Cash Flow Now or More Upside Later?

Question

What's up everyone! Happy Columbus Day!Taking a poll to get a current read on the investor marketplace for Multifamily investing via a syndication model. :)Would you rather have steady cash flow now (with downside risk) but a lower overall return (say 15% annualized over 5) OR higher upside in 3 to 5 years (say 22%+ annualized) but moderately higher downside risk?

Ben Leybovich · Answer

Well, let's think out loud a bit. Here's what we know:

1. We are late in the cycle. The pricing is up. The cap rates are compressed and look to remain this way for quite a while.

2. Good cash flow on day one means you are buying more or less a stabilized asset. After all, the definition of stable is presence of strong cash flow.

What can we conclude from the above facts?

1. If we are buying a stable building, then by definition there is not much value add.

2. If there is not much value add, and we can't hope to engineer the returns, then we must count on said cash flow as the chief driver of our returns.

The issues with this:

1. The cash flow on an NPV basis is likely not enough to be excited about.

2. In most of the country, it's fair to assume that we are out of the expansion phase and into hyper-supply. And if so, is it wise to buy stabilized assets in those markets? There are markets in younger cycles, but they are a minority.

Conclusions:

From an investment return point fo view, strong value add is needed in order to facilitate desirable returns. But, more importantly, this late in the cycle, at a time of full employment, it may be prudent to have capacity to improve the revenues.

Think of it this way. Say you are in a 7% cap market. But there is enough value add so that you can improve to 10% cap on your basis, then even if the market slows to, say, an 8% cap, you should still be OK. If, however, you buy a 7% cap without a meaningful way to improve, then you are at risk of a market slow-down.

That said, this is not a matter of preference, in my opinion. Both, in terms of investment returns and safety we should focus on strong value add. However, in this market, no one is stealing deals, and the price you will have to pay for said value add is the cash flow early in the hold.

Have I changed anyone's mind?

Jacob Sampson · Answer

I always want cash flow now.  Especially being somewhere in the ball park of the top of a market.  A lot can happen in 3 to 5 years that could negate the future benefits.

Account Closed · Answer

@Ivan Barratt

CASH FLOW NOW. unless you’re already rich.

Marcus House · Answer

As an investor I will take the first option every time.

Scott Morongell · Answer

@Ivan Barratt A lot would determine on who the sponsor is, and where the deal is located to determine which option I'd prefer. My short answer is to get your cake now. Take the cash flow and reinvest in other deals or businesses. Your overall returns with the approach as an LP would most likely beat the 22% you'd be speculating on. I would also strengthen my argument even more for cash flow now if there are A&B shares in the deal and the lower 15% sat first in line on the capital stack with the "A" share capped at 25-35% of total cap stack. It's the closest thing to guaranteed money since the deal would only have to cashflow 2.5-3.5% / year for me to not miss a distribution.

Taylor L. · Answer

Cash flow now. Projecting returns down the road is less reliable. Right now I think people are overestimating future growth and therefore discounting current cash flow too much.

Ola Dantis · Answer

@Ivan Barratt It is an interesting question to ponder!

That said, I'd say Cash Flow now.

Most investors are receptive to getting those cash flow disbursements and sometimes don't think of the upside in the nearest future.

This is the only time delay gratification can be an exception!

Greg Dickerson · Answer

As a developer it’s all about risk and upside potential. I shoot for 30% returns on my projects and hedge downside risk via location and demand. To me it’s it’s just another day at the office.

Tj Hines · Answer

@Ivan Barratt we will focus on strong cash flow day one with mitigated upside risk. I think in this market. Cash flow is highly important

Chris Salerno · Answer

Would have cashflow and low risk. Focusing on B assets in Multi Family I feel in my opinion will provide both of those for our investors.

Cash Flow Now or More Upside Later?

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