What a terrific question! I was actually asked this question at a social event I attended, when one of my business acquaintances (who is not involved in real estate), “Help me understand your business - why would anyone sell you their property if they’re still making money?”
There are a variety of reasons why a property owner would sell, despite the fact that they’re still making money from the property. I’ll share some of those reasons with you - not only to help you understand my business, but as an informational guide when talking with owners about properties you may be interested in purchasing.
Reason #1: The Owner’s Reached the End of Their Business Model
When putting together syndications on multifamily properties that will be offered to passive investors, the syndicator creates a business model for the property. The syndicator, or Sponsor, often acts as the General Partner of the real estate deal. The investors are limited partners, and the syndication is usually structured as a Limited Liability Corporation, or LLC, where the investors purchase shares in the corporation.
There are several different components included in the business model, and one of them is the proposed “hold period” - how long they plan on holding the property before selling it. It can be set up as any length of time, but usually it’s 3, 5, 7 or 10 years before the property is sold and money is returned to the investors.
Potential investors also receive a Private Placement Memorandum (PPM) from the syndicator, which also includes a summary of the offering, property description, purchase price, legal structure, distribution to investors, hold period, loan, lease and subscription agreements along with many other documents.
When the hold period is reached, the property is put up for sale, and the profits from any appreciation that has accumulated during the hold period is then divided between the syndicator and the passive investors. Based on the length of the hold period, this appreciation can represent a substantial profit for all participants.
Accessing that appreciation through a property sale is one of the main drivers of an owner’s willingness to sell the property. Even if the property is profitable – which is the case in many deals – the syndicator needs to sell the property based on what they’ve presented to investors when they presented the deal to them years ago.
Reason #2: Commercial Loan is Due
Unlike residential loans, where the terms can be as long as 30 years or more, commercial loans generally range in length from 5 to 12 years (even though they are amortized over 25 or 30 years). For example, on a multifamily property the lender could make a commercial loan for seven years with an amortization period of 30 years. Payments would be made for seven years on an amount that is based on a loan payoff of 30 years, which is followed by a balloon payment on the remaining loan balance.
To illustrate this, let’s say the owner has a commercial loan for $10 million at 7% interest. The owner would make monthly payments on the commercial mortgage for seven years of $66,530, which would be followed by a final payment of $9,181,271 to pay off the loan in full. That final payment is the balloon payment.
However, the amount of money that’s paid each month is based on a 30-year mortgage. Otherwise, the monthly payments would be prohibitive. The borrower’s net worth, the length of the loan and the amortization period all factor into the rate that the lender charges. The longer the loan repayment is, the higher the interest rate that is charged.
At the end of the seven years, it usually doesn’t make sense for the owners to pay the balloon payment of over $9,180,000, so they put the property on the market to sell it before that huge payment is due. Even though the property has been profitable and generating income, the owners are willing to sell.
Reason #3: Owners Think the Market Won’t Go Higher
At various times, some commercial property owners believe that the real estate market has reached the highest level that it can go. At this point, they feel that selling the property is the prudent thing to do, before the market begins to drop and they lose some of the appreciation that’s built up during the time that they owned the property.
Part of the problem is that many multifamily property owners overpaid for their asset. Multifamily properties are hot and are in huge demand. Because of this, buyers are paying prices above the asking price, often at ridiculous extremes when compared to comparable properties in the area.
Their analysis of the market is based on the premise that the demand for multifamily properties may wane, and they won’t be able to see those high prices or be involved in bidding wars. However, the fact is that the demand for multifamily properties continues to grow rather than decline, but nobody has a crystal ball to tell the future. Many owners who sold their properties two years ago because they believed the market can’t go any higher, regret it.
This continued growth is based on a variety of factors, including the fact that inventory of multifamily properties is low, very little new apartment construction is underway and Baby Boomers are retiring in huge numbers and significantly increasing the demand for rental units. In addition, Millennials are choosing to rent rather than buy a single-family home, further increasing the demand for rental properties. All of these factors aren’t expected to change any time soon.
I take a conservative approach when purchasing multifamily properties. I look solely at the numbers, and never get involved in a bidding war on a property. If the price rises above the level of what I feel is justified, I simply move on to another deal. That way I won’t find myself in the awkward position that many property owners find themselves in right now.
Reason #4: Owner Wants to Upgrade to Newer or Larger Property
Some multifamily property owners purchased their building as an entry to the commercial real estate market. They bought a smaller multifamily property, with perhaps 59 to 100 units or less. Now that they’ve had an opportunity to manage the property and generate income, they are looking to expand their operation by purchasing a larger property.
Another possible reason is the age of their property. If they have owned their current property for an extended length of time, it may be beginning to show its age. Or perhaps it’s in need of major improvements or renovations, and they’re not interested in investing the time or money into the property. At that point they decide to sell.
This is good news for buyers looking to purchase a multifamily property and don’t mind investing capital in it, because it puts a property on the market.
Reason #5: Inexperienced Owners Can’t Keep Pace
Another major reason for selling is that the property is owned by an inexperienced person or couple, the typical “mom and pop operation” you often hear about. They have very limited experience in managing a multifamily property and are confronted with problematic issues like tenants who don’t pay rent on time, or tenants who are causing trouble within the complex.
Another issue that comes up is that they’ve hired a property manager or property management company and don’t know how to “mange the mangers.” They don’t have a system to follow up with their property management company or the tools to effectively manage it.
Finally, some owners may have little knowledge of marketing, value-add upgrades like new kitchens and baths and their property is showing its age compared to the competition in the area. Hence, they don’t know what it takes in order to be competitive and are losing tenants to other properties. This reduces their net operating income, and they decide to sell rather than fight.
Again, new ownership can come in, analyze the market and determine the best course of action for the property. That would provide new owners with an opportunity to renovate and repair the property, take care of tenant problems and increase the rents. That in turn would increase the net operating income, so new owners would benefit in the short-term, as well as in property appreciation in the long-term.
Whatever caused the problems that made the current owners decide to sell their property; it’s good for new owners who are looking to buy. With some time, effort and money, the property can become competitive with other properties in the area and generate the type of income investors and owners are looking to achieve.
Properties may be generating a profit, but the toll it takes on owners to make that profit can sometimes be difficult. It doesn’t matter whether the business model dictates a sale, or the loan is coming due, or the owners have the sense the market has peaked, or they want to purchase a newer or larger property, or they just don’t have the knowledge, desire or experience to make the property a success - the current owners are ready to sell. These are opportunities for investors and syndicators to come in and purchase the property, as long as the numbers justify the price that they’re asking. Purchasing a property at the opportune moment can lead to profitability and success.
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About the Author
Ellie is the founder of Blue Lake Capital, a real estate company specializes is multifamily investing throughout the United States. At Blue Lake Capital, Ellie helps investors grow their wealth and achieve double-digit returns by investing alongside her in exclusive multifamily deals they usually don't have access to.
Ellie is the host of Unbelievable Real Estate Stories, a podcast that shares true stories from within the industry, and the critical lessons learned, from the most successful real estate investors, innovators, developers, and more from around the globe!
She started her career as a commercial real estate lawyer, leading real estate transactions for one of Israel’s leading development companies. Later, as a property manager for Israel’s largest energy company, she oversaw properties worth over $100MM. Additionally, Ellie is an experienced entrepreneur who helped build and scale companies by improving their business operations.
Ellie holds a Masters in Law from Bar-Ilan University in Israel and an MBA from MIT Sloan School of Management.