for the next 1 to 3 years (or the remaining time until your initial projected sales date). Then, determine how these trends compare to your underwriting projections. If the trends are better than your underwriting projections, it may make sense to wait to sell, and vice versa.
4. Age of Property
Another important factor to think about when considering the sale of your property is the date of construction.
If the property was constructed before 1980, capital expenditures and deferred maintenance will be an ongoing issue. Whatever you have budgeted to cover these ongoing issues will eat away at the ongoing return to your investors, which means that it may make sense to sell early.
5. Risk Tolerance
Let’s say you projected an 18% IRR to your investors with a 5-year exit. After 3 years, you determine that you can sell at a price that would result in a 27% IRR to your investors. In addition to the factors above, determine what the projected IRR would be if you held onto the property for 12 months, 18 months, etc. Then, perform a sensitivity analysis to determine what those 12-month, 18-month, etc. IRRs would be if the market were to shift in the positive or negative direction. If those sensitized IRRs are not significantly greater than, following our example, 27%, then you are risking the chance that you will have a lower IRR if you hold.
Most likely, your passive investors have a relatively lower risk tolerance, which is why they are passively investing in the first place. So, if you are not confident that you can achieve a significantly higher IRR (or whatever return factor is important to your investors) by waiting to sell, it is not worth the risk.
6. Investment Goals
At the end of the day, the decision to sell or not to sell is based on the returns you can provide to your investors.
Do they care more about long-term cash flow or about receiving their money and profits back within 3 to 7 years?
If they are interested in receiving their capital and profits sooner rather than later, then IRR is likely the return factor they focus on the most. Keep in mind that IRR is a time-based measurement. The IRR is higher if the initial capital and profits are received today compared to 1 year from now. The longer you hold onto the deal, the lower the IRR. So, if you are not confident that you can make up for that reduction in the value of money over time by creating more value and cash flow, it may make sense to sell now.
On the other hand, if your investors are more interested in receiving an ongoing cash flow payment, you may want to hold onto the deal so that you can continue distribution cash flow payments.
Overall, if you are confident that selling now will get you the highest return for your investors, then you should sell. Each of these 6 factors above will help you determine if now truly is the best time or if you will have a better chance at achieving a higher return by waiting.
Are you an accredited investor who is interested in learning more about passively investing in apartment communities? Click here for the only comprehensive resource for passive apartment investors.