Multifamily’s best kept secret is no secret at all; that long-term ownership provides significant financial rewards. Why do I call this a secret? Because so few take advantage of the power of income compounding that is included in the rewards of long-term ownership.
In it’s simplest version, even if expenses keep pace with rents (rents rise 3%, expenses rise 3% year after year) then still, over time, debt is reduced. After a period of years (say five or more) when debt is refinanced at its’ current balance (meaning no cash out at re-fi) then cash flow increases. Cash flow increases. Did I mention that cash flow increases?
Buy and Hold…
The wealthiest real estate investors I know are those that still own the same assets they purchased in the 1970’s and 1980’s. The SAME ASSETS. No bootstrapping into the latest and greatest over-leveraged deal, no trading up and up and up again. More often than not, the assets purchased “back in the day” are by far their smallest deals… but they still own them along with the larger portfolio. Perhaps as a reminder of where they started but probably because they are cash flowing like crazy.
You’ve heard of sellers remorse. I can think of story after story of people telling me about the asset they wished they’d never sold. How now it’s worth ten times what they paid for it back in the day. We learn from our mistakes. The best of all worlds is that this learning allows us to avoid a repeat. Buying apartments is hard work. Selling means having to find another, similar, and hopefully better asset given capital availability.
The Ten Percent Rule
One significant mistake that multifamily sellers make is taking cash from a sale and over-leveraging into the next deal. The types and kinds of justification is unending. The result is that everything has to go perfect for the newly purchased, over-leverage deal to break-even, much less cash flow. So the new owner, the one who sold a cash-flowing asset to purchase an over-leveraged asset now has eliminated the prior cash flow (that they were very accustom to seeing) in exchange for losing sleep over the new deal that, again, has to work perfect to break-even.
A better idea is to move up, but in increments. Consider my 10% rule here; if the asset sold was leveraged at 50% then leverage the newly purchased asset by 60%. Applying this rule up to 80% loan-to-value will allow the newly purchased asset to have similar financing in place to the one sold, and similar cash flow. You, the seller and new buyer, gain a new depreciation schedule and peace of mind. That’s a good combination!
There is a time to sell…
The important part to selling is to put in the “thinking time” prior to making the assets public. What’s the end game? Where will funds be delivered one day after closing? Even seasoned pro’s get the urge to sell. And here’s the bad part; some people sell out is sheer boredom. I fear this happens all too often.
One investor I know sold his assets and purchased mutual funds. His reasoning was family members were in no position to “manage the managers” and with his purchase of mutual funds he was buying long-term, professionally management assets requiring no active management by family members.
Certainly, there are a multitude of good reasons to sell a multifamily asset; from capturing capital gains for reinvestment, estate planning, repositioning corporate or personal assets, re-balancing a portfolio, use of proceeds to pursue other investments, tax planning.
Similar to interest income, re-investing in your multifamily assets pays dividends upon dividends. This is why avoiding capital expenditures is a bad idea…. you are reducing the future value of the income stream by letting a property deteriorate. Before letting this occur you are better off selling the asset.
Avoiding the sale of an asset strictly based on tax consideration is short-sighted. Tax considerations are just one part of being in business.Warren Buffet is famous for saying he will be pleased to take on an investment others pass up because of fear of the big tax bill that comes with success.
Long-term ownership is very very profitable. This is why the selection of the right markets and the right assets is so very important. When done right these same assets may be in your family’s portfolio for generations.
Comment here and tell us about assets you’ve held the longest, or about the one you wished you’d never sold! War stories welcome.
Mr. Wilhoit is the author of three books: How To Read A Rent Roll: A Guide to Understanding Rental Income and Multifamily Insight Vol 1 & 2 – How to Acquire Wealth Through Buying the Right Multifamily Assets in the Right Markets. Multifamily Insight Vol 2 — just out!
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About This Blog: Multifamily Insight is dedicated to assisting current and future multifamily property owners, operators and investors in executing specific tasks that allow multifamily assets to operate at their highest level of efficiency. We discuss real world issues in multifamily property management and acquisitions. This blog is intended to be informational only and does not provide legal, financial or accounting advice. Seek professional counsel. www.MultifamilyInsight.com