Best Practices: Getting Out Of An Investment When The Getting Is Good
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Nothing lasts forever, including commercial real estate assets' most productive years. Determining exactly when the best time is to sell a CRE asset is, however, as much art as science.
What are the most important considerations in how long to hold a property, and how do you determine the best exit strategy?
We put that question to executives at six CRE investment companies, of various sizes and holding various property types.
KBS Regional President Western United States Rodney Richerson
Because we invest only in best-in-class assets in the most sought-after locations, we're often able to achieve our strategic business goals for an asset ahead of schedule, which can sometimes support a sale earlier than planned.
Even so, before selling an asset, we examine the remaining life of the fund through which the asset was acquired, as well as current market cycle and economic conditions.
Beyond that, we conduct a quarterly analysis for each asset in our portfolio in order to ascertain any market risk or opportunities. This analysis includes tenant rollover schedules, new developments that are planned or underway in the market and, most importantly, tenant demand drivers that will contribute to future absorption.
Because we're the landlord for many of the country’s largest office tenants, it's essential that we understand how many options our large tenants will have when their leases are approaching renewal negotiations.
In some cases, there may be no existing buildings or pipeline developments that can accommodate these tenants’ needs beyond the asset we already own in a market. In these situations, we may make the strategic decision to extend our hold period for the asset. Alternately, when we have achieved our business goals within an asset and recognize strong buyer demand in the market, a shorter hold period is often justified.
KBS, based in Newport Beach, California, is one of the nation's largest buyers of commercial real estate and has completed transactions exceeding $38B.
Continental Realty Group Managing Director of Investments Robert Ireland
Part of what makes multifamily real estate so interesting is that there's no one-size-fits-all approach. Still, a given property’s holding period and exit strategy are core components of a sound acquisition strategy.
First, what is the right strategy for a specific property? Sometimes you’re looking at a property where the best play is a long-term hold, while other opportunities are much shorter in nature.
Second, what are the goals of the stakeholders? Are they looking for high current yield, or is the appetite for capital appreciation? These aren’t always mutually exclusive, but are key considerations. It’s important that stakeholder goals are aligned from the start.
Third, based on the answers to the first two questions, what type of available financing is best used for the property? For a shorter-term hold, there might be a heavy emphasis on financing with flexible prepayment options. If the plan is to renovate and refinance, the emphasis may be on loan earn-outs or availability and terms of supplemental financing. For properties with a value-add component where you also want to maximize cash flow, you can look at interest-only options.
Fourth, where do you believe you are in the cycle? We recognize, despite the volumes written on the subject, there's no crystal ball that will tell us exactly where we are in the cycle and when the next downturn may occur. But that doesn’t mean you can’t make educated estimates and plan our business strategy, financing and ownership goals around it.
Continental Realty Group (formerly Continental Realty Advisors), based in Denver, is a multifamily sponsor, participating in $1.6B in acquisitions, renovations and dispositions.
MBARK Global founder and principal Daniel Gryfe
The question has a multi-pronged answer, depending on the age of the investor and the investment strategy overall that he or she holds. History shows that the majority of owners that have held real estate long term have come out more profitable.
That said, the “fix and flip” business model would warrant a swift execution and exit — one that has made a lot of money for a lot of investors. My previous venture owning multifamily properties started as a long-term hold, but as my investor base widened, I ended up building a business around the three- to five-year internal rate of return model.
My current platform of investing in triple-net assets is for the long-term play, allowing myself and my investors to reap the benefits of cash flow from strong tenants. No matter your age, there should be a piece of your portfolio that invests for long-term stable income.
Toronto-based MBARK’s primary focus is single-tenant properties, with more than $500M of transactions delivered and $100M in the firm’s pipeline.
Parallel Capital Partners Managing Partner and CEO Matt Root
Selecting an exit strategy is critical. The optimal strategy depends on your investment objectives. If you're a developer, for example, you're in the business of creating buildings, and may need equity for new developments. So developers need an exit strategy which allows them the opportunity to free up their capital for future developments.
Another reason to exit is to alter your risk-reward profile. For example, a developer specializes in taking development risks. However, once the building is stabilized, this risk is gone. Similarly, an older building in need of repositioning has more risk than a new building. If you're unwilling or unable to deal with the complexities, costs and challenges posed by an older building, you will want to exit.
If you purchase a new strip center because it's the best in the market, at some point you may need to exit as demographics, the local economy, consumer preferences, competitive centers and tenants change — and the building no longer will be the best property in the market.
There are also traditional reasons to exit. Owners exit inherited estate properties, as beneficiaries rarely want the headache of managing real estate. Also, situations such as divorces and partnership dissolutions frequently force people to exit their investments. These human aspects of investing force you to have an exit strategy.
San Diego-based Parallel Capital Partners has completed more than 140 CRE acquisitions totaling about $4B.
SmartStop Self Storage REIT Chief Investment Officer John Strockis
The most important considerations when determining a commercial property hold period start with investment objectives, investor risk profile and asset class the investor intends to pursue. Collectively, these factors determine a targeted disposition period, depending on how the property is positioned within its market.
Generally, core and core-plus investors will hold a property for five to seven years, while a development deal could be two to four years. Typically, the risk factors for a development deal far outweigh the risk of holding a core, institutional-grade property, and consequently attract different types of investors.
The asset class itself can often determine the hold period. Retail and office properties may benefit from shorter-term hold periods, depending on market conditions, versus self-storage or multifamily properties that generally benefit investors with a long-term hold horizon.
Ideally, the ultimate consideration when selling the property is when net operating income has been maximized over the investor’s hold period, providing a return on investor’s equity that meets or exceeds the investment objectives of the property.
SmartStop Self Storage REIT, headquartered in Ladera Ranch, California, specializes in self-storage assets, with 113 self-storage properties owned directly, and other assets managed for other owners. All together, its portfolio comprises about 86,000 units.
BH Properties Senior Managing Director-Investments Andrew Van Tuyle
Each and every asset that we buy has its own business plan and expected life cycle. Since we mostly purchase value-add opportunities, we make assumptions about lease-up and stabilization periods, but can be surprised either way with how long it can take. The main factors we consider involve current performance, impact on our portfolio, and where the asset is going to trade relative to history.
Generally speaking, our goal is to retain assets long term and enjoy the cash flow. Lately, however, we've been focused on consolidating our portfolio into the western U.S., which has led to some dispositions on the East Coast.
Los Angeles-based BH Properties holds 90 properties in 17 states, including 2,100 multifamily units and 9M SF of commercial space.