I am a number cruncher — I am addicted to running the numbers, even on deals I know I won’t see to fruition. On that note, I found an article over on BiggerPockets.com that uses an apartment complex and some number crunching to explain a very important thought process when analyzing your investments.
Take a look at what Micheal Blank has to say on the subject…
How do you determine when to sell your apartment building to maximize the overall returns? I’m going through this decision-making process right now for one of my buildings, and I’d like to share with you my thinking.
As always, there are multiple factors that go into deciding if it’s right to sell the building now or later:
- Have you created most or all of the value there is to create?
- How attractive is the future cash-on-cash return?
- What do you expect the market to do? Are values likely to increase or decrease?
- What yields a higher return? Selling, holding, or refinancing?
Let’s apply all 4 criteria to my situation.
I purchased a 12-unit building with rents far under market. Three years later, income is about 35% higher than before. In my estimation, we created about 95% of the value there is to create.
Future cash-on-cash return is not that great at all; it’s estimated only at about 7% per year. This was planned from the start: I knew the value would be created by raising the rents, not so much from cash flow. Regardless, cash flow moving forward will not be stellar.
The market is stable. It’s tough to tell what cap rates will do. On the one hand, as interest rates will inevitably go up, so will cap rates, and valuations will drop. On the other hand, multifamily assets are so hot that the demand may counteract any rise in interest rates. Overall, I think the market is stable. In other words, I’m not seeing any massive upside coming from the market.
What Yields a Higher Return: Selling Now, Selling in 3 Years, or Refinancing?
In order to answer this question we need to consider the Internal Rate of Return (IRR).
I normally don’t talk about the IRR because it’s one of those complicated concepts that tends to confuse investors, and it’s rarely used for simple scenarios like buying and selling something.
But when it gets more complicated, like refinancing something, where capital is invested then partly returned and then ultimately sold, using an average annual return stops working. The reason for that is that your invested capital changes in a refinance scenario.