What to do with a property that has too much equity?

Question

Hi BP Peeps,

So I have run into a good problem. Long story short, my portfolio's equity has grown to the point where the return on equity is so low that it has forced me to consider selling my 14 unit apartment building. 4 years ago when I bought this property for 445k and I dumped in 200k and has performed incredibly well and rents have grown, the building is now worth around 1.1M. I owe 650k. As you can tell there is a large amount of money sitting there , to which has made my cash flow now negligible at best when considering ROE. To top it off my my 5 year balloon comes up next year and the interest rate almost doubles from where it was from 4.75 to 8%. I could sell my entire portfolio of 28 doors and pull the leverage lever OR I could sell this 14 unit and pay for something in all cash and do a lazy 1031 exchange, or do a regular 1031 which puts more pressure on the time frame.

To the other people who have faced this issue with too much equity sitting around and the need to grow, what would you do with this? Sell, STR, partner on bigger deal, etc?

Thanks for the ideas!

Josh

Marcus Auerbach · Answer

It's called buy and hold for a reason. And ROE is a hypothetical metric, as your equity is not realized. After selling cost and some negotiations there is really not that much money left. You have the same if not greater interest rate risk with a trade.

Real estate is not the stock market and the hardest thing for some people is often to do nothing for decades, but that is where the money is made.

Mike Dymski · Answer

60% LTV is not that low, particularly in a higher rate environment where the debt service coverage requirement (cash flow) is now limiting LTVs to 60-70% in many cases anyway.

Separately, should be able to get a commercial loan with a rate in the 6s.

James Hamling · Answer

@Josh R. there is another option, one that would raise you're ROI too infinite, eliminate that finance rate too 0%, and via reduction in $-expense, increase cash-flow.

All it requires is to not be greedy....

Your sitting at about 40% equity position. So vs buying other $, which is what finance is, it's purchasing $, how about you help solve a problem many have out there of a good, solid place for capital placement.

No, I am not saying syndicate but reality is that's where the big-$ is made, when you unlock OPM at scale. So how about you SELL the equity to a minimum # of other "passive" partners?

For example, sell too 10 "partners", each comes in at $65k, each receives 6% equity stake.

Remember when I said all it requires is to not get greedy; some would see this and obsess on being at "only" 40% ownership now and completely ignore the fact of how all that math plays out in this.

You would now be free & clear of any debt service and the expense impact of such. You can fairly collect some form of compensation for being the managing member. Everyone wins.     Except the bank, they loose, because now your partners and you are getting what $ they would have sucked out of it.

If you can get over the mental thought that you "gave away" 60% and look at the math, what the math does, I think it will blow your mind. Grant Cardone "10X" blow your mind.

And now your building a community and reputation with the BEST finance-$ there is, PRIVATE-$. Where terms are per discussion and peer-2-peer negotiations.

And once set, this shifts the focus to rinse and repeat, finding the next value-add potential and making magic happen again.

What would life look like for you Josh if you did just 10 of these properties, in grand total, and stopped there. And had "only" 40% equity stake, partners with the other 60%, but via doing value-add each is at or near infinite rate of return (ie zero or near 0 capital into it personally).

What does that income picture, and time-line to complete 10, look like vs holding onto 100% and "paying the bank" as your sole "partner"..... Which is more quickly achieved? By how many years? Or better said, by how many decades of difference is it?

Caryn Seifert · Answer

A 1031 has a definitive time frame and you may not be able to find another property that meets your criteria in that time frame depending on location.

Could you sell it to a new LLC you own and get a new loan for less than 8%?

Tim Delaney · Answer

Yeah, I feel like 1031’s can be like a chicken or egg problem. If you find a deal you can always make an offer contingent on selling your existing properties. You may pay more for that extended closing window, but it may be worth it. Just a thought.

Tim Delaney · Answer

That seems like quite a jump in rate! I’m getting quotes in the high sixes to low sevens right now on commercial loans so the first thing you may want to do is double check that. Obviously a lot can change between now and next year as well.

1031 would seem an obvious choice. There are rumblings that over the next year or two more apartment buildings may come available. I’m not a 1031 expert but I believe you need to use the same amount of debt you currently have. Plus if you bought with all cash from the proceeds of the sale you would be trading down in asset value quite a bit.

Depending on the refi rate you could consider keeping this and refinancing it to pull some cash out which you could use as a down payment on another property.

Just some thoughts, hope they help

Chris Seveney · Answer

@Josh R.

We are sitting on what I would consider a significant amount of equity but our debt is at 3% or less on our loans (or we own outright).

Right now we are not selling anything or cashing out that equity - if anything I would look to acquire a property and find a HML that would cross collateralize one of my other assets so I don’t have to sell it but use it as collateral.

Jake Andronico · Answer

@Josh R.

Assuming you mean a reverse 1031 exchange when you say "lazy" 1031?

If so, and you have the cash, that's definitely an option.

If you're able to do that, that's interesting. Some great deals out there with so many buyers on the sidelines.

If I was in your position, that'd be my first choice. Also, when you go to sell, your buyer pool will be running into similar scenarios with lending.

Dave Foster · Answer

@Josh R. If you do sell and do a 1031 exchange there are a few things you could do to make your exchange as smooth as possible.

The first option, If you do a traditional 1031 exchange and find a property that you really like don't hesitate to get it under contract. There is nothing that says you can't be under contract to sell within or before your 45 day identification period even begins. You can also use contingencies as previously mentioned.  Or overlapping due diligence periods.  Naturally, your relinquished property/properties must sell before you can take title to the new ones but at least it keeps distance between those time frames.

The second option would be a reverse exchange. This is when your intermediary would take title to the replacement property before your relinquished property is sold. This would give you up to 180 days to sell your relinquished properties and not have to stress the identification time frames.

The third option would be to parcel it out in steps.  Only do a 1031 on this building.  Leave the others for another day.  Given the relatively high nature of rates still you might find more flexible sellers that will let you buy into better cash flow than that adustable re-set.  Even if it's not as good as you'd like simply hang on and then refi later down the road as interest rates come down with time.

Mark Cruse · Answer

Great problem to have. Id refinance, pull that equity and get something else. Probably would be something very distressed in a decent area so I could add value. But for real, its so many angles here. So many have presented great options. Nothing more to add from me outside of saying job well done.

What to do with a property that has too much equity?

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