Multifamily Underwriting Series 10: Exit Strategy

Welcome back to the Multifamily Underwriting Series. This is number 10, Exit Strategy. Here are the previous posts in this series:

This is the last post in the Multifamily Underwriting Series. I hope that this deep dive will help you when you are making that multifamily purchase.

Exit Strategy

Spending all this time and effort on purchasing a deal will do you very little good unless you plan for what you will do with it. It’s important to remember that exit strategy planning is not about picking one; it’s about building a set of possible exits, one of which you will select when the time is right. Give yourself options. This will be critical when the market changes unexpectedly.

Your Certain Goal

We don’t have 10 more posts to talk about your long-term certain goal, but if you don’t have this goal yet, there’s no time like now to create it. This goal is your most important thing to help guide you now. If you haven’t created one, click on the link and then come back.

For each of the following exits, you need to look back at the numbers and change them like you did for stress testing. You’ll create a new tab on your spreadsheet which shows the projected numbers for the start of year 0 (purchase year) to 20 years out (or more, if you want). Inflation generally increases at 3% per year, so multiply each year’s expenses and income by 1.03 and have the spreadsheet run the metrics. In the first couple of years, you will be doing some major changes to income and expenses. If you do that, put those changes in, rather than the 3%. This should stop after those first couple of years and your value-adds are all completed. Add a new row, which is the principal on the loan. It will be paying down each year of the project. Add another new row, which is property value. That will be calculated based on the NOI and the cap rate.

Long-term hold

This strategy assumes you will be keeping the property until the mortgage is paid off. You are looking for long-term growth and then steady income when you retire. This is the typical investor strategy. You will then sell the property and put the money in some kind of growth account to use as you retire – without the hassle of owning the property. The focus will be on increasing property value over time, using the cash flow to make future repairs after the initial value-add. Value-adds will be less important here and some will get deferred until right before the sale to maximize their impact. Risks here are taking your foot off the gas and forgetting about the property. Also, you’ll have a large tax burden when you sell the property.

Very Long-Term Hold

This is the same as the previous one, except that you never sell it. The property gets passed down to your children. You can also take advantage of a 1031 exchange in that your death wipes out the tax burden completely. Risks with this one include if your children don’t want to deal with an apartment building, and that you personally don’t get to enjoy a huge windfall upon sale.

The Multifamily Flip

This is the typical multifamily project. It’s a hold in that it is usually at least for 5 years. It’s a flip in that you are doing repairs and planning to sell after completion. For these, you need to anticipate what the market will do upon sale and be flexible to sell early or delay if the market is not right. The risk with this one is you may not be ready to sell, but the bank may require a refinance at an inopportune time. You also will have a big tax burden when you sell, unless you 1031 exchange it. Here are some reasons the 1031 is good and is bad.

If Investors are Involved

For investors, you will have to figure out a solid plan before even signing them up. Your plan can include multiple exit strategies, but they need to be considered on the subscription documents that the investors sign. They will be unhappy if you do a completely different strategy than the one you told them you would do. With investors, typically, there will be a sale around the 5-10 year mark. Your risks here will be similar to the flip, above. But now add to that the fact that you are handling other people’s money and your liability goes up.

Conclusion

I’m glad you made it through 10 weeks on the same subject. We saw many ways that the deal will not work. Only after doing all these steps can you safely come to the conclusion to buy. This can be discouraging, but it will help you to not lose a bunch of money. Also, it can show your banker, partners, investors, and spouses that you know what you are doing. Take the time to run through all these steps for each deal until it falls out or makes it to the end.

Make sure you do the final exit strategy step. So many investors will never think of this, having only one idea for exiting. They fail when that doesn’t work out for some reason, even though the deal started off a good one.

Always remember that you need to use help whenever you are unsure. You’ve hopefully built a great team to assist you. Run the deal by your agent, attorney, accountant, and banker. Much like the metrics, each will have one perspective on the deal and you will need to put all their advice together. Ultimately, you are the one making the decision and will have to deal with it. Stressful? Absolutely. But compare that to the upside: financial security for your future. It’s worth it.