Updated: Jan 9
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 longe