Real Estate Exit Strategies - EP10

build-to-rent exit strategies multifamily Oct 26, 2021

If you're actively involved in a build-to-rent investment, chances are you're doing so to make money. One of the most important steps of the investing process is to figure out your exit strategy. Not planning your exit can result in big losses in income, and planning your exit can net you big returns.

"Now, the good news on commercial financing is they won't let you rev it to the hilt. There must be what's called a debt service coverage ratio there, which that's a fancy way of saying there's more than enough money coming in to cover your debt and then some. So you can sell it, you can refi, and something that we've started to see a little bit more of." - Steve Olson, B2R Show

Welcome to the Build-to-Rent Podcast. It's a beautiful day here in Provo, Utah. I'm Steve Olson here with Chase Leavitt and Sherida Zenger. There is a topic that we want to cover quickly today that I think is one of the very most important you want to do. Build for rent. I'm not going to assume you're running a charity.

You want to get paid at some point. You want to get paid. Now, if you're not in it to get paid, then I don't know what to tell you, but if you do the most key thing is to figure out. How do I know what my exit strategy is? Right? That's the payday, there are some paydays along the way, depending on how you structured your build-to-rent.

For example, if you're doing it for yourself, right. You're just building a couple of properties, your paydays, or your rental income refinances, proceeds sales proceeds at some point down the future. Uh, what if you're doing a build for rent to sell? That's your, that's your exit strategy, right? You're going to sell it right out of the.

What if you syndicated a build-to-rent. You've got multiple profit centers along the way. You've got to promote, right? Your developer fee. You've got your refi proceeds. You've got the cut of your waterfall distribution at the end when you sell the property. There's a lot of ways, to exit something that's built for rent.

We wanted to kind of play around with that a little bit today, and maybe get you thinking a little bit about some different ways that you could exit your, your build for rent.

Number one. Let’s start small here. If somebody is going to build, uh, their own rental property, something that I'm seeing as being more and more popular as they build a brand-new Airbnb, right. That you're seeing a lot more of that. And I don't think that we've seen even close to what we're going to see, but if it were you too.

What would you be thinking about in terms of an exit, how long you want to be in how you're going to sell what's on your mind there? Well, when I think of an exit strategy, I think of the first thing that comes to mind and it can vary depending on the investor to investor and who that person is in, in what their goals are, and what they're trying to accomplish.

Are they looking to exit and sell and collect? Their income or they're their profit in that property. Do they want to put in something else where they can have more doors or are they just looking to collect their capital where they can maybe build their dream home? There's just a lot of different ways.

We can spend this depending on that person, depending on what their goals are and what they're looking to accomplish. Yeah, I think that's a key thing too. What is your end game? Right? What are you trying to do, how much passive income do you want? What, what is that goal at the end? And then let's walk it back a little bit, but I think as far as, you know, an Airbnb and exit strategy, obviously you're going to want something that is, if you're building it yourself, it's new.

And maybe you have an idea that, Hey, at 10 years, I want to flip out of this. I don't, I want to get into something new or in a different phase of maybe the same project. I don't know. I mean, some people will want to flip out a little bit quicker than. But yeah, but when it comes to exit strategy and when you sell property, at least for me, when I sell property, if I'm going to sell a good asset or something, that's performing cash flowing, great cap rate, I'm going to sell it and put it into something that is hopefully better.

Right. You don't want to sell that and go to something worse. I'm always looking for opportunities and deals. Yeah. Yeah. And maybe your strategy is to hold onto this right now and then just wait for the next opportunity to present itself. You know, I know we were talking yesterday when we had met up, I was out of town this past week and one of the gentlemen said, geez, if I would have bought 20 acres, you know, in my hometown, when I was growing up, you know, 15, 20 years ago, think of how much money I would be sitting on.

Well, the truth is, you need to buy something now because you're going to say that in 15 to 20 years, Down the road. So maybe your strategy is I'm just going to buy this to hold it until another opportunity presents itself because there's also the strategy of, Hey, I could do a cash-out refi, or I can do a hilar on that and get into something else if there's enough equity in that property.

Right. I think there are a few different ways to look at it, but yeah, it depends on the person and depends on their goals. Some people might not have time on their side to sell and sit around. Some people might want to just keep their property or get cash. Because that's where they're at. They're looking for retirement money and maybe they're in a position where they can't get more loans down the road.

They're trying to get as many as they can. Right now, talk about more loans because I, I'm not sure everybody would understand what you mean by that. If you're doing conventional Freddie or Fannie financing, you're only allowed 10 loans in your name. Now you can do these two different ways. You can have you and your spouse.

On the loans together, and you can get 10 loans or if your spouse has income and you have income, you could potentially get 10 loans yourself, but you max out at that, those at that 10 loans, after that you'd have to go commercial or pay things off. So, people like to take advantage of that financing cause they usually have better terms 30-year fixed a lower interest rate than something that's commercial.

Yeah. We could talk about this for a long time now because Chase and I are working on a deal right now. Where that's the case. You mind if I am out some, some of this deal, right? He made a face. So, he might mind a little in the edit button ready, but no, you, you found yourself making money, um, an offer. You couldn't refuse on some land, you sold it and you've got to do a 10 31 and I had a listing on a duplex and it's an okay deal.

You could find a better deal. Like if you waited for some of the new construction that we use, But you're up against the clock. Exactly. Right. So, your exit strategy on this one we're doing together is to park the money, protect it from taxes, reset my clock until something different comes along and then you can reevaluate at that point.

Yeah. Obviously, I'm a little bit biased when it comes to new construction. Fig I know what those numbers look like. I've been through it before. I know what that risk is, and I feel like there's a great opportunity there. And so, if I see something comparable, whether that's the next opportunity or something else.

When the timing's right. That's when I plan to exit or position, that's a big thing to consider an exit. Is taxes a hundred percent? I mean, that drives so much of the market. I get, I get 10 emails a day off, hey, buy this CVS, buy this carwash. And it's a mediocre cap rate. But if you're looking at a tax bill of $700,000, would you buy that car wash?

1200 positive cash flow a month and not pay $700,000 in taxes. Absolutely. Why wouldn't you, would you rather pay Uncle Sam or would you rather have yourself having an income-producing property and be able to write those taxes off? Yeah, yeah, definitely. And that's how I feel about that. Duplex. I'm glad you brought that up.

I don't feel like it's the best, um, cap rate or cash flow, but to be able to get some income for the next three to four to six, eight months, whatever it is versus having sitting with the comment. Makes sense. Makes sense. Well, and it can only sit with the accommodator for so long. Yeah. Yeah. And that as well, I think the big thing too, was him being able to reset his clock.

Right? Yeah. Being able to reset that 10 31 clocks, you only have 45 days to identify after you close on the departure property and then you have 180 days to close on that. So there, there is a tight window there. Yeah. A thought that just came to me, you know, we were talking about Airbnb for a second and vacation properties and.

We're dealing with this; I'll make an observation. And then I'll talk about something that we're dealing with right now. That's kind of a pain in the butt, but, um, the kind of property that you build might choose your exit strategy for you. I would favor constructing properties that give you multiple off-ramps, right?

Lots of different ways that you could potentially exist in the future. For example, I closed on a 32-unit townhouse project in Phoenix. We're going to Platte this as 32 townhouses, right? Not as one entire, um, one entire subdivision, so, or sorry, one entire project. So that way in two years is the price of a single townhome.

Really astronomical. Do we want to just pick the, pick these off one by one and gradually sell? Right. We want to have that option available to us. I took my family on vacation. It was at last fall to the Florida panhandle destined, which is awesome. But I saw so many vacation properties down there and we would walk from the place we were staying at to the beach.

And I saw probably five or six, big new vacation properties, single-family homes. But they looked kind of like a glorified apartment complex, right? There are five family cars parked out there. It's a family reunion. And that builder built that thing as a value-engineered box. Right. It was built as a vacation property to maximize bedrooms and maximize income per night for all these families that year around go to Destin and want to live close to the beach.

And that's great for him. Right. He's going to maximize that, that charging it. But what, what about when he goes to exit? Right? Is the vacation market good? Is it bad? Can you really sell it to somebody that's just going to live there? What is that?

That exit is kind of fuzzy depending on what the vacation economy looks like.

Isn't it? Absolutely. Here's. What's fuzzy. You remember COVID year, year and a half ago and things were on lockdown for a little bit. What was that? March? April. Vacation rentals. We've brought St. George before you're talking about Florida. I thought those were going to get hammered. I was like, oh no, no, no one can go anywhere.

They're in trouble a couple of months later. They're killing it down there. I know for St. George; I can only imagine in other locations within the US same thing. Yeah. So, he could get a huge curveball, whether it's COVID or something else that you can't foresee, or you don't know, they could either hurt or help.

Uh, Airbnb or vacation rentals. Yeah. You don't know what to do on those black Swan events. Go ahead. Share them. Yeah, that was interesting. I had just had a conversation with some friends, and they picked up two homes down in Scottsdale, Arizona, and they said they purchased him when the pandemic hit, and people were panicking because they were Airbnb and they were panicking thinking I'm not going to have any income.

He said, he picked these up rehabbed the heck out of them. And he said they're making $30,000 a month per. Just doing an Airbnb on it. He said we couldn't have gotten at a better time, but he said, now go try to find something. You're not going to find something because the prices have skyrocketed right now.

Yeah. Cash is king. When those black Swan events do happen, the thought, I mean, the same thing, right? You would've never thought that that's what has changed that market, that vacation, home panic, uh, what, a lot shorter-lived than I thought it was going to be. I think it probably lasted a lot longer for hotels.

Given the nature of what a pandemic is, uh, during spring break of 2020, my family, you know, that was a bad time, but we got in the car, and we drove to Scottsdale and we stayed in an awesome Airbnb for like nothing. Right. And we've since looked at it, it's like six times more per night than what we paid for it in April of 2020.

Right. So that just illustrates a point of the kind of product you build may determine your exit for you. We've got this big fourplex project in Phoenix that we've been getting ready to start construction on early next year. And I got the news from our development team that, um, this, this is hotly debated as to how this happened.

Stay tuned, but apparently, the city isn't going to let us plat this as fourplexes anymore, or maybe they never were. We don't know. And this means that we must start all over with a new subdivision plan. It's going to take at least a year, and nobody wants to do that. This thing is queued up and ready to go.

We've got clients ready to buy it. The solution is to record this final plat as a condo plat, right? This means the HOA over the entire property is going to be the owner of the ground. The owners of the properties themselves still have fee simple condo real estate. They can sell. Quote unquote townhome, but they don't own the ground.

It's kind of silly because it says, well, that means you can't knock over and build something new because you don't own the ground. It's a townhome project. You were never going to knock it over anyway. But unfortunately, that limits exit. Would you, would one of you elaborate on how that exit gets limited only by the financing.

I know we talked about how this project's going to work. It's being built at. Income-producing. They're all rentals. And if you want to go again, Fannie Freddie conventional financing, I, the lender's not going to lend on that because you must have 50%. It must be owner-occupied. Yeah. And that's not going to be our project.

So, this project then takes a little bit of a turn because we have to go conventional or commercial, excuse me. So do commercial loans on this or cash that doesn’t hurt this project too bad because we are in an opportunity zone. And those people that wanted to take advantage of that can take advantage of that.

They'd have to use commercial financing anyway, but it does, it changes up. Who you're going to sell to and limits it, where some of our other projects you've been able to sell to owner-occupied or sell to somebody, you know, that can use conventional financing where this one is going to be strictly commercial or cash?

If you record it as a condo, and everybody that bought it has to use commercial financing.

When Bob, the investor wants to exit per the title of our episode, occasionally we'd like to remind ourselves what we're supposed to be talking about, but when he goes to exit the person that buys it from him, either it must have cash or commercial financing. It's kind of like the grocery store. You go in there and say, Hey, I want to buy this loaf of bread.

Can I pay you with a visa, MasterCard? They said, well, we only take Americans. You're still going to sell it, but you did limit the amount of liquidity, the number of buyers for the product. So, what you build, is it CLI or sometimes legally, in this case, put, potentially limit your, your exit strategies. Yeah.

Yeah. So, we can transition then and we can look at going. We can look at going bigger, right? We're going to do a big project, maybe a partnership or a syndicated. Where we have multiple investors, you are, what's called the general partner, right? You're driving the ship and there's a whole bunch of things you have to do with the sec in order to make this legal.

We're not telling you what you should or shouldn't do there. Talk to your attorney about that. But when we talk about exiting syndication, the traditional model is we bought an asset. It might be an apartment complex. That's really old and run down, or it might be land, an apartment complex on, or a bunch of homes.

Right. And then we go through construction, we get a certificate of occupancy, which means it's done. We then lease it up and upon lease-up. We've got some, a couple of direct. That we can go, right? It's fully leased. You have taken all the risk out of the balloon at this point.

There are big investors out there, life CO's and REITs and people like that that are going to pay a top dollar a fancy way to say that as a compressed cap rate, right, they're willing to pay a lot of money because you took all the risk out of it.

And that's your exit strategy. And that whole process is probably going to take you three to five years at some. But the kind of along the point of what we talked about with chase earlier, what if you don't want to do that? What if everybody in your partnership is willing to stay in longer instead of selling let's refinance, right?

A mentor of mine used to say refi till you die. Right? There's no taxable. You pull the money out. You take advantage of that, and you're good. If you didn't refi over, you know, to the hilt.

Now, the good news on commercial financing is they won't let you rev it to the hilt. There must be what's called a debt service coverage ratio there, which that's a fancy way of saying there's more than enough money coming in to cover your debt and then some. So you can sell it, you can refi, and something that we've started to see a little bit more of, and I'd love your comments.

Could you sell it to CFO, what it's done, and it doesn't have any tenants in it? Is there any interest in that kind of thing you could sell before CBO technically put it under contract if you're using our model because our buyers carrying the construction loan? Right. So yeah, you can sell that or put it under contract, and then once it has CFO, you can close on that unless it's a cash buyer and they want to take that out.

But yeah, there are absolutely people that will take it on and assume that risk of getting that tenant. Because they know that it's a good deal when I'm doing a deal right now in Provo that's like that. And there doesn't seem to be any problem with it. So yeah, I mean, it's a way for the investor to get some of their gains out of it.

And then 1031 exchange, maybe they want to buy one or two other properties with it, 1031 into it. Or maybe they just did it to make a little bit of cash. They're going to pay taxes on it. And they're okay with that. I have a call with two institutional investors tomorrow, both of which are interested in buying.

Right, because I think what that's a symptom of is the volatile construction environment, right? The cost of the land, the cost of the dirt, a C of O is something that's relatively quantifiable. Here's how much it costs, and they can manage their own risk from there. But they're just not willing to take on the construction risk, which is getting to be more and more every single day.

If the microphones were on before this podcast, you would have heard us ranting about that because we're getting clobbered. And in Idaho right now, construction risk. Right. So, and I think you're able to sell at a little bit lower of a cap rate at that point. I think some of those investors are going to come in, be willing to take a lower cap rate, knowing the risk is out we're well, most of it is they'll take police risk.

Yes. They don't want to take the construction risk. Yeah. But that's the big money like you talked about before, the bigger projects that you take on and you finished and stable. Or if you're selling off the CFL, they're willing to come in and buy more because that's the big money. And the big money is okay with buying a lower cap rate.

What I've seen. I have my brother, um, his father-in-law, and I'll keep the details fuzzy because I didn't get their permission, but he works for a state government pension, and they buy big pieces of commercial real estate and multi-family properties. And they'll, they'll pay top dollar. I mean, they underwrite it like crazy, but when you're talking about managing billions of dollars in a pension, right, and you want to place that money and earn a few percent a year on your money to them, that's great.

They want low drama. They want a return on their money. They got to keep those billions of dollars working. So that's an entirely different problem than somebody who's flipping out of their Airbnb house. They were built in Scottsdale. Yeah. Yeah. Yeah. Well, um, I think that'll do it for now.

I would rate that a better-than-average build-to-rent podcast episode. Don't go back and try to find out what's below average. We won't tell you, but, uh, thanks to everybody for listening.

We'll catch you next time on the build-to-rent podcast.

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