When a multifamily asset underperforms, how should investors react?
Clearly, creating an effective exit strategy is important prior to acquiring a multi-unit property. After all, investing in this highly profitable market doesn’t come cheap. With that in mind, you will need to think of a way to recuperate your losses when the market for multifamily properties isn’t doing well. We are at peak in many over-heated markets around the country as I write this.
There are buyers but very few multifamily assets that are available in good emerging markets, bidding wars are happening and the sellers want to dictate much higher sales prices due to extreme competition. But syndicators, like me, need to be very careful and savvy in picking the deals on actual financial numbers and with highly motivated sellers. It may take underwriting 100 deals to get one golden nugget, but that is the only prudent way!
If a multifamily asset is consistently underperforming; Many investors would think about selling their assets right away before losing too much of their value to an unstable market. For this, they need to calculate for their return of investment against the actual value they paid for in the first place. Regardless of how slow property sales are going, you need to make sure you still get a handsome amount at the end of the day.
How will you do it, though?
Again, before buying a multifamily property, you need to break the ice on the things you need to prepare. Property liquidation involves how much you actually gain from the property itself. At Moneil, we make a distinction between using cap rates and cash-on-cash returns. These help you build the value of these assets and determine a selling price that brings in the highest return.
Once you have used these instruments to calculate your assets’ value, you can now select a proper exit strategy that will deliver the highest rate of return. Here are my favorites:
- Hold and Sell
If you opt to generate a positive return, you can hold the asset until the market stabilizes. Job growth and tight inventories can drive up the prices for condominium and apartment units. Adding to the appreciation of multifamily values is the fact that millennials are buying large swathes of multifamily units across emerging local markets in states such as Texas and Washington.
When you hold and sell, the trick to get the highest return is to start with a good number of apartment units at 80 percent of the asking price. For example, if you are set to acquire 120 units for an asking price of $3 million, you can negotiate to scale down the price to $2.5 million. When the market is going well, rising rents will drive the value of these units upwards. Give it another year and the value will snowball to a selling price that covers the initial cost of acquisition and, more importantly, brings in a large profit!
- Forced appreciation
Another great way to get large profits from liquidating your multifamily investments is forced appreciation.
Using this strategy, you can set (or manipulate, if you will) the value of your assets through property improvement projects. For one, you can renovate these units and repair non-functional or broken fixtures. This, of course, is a large investment on your part, so you might as well secure your finances for the repair and renovation works. Another way to consider is to provide more available living spaces. If you can’t afford to build more rooms, you can at least convert certain portions like the basement into bedrooms or apartments. That way, you enable the appreciation of the properties with lesser costs.
Lastly, you can limit your monthly expenses by controlling electricity and water consumption. For this, make sure to install energy-efficient bulbs and opt for waterless urinals. The amount you save on these essentials can help drive asset prices up.
If you are focused on enhancing the expandability of your assets, you are looking at a strategy that allows you to tap into a new income stream and raise the value.
Repositioning involves a lot of approaches. For commercial assets, building modifications can help you tap into new markets, thereby increasing the rents for these assets. However, a more viable repositioning strategy involves lesser capital expenses than remodeling the entire appearance of the assets.
You can use ratio utility billing (RUBS). This allows you to transfer part of your monthly utilities costs (i.e. water and power) to your tenants. This eventually increases your net operating income and, in turn, raises the capitalization rate of your assets. With that being said, you can set a higher price for a handsome profit, and this is because you didn’t pay a single cent for repositioning your multifamily units.
Now that you have an exit strategy in mind, you can now hunt for potential multifamily investments. If you have other exit strategies that should be mentioned here, feel free to share them in the comments below.