Why do most syndications sell instead of long term hold?

[Kalen Jordan]

Seems like pretty much all the syndications I've seen recently exit within a short number of years - I'm curious why they don't hold long term?

[Michael Ealy]

Originally posted by @Kalen Jordan:

Seems like pretty much all the syndications I've seen recently exit within a short number of years - I'm curious why they don't hold long term?

 There are several reasons and it also depends on the apartment syndicator.

Here are some of the reasons why my exit time frame for apartment deals is 3 to 5 years (although, in one of my deals lately, I have an exit of 6-10 years):

1.  My strategy is VALUE-ADD. So as I increase the NOI of the property, with today's low cap rate environment, I create significant increase in value. A lot of things can happen in the next 10 years - one of which is cap rate decompression. If I exit in 3 years (and hopefully, cap rates have not decompressed significantly), it BENEFITS my investors because they get a BIG profit from the sale. Big profit from the sale means higher IRR for the project and higher IRR for the passive investors.

For example, if in 3 years, the cap rate is the same - say 5%, per every $100K in increased NOI, I increase the value of the building by $2M. If 10 years from now and cap rates go up to 6%, the same $100K increase in NOI will only increase the value of the building by $1.67M - about $333K less.

Of course longer term, the income should have increased more but the faster the increase in value, the higher the Internal Rate of Return.

2. Compound the return by getting into another deal. By exiting quickly, I can compound the returns for my investors since they can choose to reinvest their capital into another value-add deal. IRR factors in the time-value of money so the faster the money is reinvested after it grew, the more it will grow.

If with 2 investments, investment A you get 2X equity multiple after 5 years but investment B, you get 3X multiple after 10 years, which one is a better investment? Hands down, investment A. Specially if you can reinvest it in another deal with a 2X equity multiple again - then that means, you grew your capital to 4X (2 x 2) in 10 years!

3. Aiming for projects with faster turnaround gives us an option to REFINANCE if we decide to hold the property long term and take advantage of the low interest environment. I love value-add projects because with a little bit of work, I can increase the NOI, increase the value in a few years and refinance and take advantage of the low interest environment. If the increase in value is big enough, I can refi and return all of my investors' money back in 3 years and they retain their ownership equity in the deal. It's better to refi now (or in a few years) vs. 10 years from now where the interest rate is likely going to be higher than where it is today.

4.  Protect the cashflow from Higher Interest Rate in the Future. If let's say my strategy is not value-add and my NOI remains the same, say on year 5 until year 10 but the interest rate goes up 100 basis points during those years, my cashflow actually drops because of the higher debt service. So the sooner you can exit, you can avoid the risk of higher interest rates. Of course, you can avoid this risk if you get a fixed 30 year loan but you get better rates for 10-yr ARM - which translates to higher cashflow and higher yield for the investors. But since there's a 10-yr time limit, I aim to exit in 5 years because if something happens and there's a couple of years delay in exiting the investment, I will still be within the 10-yr ARM.