Real estate Syndications are the pooling of funds to buy real estate assets – in our case, our favorite is Multifamily – much larger than an individual can do on his or her own.
Although all involved in the syndication, sponsors and limited partners, benefit from cash flow distributions, whether monthly, quarterly or semiannually, the big returns (of capital and targeted irr) of syndication happens at the sell at the end of the hold period.
For sponsors and passive investors alike, it is essential to recognize the importance of the exit strategy. In fact, the exit strategy is more critical than the entry strategy.
Why?
When the asset is sold, investors receive their capital, and if the asset management was executed according to plan, their targeted returns.
Without a proper exit strategy, there is only hope. Hope that the team can sell the asset at the desired higher price.
Exit strategies involve the following:
- Repositioning asset through improvements – these include executing all planned repairs at the time of acquisition, capital improvements throughout the hold period and any improvements/repairs during unit turns.a
- Executing rent increases – Rental income is the fundamental piece of performing multi-family assets. Growing that income through physical improvements and management operations is essential to growing value for investors and providing great living for residents.
- Projected occupancy increases – When both of the above are happening, vacancy should decrease and occupancy will in crease. People want to live there, there is higher demand for the property and the units are more filled. Achieving reductions in vacancy and improved occupancy as part of the business plan helps position the property for the next owner and further prepares the syndicate for the sell.
- Executing reductions in expenses – In addition to managing income, reducing expenses is another way to improve net operating income. What are the team’s plans for reducing expenses? Examples include, renegotiating landscaping contracts, more efficient utilities systems, improved screening for higher-quality residents (less wear and tear on units), and more.
- Projecting a terminal cap rate – This final detail can make or break the profitability of the sale, and it is all about conservative estimates. Rather than the actual effort required to execute rent increases, reduce vacancy, and minimize expenses, projecting a terminal cap rate, or the cap rate used for the valuation at the time of sell, is all about estimates.
No one knows for sure what the cap rate will be years down the road when the syndicate intends to sell, so with so much uncertainty, it is best to assume a conservative cap rate from the very beginning. This means to project even a higher cap rate than that at purchase (remember, cap rates and prices have an inverse relationship: higher cap rate means lower price paid for the same net operating income and vice versa). For example, if the team purchased the current asset at a 6% cap rate, their conservative estimate for terminal cap rate could be 6.5%. Many syndicators use a .5% addition to estimate the terminal cap rate. Often, they are able to sell for much better and at a lower cap rate, but this conservatism drives for lower expectations and to plan accordingly.
To not have an exit strafegy is depending on hope only, such wishful thinking is unaffordable in an uncertain market. Working with an experienced sponsor and solid business plan at the beginning are both essentials for ensuring a proper exit strategy.
