Why do most syndications sell instead of long term hold?
Austin · Member since 2015 · 149 posts · 80 votes
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?
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.
So, if you invested $50k into a value-add deal, and it's now worth $100k, you have to look at your cash-on-cash return. Let's say it's at 10% after the value add ($5k per year). Sounds like a nice return, BUT, you actually have $100k in equity at this point, so you're actually only making 5% on your money. If you can cash out and invest it into another deal with 10% cash-on-cash, now you're making $10k per year, and getting a true 10% return on your money.
That's just another way of looking at, what others have said, is "maximizing your ROI." Of course not all deals are created equal, so you have to look at them individually, and also consider what alternatives may be available in the market at the time.
Yes, the deal sponsor makes a significant amount on the sale, but it's often the best scenario for passive investors as well.
Agreed, and this is return on equity.
Add to this a discount on the cash flows due to a risk profile, and that cash flow may not look nearly as attractive...
@Michael Ealy do you have a Delaware Statutory Trust set up on your deals for 1031 purposes? Interested investor. Thanks.
@Michael Ealy do you have a Delaware Statutory Trust set up on your deals for 1031 purposes? Interested investor. Thanks.
Hi Eric,
I don't have one set up yet although I've looked into it in the past. Instead of me hi-jacking this thread, I will reach out to you. Thanks!
These are great questions Rhett.
1. What I tell my investors - I tell them the projected exit but I also tell them a back up exit strategy (usually refinance and keep). Again, I want them to be prepared for the worst. Most of the time, my investors really don't care given that they make money whether we exit early or we exit later than expected.
2. Yes - this will work on new build but it all depends on how good the deal is, the location, etc. Done right, new builds can be very lucrative and can deliver project IRR of as much as 50%.
3. As far as being in an OZ, to be honest, I don't really focus my investing strategy on it. @Greg Dickerson might want to chime in about it.
These are great questions Rhett.
1. What I tell my investors - I tell them the projected exit but I also tell them a back up exit strategy (usually refinance and keep). Again, I want them to be prepared for the worst. Most of the time, my investors really don't care given that they make money whether we exit early or we exit later than expected.
2. Yes - this will work on new build but it all depends on how good the deal is, the location, etc. Done right, new builds can be very lucrative and can deliver project IRR of as much as 50%.
3. As far as being in an OZ, to be honest, I don't really focus my investing strategy on it. @Greg Dickerson might want to chime in about it.
One of the main reasons syndicators do not hold onto the property is that the profit is in the sale not the cashflow. Most syndicated deals have very little profits if any going to the sponsor out of the cashflow. A refi will only pull investor capital out and not profits or very little so that doesn’t generate profits for the sponsor either.
Second the IRR is higher the quicker they exit. They must exit in 3-5 years or sooner in order to hit the returns offered to investors.
Opportunity zone deals need to be held for 10 years to gain maximum benefit. The biggest challenge to this is it will lower the IRR. The Ozone deal needs to stand on its own before any tax benefits. This is the key most developers are missing. The Ozone benefit is the icing on the cake not the main ingredients.
@Ben Leybovich I think you made @Alina Trigub 's point in your statement that you always underwrite a 10 year hold and secure 10 year terms on your debt. It's the benefit of having options and to reduce the impact of variable of time as much as one can. We all want to maximize ROI and it sounds as if we're all in agreement on how to do that from a math perspective (numbers don't lie). Having the flexibility and mindset to weather a longer term hold greatly reduces the time/market variable from the equation so no one is backed into a corner. One then gets to choose the ideal exit window when they believe returns will be maximized - hopefully that is sooner rather than later and there is still opportunity in the market to redeploy capital to compound.
The best of both worlds, which has been mentioned, is to do a cash out refi to pull 100%+ capital out of the project to de-risk the asset and continue to cash flow ONLY if one believes there is more upside in the market and asset.
For example: we just sold one asset after a 3 year hold because we were able to exceed our targeted return metrics and weren't convinced on further upside. We are also in the process of refinancing two assets where 100% of capital will be returned to de-risk and continue to operate because we believe the deals and their respective sub-markets still have legs.
Happy and safe investing, everybody!
@Greg Dickerson My only disagreement with your statement is in terms of sponsor compensation after a refi. Theoretically, and it depends on how the operating agreement reads, if 100% of capital has been returned and investor capital accounts are brought to $0 then all future cash flow will be split between the LP and Sponsor at whatever the terms are (80/20, 70/30, 60/40, etc).
To your point, though, the volume of cash-flow after a refi is dwarfed by proceeds from a sale.
@Greg Dickerson My only disagreement with your statement is in terms of sponsor compensation after a refi. Theoretically, and it depends on how the operating agreement reads, if 100% of capital has been returned and investor capital accounts are brought to $0 then all future cash flow will be split between the LP and Sponsor at whatever the terms are (80/20, 70/30, 60/40, etc).
To your point, though, the volume of cash-flow after a refi is dwarfed by proceeds from a sale.
Yes that’s correct. I was saying that there may not be much profit if any to split after a refi. As debt service will increase after equity is pulled out. Not that a sponsor would not receive a share in any future profits. As you mentioned that would be as per the operating agreement.
Our highest and best use is to force equity via rehabbing. If you are not doing that then you are standing still.
Sophisticated investors re-leverage after their return on equity goes down.
Cash on Cash Return on Investment (COC Return)
The pre-tax year-end cash flow divided by the actual amount of original investment you have invested.
COC is used to compare your investment with other options excluding factions such as the use of leverage (mortgage), taxes, appreciation over time, and mortgage paydown over time. As time goes along and your investment goes well due to your tenants paying their rent as they should and the home going up in value due to inflation and market appreciation, COC becomes less relevant.
For example, if you purchased a property with $22,500 down payment, $5,000 in closing expenses, and $2,500 for some touch-up paint and new carpet, you are all-in for an original investment of $30,000. If at the end of the first year with your rental property in operation that you are able to profit $10,000 from cash flow after all operational expenses and debt service were paid, your COC return would be $10,000/$30,000 or 33%.
Sophisticated investors compare COC with other investments to determine the highest and best use for their liquidity going into an investment whereas ROE is used once the investment is owned. COC for mutual fund and stock investments have been known to have been in the 8-10% COC range.
Return on Equity (ROE)
One of the few downsides of real estate investing is that your investment is illiquid unless you sell or refinance the asset.
As you hold on to investments you are increasing you equity position over time via the following:
Mortgage paydown
General appreciation from the market
Forced appreciation from any property improvements
Say you had a great investment kicking off 20% COC a year. Your return on equity shortly after purchase on a $100,000 home that you used $20,000 to acquire is making you $4,000 profit a year. In this case, your ROE would be 20% ($4,000 divided by $20,000).
Great!
But say a couple years go by and with a hot market the property is now worth $160,000. You return of equity on the $160,000 home that you used $20,000 to acquire is now making $5,000 profit a year. In this case, your ROE would be only 6.25% ($5,000 divided by $80,000). Note: This does not include mortgage paydown.
For the minor headaches rental property ownership brings 6.25% would not be worth it. I personally believe that when you ROE dips lower than 10-15% you need to look to make a change in your portfolio via 1) Cash out refinance, 2) 1031 exchange or, 3) simply selling the asset.
@Kalen Jordan this question comes up a lot. It always points back to what the investors are looking for. There are advantages to both, but it depends on the investors’ goals.
Some investors want their initial capital back for a number of reasons. Others, who intend to continue to reinvest their proceeds from a sale, actually see it as a pain when a deal sells (especially a great deal) because they then have to go find another great deal - and they have to address capital gains.
With our investors we find that most would prefer to have a fund with multiple assets where these individual assets can be sold over time and 1031’d into more or larger assets and distributions continue to grow over time. We are currently working on a fund that may have this structure.
Luckily, there are deals out there of all shapes and kinds.
Shoot me a DM if you would like to discuss further.
@Ben Leybovichthere are other reasons why @Alina Trigub and others may say holding is safer during uncertain times. To me, it feels like you're taking a micro view (looking at the CRE market as the thing, rather than the global economy). If a debt jubilee occurs, in which all debt is forgiven, either in the US, or globally, then you'd rather have hard assets than cash in a bank where it may be within reach of the government. I'm not knowledgable enough to weigh in on the particulars of how it would work, if it could happen, or how to best survive it, but Neal Bawa has advised all RE investors to get familiar with the concept. So, yeah, you could say a hard asset is safer than cash in some circumstances if you're open to seeing that those circumstances are a possibility.
@Ben Leybovichthere are other reasons why @Alina Trigub and others may say holding is safer during uncertain times. To me, it feels like you're taking a micro view (looking at the CRE market as the thing, rather than the global economy). If a debt jubilee occurs, in which all debt is forgiven, either in the US, or globally, then you'd rather have hard assets than cash in a bank where it may be within reach of the government. I'm not knowledgable enough to weigh in on the particulars of how it would work, if it could happen, or how to best survive it, but Neal Bawa has advised all RE investors to get familiar with the concept. So, yeah, you could say a hard asset is safer than cash in some circumstances if you're open to seeing that those circumstances are a possibility.
So, now we are basing strategic investment decisions on a "debt jubilee"...
My mother is a very smart Jewish woman. She's taught me many things, one of which is this:
If you look for brains up your ***, you will eventually find them :)
@Ben Leybovich Global financial policy is far too complicated to hash out here, but I'd suggest if you want to know more on the topic you, google can help. In my line of work in marketing, I'm paid to create solutions and ideas that don't currently exist. So something I like to keep in mind is that all the things you never expected to happen or even knew were possible suddenly seem so obvious once they happen or someone brings them to your attention. But in the context of this conversation about massive uncertainty, once the unthinkable happens, whether one's head is in the sand or up their ***, it doesn't matter much.
Most syndications are groups of 10-20 passive investors. They're in it for the income growth. The first 7 years you can play games like interest-only loans and cost segregation to bump up the return instead of a longer hold.
Also, most loans are for a 7-year balloon. Add in that keeping 10-20 people on the same page for 7 years is a major achievement.
In almost all syndications, you're in it for life of the project. If some guy wants out, the main option is the remaining partners buy him out.
Great post but good lord, the level/degree of cut and pasting on this thread was epic. Nice to see this one revisited.
I personally don’t mind the GP making profit from the 3-5 yr hold as I like to put the new equity immediately to work along with original capital.
Most syndications are groups of 10-20 passive investors. They're in it for the income growth. The first 7 years you can play games like interest-only loans and cost segregation to bump up the return instead of a longer hold.
Also, most loans are for a 7-year balloon. Add in that keeping 10-20 people on the same page for 7 years is a major achievement.
In almost all syndications, you're in it for life of the project. If some guy wants out, the main option is the remaining partners buy him out.
Interesting perspective. I'm not sure I agree with that being the reason for the shorter term period, but still interesting. The syndications I invest in fill up their 99 investor slot maximums very quickly because folks are waiting in line for their next deals. 5-7 years is the ideal period for which an effective value-add or opportunistic strategy will play out.
With that said, when selecting a syndicated investment, you really are putting a lot of trust into the syndicator. You want someone who is not only experienced and intelligent, but you also want someone who is mature and will maintain their poise and composure if things get tough. Character is important when determining if a syndicator will do the right thing for his/her investors.
Regarding some of the stuff that's been spewed in this thread, I think a syndicator that feels the need to thump his own chest by bashing another syndicator or ideas from other posters and post a lot of belligerent stuff on a forum like BP is a very big red flag... well, at least for me it is. And that syndicator should be the last person with whom you should entrust your hard-earned money. I think we all know who I'm talking about.
"With that said, when selecting a syndicated investment, you really are putting a lot of trust into the syndicator."
I guess you have to trust them, but you need to know enough to read and understand the investment.
In 2009 before the crash, people couldn't find enough TICs to throw money into. So a lot of bad/weak ideas got funded and some games played:
1) Actually sold raw land as a TIC. You get no depreciation and your only income was appreciation.
2) Taking in $12M to buy a $10M property. Then using the excess $2M to pay back shareholders while the property was spinning up.
3) Am not crazy about interest-only loans since a good way to build equity (in case price appreciation doesn't meet your standards) is debt reduction.
4) Some leased buildings were really sold on pretty shaky leases and neglecting the $/SqFt. I've seen a coffee cart (250 sqft) with a $2K/month least being pushed at $2M. You're paying $8000/SqFt and getting someone to pay $2000/month or $100/sqft/year on a lease is pretty breath-taking. You've always have to make allowance for a tenant leaving.
5) Other thing with some TICs is STNL deals. Your whole cash flow is dependent on the tenant staying (which is why apartments are diametrically opposite). That's the problem with single-tenants is you're walking a tight rope. They don't do well and they leave, they do real well and they want to move to bigger.
6) There is a certain retail business (actual company) that builds its own store along with a strip mall and then sells that. However, they write the lease for their business and give themselves rent holidays down the road. The RE is income for them in a sale-leaseback arrangement.
Because they are flipping, which takes years, not months. no large group of people will have the same long term goals, theyll want to realize all the "capital appreciation" at some point.
shorter time lines are typically an easier sell for the syndicator as well
So, as a syndicator, I'm influenced a lot by what investors expect and desire. Right now, average return rates are mid-teens, so I need to be in the mid-teens to be competitive. Average hold times range from 18 months to 10 years, so my model is somewhere in between those numbers. There's been a lot said on hold times and it's true that (in most cases) the highest returns come at the 3-5 year mark. There are some investors that are interested in long-term, but the sentiment now seems to be that 5-10 years is the MAX that the average person wants to tie up $50-100k. I do agree with you that the goal should be long-term ownership and cash flow. Nothing like holding a property free and clear. If you assume 25 years to pay off a mortgage and you purchase a C-Class property that's already 25 years old... you see where I'm going? I think I prefer the buy-and-hold-for-a-while-and-then-sell model with a sweet spot of around 5 years. No big calculations behind that number, just my gut feeling.
If you are looking at buy-and-hold model on multifamily, easy way to handle long-term cap-ex expenses is to set aside money every month. Right now, I think $300/unit/year is a fair amount. As the building ages, that number needs to get bigger and bigger because the expenses rack up...
@Kalen Jordan
In most markets values have increased so rapidly in the last 5 years its triggered return requirements. Many times you’ll hear a group say “they made us an offer we couldn’t turn down”.