IRR is a great metric to pitch! What about when not selling

[Marc Izquierdo]

Hi everyone! When I’m underwriting a deal and there is a sale involved, there is no doubt that IRR is one of the best metrics to use and to give your potential investors. However, my model is to buy, refinance, and hold into perpetuity. In the future I may sell if the opportunity arises but it’s not in the business plan. Without a sale, IRR sort of breaks down. So to substitute IRR, all I’m left with is an average annual return or an average cash on cash return over say 10 years (because I have to define some time period) to show investors what they’ll make. Every syndication example that I’ve seen has had a sale at some point in the model (usually 5-10 years). Thus an IRR was able to be calculated. I’m wondering what people suggest if you dont plan on sellIng as far as marketing your deal to investors. How does a conversation like that go? What numbers would they be interested in since IRR is off the table now. If anyone has experience or suggestions I would appreciate it! Thanks in advance

[Brian Burke]

The reason that every syndication example that you've seen has a sale at some point is because the first question that your investors will ask you when considering your deal is "when will I get my money back?".  "Never" is not a good answer, and any deal structured that way is unlikely to get funded--so all of the offerings you see are structured for a defined period of time. Legacy-style holdings are for your own capital.  A lot of family offices will do this--they'll just own the asset for generations.  But they don't do that with a syndicator, they'll own it directly.

Perhaps you have investors with a different appetite, but I can tell you that after having raised over $80 million I couldn't get a deal done for even a minuscule $1 million raise if I didn't have at least some type of exit plan.  In the mind of most investors, a refinance isn't an exit plan.  It can give a return of some capital, and at some point you might be able to refinance again and return the rest, and in rare instances even more, but the investor is still in the deal.  Investors looking for that type of deal are few and far between.

Another reason that you don't see forecasts in perpetuity is that they are meaningless.  No one can predict what rent growth will be 20 years from now.  And how do you factor in capital improvements?  Do you refinance and take out cash to pay for a new roof when it's due?  Or to upgrade the units all over again in 10 years?  All of those unpredictable variables would have to go into an analysis that stretches out that far and no one will get that right--rendering the numbers useless.  This means that your investors have no way to grade you.  Are you outperforming, under-performing, or right on target?  No one would know.  And then what happens when your investors start to die off?  Now you are dealing with their heirs, who are stuck in an investment they didn't choose to be in and start suing to force a sale...ugh!

Having said all of that...if you are going to do to this all you have to go on is maybe showing a cash-on-cash return for each year for the first few years and saying that after that your investors just have to rely on blind faith that this is still the best investment for them, because it will be impossible to quantify it to them in advance.