Why do most syndications sell instead of long term hold?

60 Replies

Seems like pretty much all the syndications I've seen recently exit within a short number of years - I'm curious why they don't hold long term?

Because a) investors want their money back as soon as possible; and b) sponsors want to do more and bigger deals and nothing builds track record better than completed transactions.

I don't think that's necessarily true. There are a lot of groups that target 5-10 year holds in addition to groups that focus on 3-5 years. 

There are several reasons. The first being that the shorter the hold period the higher the IRR and the velocity of money is increased.

The second is that the majority of a sponsors compensation comes after a capital event (sale/refi) when they get into the "promote" or carried interest. 

Additionaly after 3 years some investors start wanting their money back regardless of the hold period and performance of the deal.

I like @Nick B. 's answer.  The other reason I've heard is you don't want to end up getting clobbered by large capital expenses like roofs and HVAC units.  Get in, fix it up, sell it when it still looks nice and fresh before it eats you alive!

Just like banks make most of their money charging fees on loan origination then sell the loans to the secondary market, so too syndication make their big payday from acquisition fees and boosting resale value.  Keeping a property means that money is locked up = no more fees and deterioration & more upkeep = lower resale value.  

Originally posted by @Kalen Jordan :

Seems like pretty much all the syndications I've seen recently exit within a short number of years - I'm curious why they don't hold long term?

 There are several reasons and it also depends on the apartment syndicator.

Here are some of the reasons why my exit time frame for apartment deals is 3 to 5 years (although, in one of my deals lately, I have an exit of 6-10 years):

1.  My strategy is VALUE-ADD. So as I increase the NOI of the property, with today's low cap rate environment, I create significant increase in value. A lot of things can happen in the next 10 years - one of which is cap rate decompression. If I exit in 3 years (and hopefully, cap rates have not decompressed significantly), it BENEFITS my investors because they get a BIG profit from the sale. Big profit from the sale means higher IRR for the project and higher IRR for the passive investors.

For example, if in 3 years, the cap rate is the same - say 5%, per every $100K in increased NOI, I increase the value of the building by $2M. If 10 years from now and cap rates go up to 6%, the same $100K increase in NOI will only increase the value of the building by $1.67M - about $333K less.

Of course longer term, the income should have increased more but the faster the increase in value, the higher the Internal Rate of Return.

2. Compound the return by getting into another deal. By exiting quickly, I can compound the returns for my investors since they can choose to reinvest their capital into another value-add deal. IRR factors in the time-value of money so the faster the money is reinvested after it grew, the more it will grow.

If with 2 investments, investment A you get 2X equity multiple after 5 years but investment B, you get 3X multiple after 10 years, which one is a better investment? Hands down, investment A. Specially if you can reinvest it in another deal with a 2X equity multiple again - then that means, you grew your capital to 4X (2 x 2) in 10 years!

3. Aiming for projects with faster turnaround gives us an option to REFINANCE if we decide to hold the property long term and take advantage of the low interest environment. I love value-add projects because with a little bit of work, I can increase the NOI, increase the value in a few years and refinance and take advantage of the low interest environment. If the increase in value is big enough, I can refi and return all of my investors' money back in 3 years and they retain their ownership equity in the deal. It's better to refi now (or in a few years) vs. 10 years from now where the interest rate is likely going to be higher than where it is today.

4.  Protect the cashflow from Higher Interest Rate in the Future. If let's say my strategy is not value-add and my NOI remains the same, say on year 5 until year 10 but the interest rate goes up 100 basis points during those years, my cashflow actually drops because of the higher debt service. So the sooner you can exit, you can avoid the risk of higher interest rates. Of course, you can avoid this risk if you get a fixed 30 year loan but you get better rates for 10-yr ARM - which translates to higher cashflow and higher yield for the investors. But since there's a 10-yr time limit, I aim to exit in 5 years because if something happens and there's a couple of years delay in exiting the investment, I will still be within the 10-yr ARM.

The typical reason is the value add or repositioning play. The ROI that is quoted/projected on these to the syndication (funding partners) is often in excess of what the income could sustain/justify. The goal with these is to sell for a premium at a low cap to a fund or "passive" investor.

Great explanation @Michael Ealy !

@Kalen Jordan if a lot of syndicators are being honest, the real reason they sell is because our biggest capital event is on the back side. AKA syndicators make money on sale, not on holding. 

I think that's a flawed reason to sell and NOT in the investors best interest. Refinancing and/or supplemental loans can get you your capital back, without the hassle of selling. 

My preference is to model a 5-7 year hold with a sale in that period, but if I can fulfill the business plan and keep the property, I am going to. That is essentially an infinite return for the investors at that point. Who wouldn't want that?

@Kalen Jordan it all depends on the deal, strategy and what's happening in the market. For example, if you buy a value add deal usually you hit your peak ROI in 3-5 years. At that point you'd want to sell and buy another value add deal so you can do the value add work again, create more equity, and sell in another 3-5 years. Or if you buy a nicer/newer property that doesn't need a lot of value add work maybe you'd hit your peak ROI in 10 years then you could refi or get a supplemental loan to do value add work and sell in 5 more years. There are a lot of factors to consider and every owner should be monitoring quarterly to seek what the best decision is for investor returns.

@Kalen Jordan

Not all deals are created equal, and not all operators do things identically. We typically hold our properties for longer term. My theory is that given the current state of the economy, I want to be prepared for the worst. So I'd say continue networking and talking to other operators if you're looking for a longer hold time. 

Best!

@Michael Ealy offered good food for thought. I love it.

But, Michael's explanation is almost too much. The simple math is that when the investment return is maximized on a risk-adjusted basis, it's time to get out. The more time you allow into the equation, the more external factors pushing the risk higher.

Thus - get out when the investment is maximized, but be prepared to stay for a decade if can't get out.

Not all. Our investment strategy is typically 7-10 years, especially later in investment cycles like we are now. It all depends on your investor base and what they are looking for. 3-5 year investment strategies cater to investors looking for IRR (although over the long run, I haven't seen much difference across strategies) while 7-10 year investors typically focus more on "cash on cash" aka cash flow from operations.

It’s true though that most investors, especially younger investors, prefer shorter term investment horizons. Even though they rush to re-invest as soon as they are paid out anyways.

Originally posted by @Todd Dexheimer :

Maximum profits. If you fix and add value to an asset its highest value is shortly after the renovation is done. The longer you keep it the less ROI/IRR

Interesting - I'd have thought that holding it essentially forever and having the tenants pay off your mortgage and then getting a pop at that point would give you the best ROI - similarly to how people tend to long term hold SFRs.

I realize additional capex expenses come into play down the line but don't you just have to properly budget for them?

 

Originally posted by @Ben Leybovich :

@Michael Ealy offered good food for thought. I love it.

But, Michael's explanation is almost too much. The simple math is that when the investment return is maximized on a risk-adjusted basis, it's time to get out. The more time you allow into the equation, the more external factors pushing the risk higher.

Thus - get out when the investment is maximized, but be prepared to stay for a decade if can't get out.

What are the risk factors that push risk higher? I assume that capex expenses and changes in the market could be two, but wouldn't you just need to properly budget for the capex expenses? 

And re: changes in the market, what if the market is continuing to appreciate strongly? Aren't you better off staying in a deal that you got into 5-10 years ago having enjoyed that appreciation and looking forward to more strong appreciation?

Is the same true of SFR's where it's common to long term hold them and then get a pop in CoC when your mortgage is paid off down the line?

 

Originally posted by @Kalen Jordan :
Originally posted by @Todd Dexheimer:

Maximum profits. If you fix and add value to an asset its highest value is shortly after the renovation is done. The longer you keep it the less ROI/IRR

Interesting - I'd have thought that holding it essentially forever and having the tenants pay off your mortgage and then getting a pop at that point would give you the best ROI - similarly to how people tend to long term hold SFRs.

I realize additional capex expenses come into play down the line but don't you just have to properly budget for them?

 

The big money in real estate (or in any business) is in adding value. For every dollar increase in NOI, property value increases by $20. The return generated from mortgage pay down is the interest rate on the loan...sub 5% in commercial right now (poor return).

 

Originally posted by @Kalen Jordan :
Originally posted by @Ben Leybovich:

@Michael Ealy offered good food for thought. I love it.

But, Michael's explanation is almost too much. The simple math is that when the investment return is maximized on a risk-adjusted basis, it's time to get out. The more time you allow into the equation, the more external factors pushing the risk higher.

Thus - get out when the investment is maximized, but be prepared to stay for a decade if can't get out.

What are the risk factors that push risk higher? I assume that capex expenses and changes in the market could be two, but wouldn't you just need to properly budget for the capex expenses? 

And re: changes in the market, what if the market is continuing to appreciate strongly? Aren't you better off staying in a deal that you got into 5-10 years ago having enjoyed that appreciation and looking forward to more strong appreciation?

Is the same true of SFR's where it's common to long term hold them and then get a pop in CoC when your mortgage is paid off down the line?

 

CapEx can be budgeted for, but on a long-term basis this is much more difficult to do than most think.

But, the larger issue is this:

An exit out of an asset is a synergy of 3 elements. One - market appetite, which is reflected in the capitalization rate. Two - the NOI. Three - CapEx. While I can to a considerable extent control the NOI and the CapEx, I have zero control over the market.

Thus, my perspective on this is simple - once the investment is maximized on a risk-adjusted basis, don't be greedy and get out. Zero risk and money in the pocket is better than some/any risk with money on paper.

Naturally, there are caveats, but this is the main thrust.

 

Originally posted by @Alina Trigub :

@Kalen Jordan

Not all deals are created equal, and not all operators do things identically. We typically hold our properties for longer term. My theory is that given the current state of the economy, I want to be prepared for the worst. So I'd say continue networking and talking to other operators if you're looking for a longer hold time. 

Best!

Alina, your answer makes no sense to me. Please clarify.

You say "My theory is that given the current state of the economy, I want to be prepared for the worst". In what universe does holding onto assets in what you deem as an economic uncertainty a good or safe plan?! 

If you are squeamish about the "current state of the economy", meaning you are concerned about the future, wouldn't the most prudent option be to make money off the table and de-risk 100% ?

And, working the logic backwords, if you are convinced that holding is the best option, shouldn't we derive from this that you are in fact bullish on the economy staying strong...?

Do you see the conflict in your commentary?

@Ben Leybovich

Generalizing here to possibly explain Alina’s point but true for the most part, If you invested in a property in 2008 on a 2-5 year strategy your return was probably in the -100% to 5% annual realm. If it was a 10 year strategy, it was probably in the 0-10% annual realm.

If someone is uncertain in the market, a longer term hold mitigates some of that risk. Actually, part of the beauty in a long term strategy (10+ years) is that you can factor that there will be a recession at some point in your hold and therefore reduce the need to time the market. It also allows you to always be a market buyer whereas if you’re trying to time the market, there should be periods of time that you’re not buying.

Originally posted by @Bobby Larsen :

@Ben Leybovich

Generalizing here to possibly explain Alina’s point but true for the most part, If you invested in a property in 2008 on a 2-5 year strategy your return was probably in the -100% to 5% annual realm. If it was a 10 year strategy, it was probably in the 0-10% annual realm.

If someone is uncertain in the market, a longer term hold mitigates some of that risk. Actually, part of the beauty in a long term strategy (10+ years) is that you can factor that there will be a recession at some point in your hold and therefore reduce the need to time the market. It also allows you to always be a market buyer whereas if you’re trying to time the market, there should be periods of time that you’re not buying.

Not quite. The "ability to hold" if necessary is what minimizes the risk, not holding itself.

Why would you hold into uncertainty? Most MSA's may not quite be in hyper supply but are getting there. Not all, but most. This is likely what Alina is referring to as uncertainty. And if this is the case - take profits and de-risk.

In other words, if her major premise is - I am not sure about tomorrow, then why would she want to stick around to find out? Makes no logical sense. Take the money and run.

And, of course, if she is willing to stay in, this is indicative of a bullish attitude toward the future, and all this talk about the economy is just lip service.

I'm just trying to figure out exactly what Alina's perspective is here.

@Ben Leybovich

“I’m uncertain of the market over the next few years but over 10+ years I’m very optimistic of real estate.”

One can be optimistic of real estate in the long run and pessimistic in the short run.

Also, whether you’re required to hold for a long period or have the optionality to hold for a long period, your risk and market volatility is reduced as outcomes resort to the mean as time continues. As for ability vs requirement, the benefit or difference in risk is associated with the additional cost. If the ability to hold comes at the cost of a 7% interest rate whereas I can commit to hold at a 3.5% interest rate, which one is more risky?

There are many good answers in this thread. One of the key reasons has to do with the IRR return waterfalls that are created with shorter time holds. Basically the hold period is determined by the IRR curve and maximizing that. This is impacted by debt/equity ratios, cost of capital, improvements ratio, etc. It basically comes down to financial engineering.

Originally posted by @Kalen Jordan :

Seems like pretty much all the syndications I've seen recently exit within a short number of years - I'm curious why they don't hold long term?

 Kalen, Great questions!

All operators are different. I know some that will keep refinancing until investors are paid and keep the property for 10-40 years.

Some investors will hold for 10-40 years and the splits are different 

Most are holding a 3-10 year term. 

Investors want their capital back to then deploy that into more deals. Operators are always wanting to do bigger and better deals. We do a waterfall structure and most people want the class was they will get a higher/quicker return instead of waiting long term to get a higher return. I hope this helps you in understanding. 

Looking forward to your success. 

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