Joe and Theo are back for another edition of Follow Along Friday! Today we?ll hear about what things we should be looking at when deciding to sell an apartment community. We?ve covered this before, but today in greater detail than ever before. If you enjoyed today?s episode remember to subscribe in iTunes and leave us a review!
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[spp-tweet tweet="?If they can?t execute the business plan, they probably won?t be able to close the deal? - Theo Hicks "]
Mentioned In This Episode:
8 Step Process For Selling Your Apartment Community
Three Ways An Owner Benefits From Selling Their Apartment Off-Market
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TRANSCRIPTION
Joe Fairless: Best Ever listeners, how are you doing? Welcome to the best real estate investing advice ever show. I'm Joe Fairless, and this is the world's longest-running daily real estate investing podcast. We only talk about the best advice ever, we don't get into any of that fluffy stuff.
We've got Follow Along Friday today. Today we're gonna discuss the 8-step process for selling your apartment community. Let's dive right in.
Theo Hicks: So this is based off of a question received from a listener. His name is David, and he said: "I wanted to ask you if you have any suggestions or tips on the selling process. I wanna be as knowledgeable as possible going into this process. Any books, specific podcast episodes or just general tips?"
We are gonna do a specific podcast episode on this, so we're gonna fulfill that. This is also based off of a blog post that we have with a similar title; of course, as we're doing it live, we're gonna go in a little bit more detail on the selling process.
As you mentioned, it's 8 steps, and the first step is to actually identify when to sell the property, because that's going to differ from deal to deal. High-level, Joe, how does your company determine when you're going to sell the apartments you guys bought?
Joe Fairless: Well, there's a short and a long answer. The short answer is we determine when we're gonna sell based on what type of returns we can get when we sell. That's the short answer... And if those returns are going to hit the projections, then we're going to consider it and likely will sell; if it's gonna exceed the projections - then again, we'll consider it and likely will sell.
If it will not hit the projections, but there are some things on the horizon from a market standpoint - maybe we're in a market that just lost 50% of the employer base for whatever reason, I don't know why, but maybe that's what happened, and we don't see a way that that's going to get turned around in the near future, then our job as general partners is to focus on capital preservation and mitigate risk as much as possible for our investors.
So while returns are great, losing money is worse than as good as getting a return feels or is. So we want to first and foremost protect the capital that we have on the investment, so we would look to sell if we wouldn't hit the projected returns, but there's a variable out there that we see is going to be present in the near and long term, then we'll get the money back to the investors and get whatever type of return we can, and then move on with something else, and know that we have a variable we need to look out for on future deals that we didn't see previously.
So that could be, like I mentioned, some employers, and it could be an area that we thought would continue to be as it currently was when we bought it, but instead maybe a school district got rezoned and now the property is no longer in the good school district, it's in a bad school district, and that hurts the value of the property, so we see that as a long-term issue, not something that's short-term. If that's negatively impacting the property, then we're gonna need to figure something out.
So that's ultimately what we look for - can we hit the projected returns, can we exceed them? Okay, then we're gonna seriously consider it. And if we can't, but there is another variable in play that is on the horizon that we don't see going away, then we'll still look to sell, assuming that we can't push through that and come out the other side.
Theo Hicks: So you buy a property and the initial business plan is to hold for five years; that's kind of just the projected, but as you've mentioned, if something happened in the market that makes sense to sell it earlier, or if for example your projected sale price after five years was 20 million and after three years you can sell for 20 million, you'll exceed your return projections by doing that if you're selling it earlier, and the IRRs based off of the time of when you sell the property, or how long the capital is tied up for.
Joe Fairless: In your example, if we can get 18 million for the property instead of 20, even though we projected 20 in year five - many variables in play, but the IRR is likely gonna exceed what we would have achieved if we held it two more years and got an additional two million dollars on the sale... So then we'd consider selling.
As soon as we buy the property, we're constantly assessing what we should do with it relative to the business plan, relative to the market, and we get brokers' opinion of value at minimum on our properties, and we see "Okay, based on where we're at with the business plan and where we projected, we can get x% of the total exit purchase price that we were projecting now - how does that look from an investor return, and what do we wanna do?"
Then you're also considering along the way the type of debt financing you have on the property, when does that become due... Because you're gonna need to make a decision in, say, three years, so if you have to make a decision in three years, then you need to start looking at it in year one, in year one and a half, because you don't wanna be pushed in a corner.
Theo Hicks: Okay. You also kind of mentioned something else I was gonna talk about for this step of wanting to sell - the way that you determine the value of the property to figure out what returns am I gonna get is through that broker's opinion of value that you're getting every 12 months. That's essentially a broker doing their sales comp approach to determine what the value of the property actually is, using the net operating income.
I think you mentioned they'll give you like a high, medium, low sales price, and from there you can determine, "Okay, based off of me selling it now, what are the returns going to be, based off of this broker's opinion of value?" and then move forward from there.
Before we move on to step two, when you get the broker's opinion of value, do you get them from the broker that you used to purchase the property, or do you get them from multiple brokers you're working with? What broker do you decide to go with?
Joe Fairless: Yeah, you don't get it from a lot of brokers. You should pick your partner or maybe have one other partner... So maybe at most get two brokers' opinion of value... In my opinion. This is my opinion.
The reason why you don't get multiple brokers' opinion of value is you'll hurt your reputation with all of them if you're asking all of them to do it, number one. Number two, if you at this point are unsure of which broker you should go with, and you have to get five brokers' opinion of value to see who can get the best price, or who thinks they can get the best price, then you are not doing your homework and you are not building relationships that you should be building along the way... Because by the time you're looking to sell a property, you'd better have strong relationships with at least two brokers in your market, and those are the two brokers who you can use to get the broker's opinion of value.
And how you select which one you go with - well, it's either the strength of the relationship... That's assuming that the brokers' opinion of value are similar, by the way. If they're drastically different, then you need to dig in and understand why are they different, and then you might uncover some things that will help you position your property or you didn't know about your property etc.
Ultimately, it's a combination of strength of relationship and confidence that they'll be able to deliver on what they say they can deliver on... So you look at their track record and history; this is assuming that the brokers that you've selected have a track record, have a history, and you can confidently assume that they're going to get their conservative estimate... Because as you mentioned, they're gonna give you a conservative estimate and they're gonna give you a more aggressive estimate for what they can sell the property for... And assuming that they have delivered on conservative estimates in the past and you can assume they'll deliver on yours too, especially if that's within the range of the other one, so then it's just a matter of relationship.
Theo Hicks: Exactly. So essentially, you're not necessarily going with the broker's opinion of value that has the highest price; there's other factors to take into account, so you want the best broker's opinion of value, which comes with the best price and the best actual broker.
Joe Fairless: Doesn't that sound so similar to how you select a buyer when you are selling? You don't just go with the buyer who's offering the highest price, you go with the buyer who has a high price, but also that you know will close the deal, will do what he/she says they're gonna do.
Theo Hicks: Exactly.
Joe Fairless: We have won deals, and one recently, where I know for a fact that we were $400,000 less than the highest offer, and we got awarded the deal; it's because of our track record. That goes the same with when you select brokers - you also go for the track record. If their aggressive estimate is a lot higher, then you've still gotta take into consideration who they are and will they be able to deliver?
Theo Hicks: Yeah, exactly. We'll kind of go over what Joe has mentioned in more detail in step five, the best and final seller call.
So step one is to find when to sell, which we've talked about. Step two is once you've made a decision to sell, you need to be -- of course, you're going to be mindful of the sale, but you wanna make sure that you are setting yourself up to get the best offer on the property. If you're buying property and you're underwriting deals and you're screening deals and you're doing due diligence on deals, so you know what you're looking for when buying a deal - you wanna make sure that certain things that you would use to disqualify a deal [unintelligible 00:10:55.26] at your property, but secondly, you want to obviously maximize your income and minimize the expenses before selling the property, because the property value is gonna be based on net operating income.
A few examples of things you can do are, for example, if you plan on selling it a month, you have to determine if it makes sense to renovate those units. Is the money you're gonna put into those units gonna be less than the increase in value from the increase in rents from renovating those units? If not, don't renovate them. If they do, then do renovate them.
So it's not automatically hold off on renovations, it's just kind of going in the details and determining what the rental premiums will be based off of those renovations and determining if it's worth doing that.
Another example would be to increase your marketing budget. But again, if increasing your marketing budget is not gonna get rewarded more than the cost to market, then don't do it; but if you are, you're gonna get that extra couple of percentage points in occupancy, then increase your marketing budget.
Something else that you can do, no matter what, is to pursue your collections more aggressively. One thing that -- when we are looking at deals, you don't wanna see a high bad debt or high delinquency, so when you're going to sell your property, you wanna make sure that you're pursuing this bad debt and minimizing it as much as possible, because it makes the property look better, but it also increases your net operating income.
Those are just a few examples of things that you can do. Basically, just look at your T-12, look at your revenue line items, look at your expense line items and figure out what you can do to increase the former and decrease the latter. That's step two.
Step three - Joe kind of already mentioned this... It has to do with notifying your lender that you're gonna sell the property. For example, let's say you've got a loan that has some sort of pre-payment penalty after [unintelligible 00:12:36.05] for three years. Maybe it makes sense from just a sales price perspective to sell it, but you have to take into account any type of penalties or yield maintenance, or the fees that you have to pay on the loan by selling the property earlier.
Practically, what you do is you send your lender a notification of disposition, letting them know that you intend on selling the property, and then also you need to have an understanding of any type of penalties you're going to pay for doing so... And then taking that into account when you're looking at if it makes sense to sell or if you should wait until all those fees go away.
Step four - this is after you've got your broker, based off of your best (not the highest, but the best) broker opinion of value, and then next is for them to start a bidding war. This involves them creating their offering memorandum, marketing the property, them bringing people onto the property, showing the deal... Essentially, everything that you went through in order to buy the property, they're gonna have people doing it at your actual property.
Joe Fairless: It might make sense to not have the property go on market. One of our properties that we sold, we did not put it on the market, and the reason why is because a local group who owner property around where our property was came in with a very, very strong offer... And we know the market, the broker knows the market, so we know that it was unlikely that the market would pay what we were getting in offer from this local group... And the local group owned property around that area, so they could operate it differently and more effectively than other groups who were coming in and just buying the property without the scale that this group had in this neighborhood.
So have a conversation with your broker and ask him/her about if they think it would make sense to do off-market as well. Listen to them, and then you make the decision. That should be after you get the broker's opinion of value for the conservative and the aggressive range. Most likely, it will make sense for you to take it to market, most likely... But there are circumstances...
Another circumstance where we've sold a property off-market is a broker recently represented a seller in the same sub-market, and he had multiple buyers who didn't get the deal; only one got the deal, and he came to us and he said "Hey, I've got a group, they're willing to pay all cash, they are wanting to buy in your area, and here's the price that they're looking to give you for your property", and we're like "Okay." Why go through the whole process...? Because they just went through the whole process in the same submarket for a similar property, so we know what the market will demand (or command) for deals... So we skipped ahead and then didn't have to go through the whole song and dance with tours and everything else.
Theo Hicks: We have a blog post that's entitled something along the lines of "3 ways an owner benefits from selling off-market." It's written from the perspective of you being a buyer, but you can also learn about why you might potentially wanna sell your deal off-market because of those three benefits.
Step five - this is assuming you're the deal on-market and not off-market - is to have a best and final seller call. As we were discussing when we were talking about which broker to go with, you have to have the same approach when you're determining which offer to go with.
The highest offer is not necessarily the best offer. There are other things that need to be taken into account about the buyer before you go through the process of awarding them the deal... Because then your property is gonna be tied up for that time, and they're backing out, that's 1) additional money that you're gonna be losing because you are selling the property 60-90 days later at a minimum...
So on the best and final seller call, essentially you want everyone to submit their best offer, and then you will have a conversation with the buyers to get more information on their background. You wanna know what their track record is. It's kind of like what Joe just mentioned - they sold a property to someone off-market who had just bought a deal, so they had the confidence that they'd be able to close.
If the buyer doesn't have a solid track record or doesn't have a team with a solid track record, then you don't really have any proof that they can actually close on the deal besides their word and just this offer price.
Something else you wanna know is how they're actually gonna fund the deal. Again, if they don't have their debt lined up, they don't know if they're buying it all cash, where is that money coming from, if they're buying it with debt, where is the down payment coming from and where is the debt coming from, can they qualify for the debt...? Because obviously, if they can't fund the deal, they can't close on the deal.
You also wanna know what their proposed business plan is. Say, for example, you're selling a property that is completely renovated and their plan is to do a value-add business plan and raise the rents by $100 - are they gonna be able to do that? Will they even be able to qualify for a loan based off that underwriting? Will their team be able to execute on that, and will they agree to execute on that? If not, they're probably not gonna be able to close on the deal.
Then another thing you wanna ask is who their team members are, who is their property management company... I'm assuming most importantly will be the property management company, because they're the one that's going to be actually operating the property...
Joe Fairless: Debt.
Theo Hicks: And the debt, as well. These are all things that they need to have lined up in order to close on the deal. So essentially, the purpose of this best and final seller call is to confirm that they can actually close on the deal, and that involves asking about their track record, who's on their team, what their business plan is and how they actually plan on funding the deal.
Then from there you can have a conversation with your team on what's the best offer to accept, and it may not necessarily be the highest offer.
Step six is after you select the best offer is to negotiate a purchase sales agreement. That's the actual sales contract, so it's different than the letter of intent that they probably submitted prior to the best and final seller call. This is an official contract.
Joe Fairless: On the purchase and sale agreement, as a seller, make sure you use your template, and then provide that to the buyer. You're starting with a home-court advantage if you do that.
Theo Hicks: Yeah. Don't let the buyer send you a purchase sales agreement. Make sure that you yourself are drafting that.
Joe Fairless: Your attorneys.
Theo Hicks: Step seven - once the deal is under contract, you want to make sure you're fulfilling your due diligence obligations for the purchase sales agreement... It's depending on what's in the purchase sales agreement, but 24 hours notice the can come visit the property, and you're providing them with all the financials on a timely basis, and things like that.
Again, at this point you have gone through that process yourself, so put yourself in the shoes of the buyer and understand that they need to perform due diligence on their property in order to confirm their assumptions, so you need to be open and provide them with that information and allow them to tour the property and things like that.
Lastly is step eight, which is the close and distributing the sales proceeds to your investors. So you close on the deal and you make sure that you are taking the sales proceeds and distributing to your investor based off of how much money they invested in the deal.
Joe Fairless: That's likely gonna happen in 2-3 different distributions, because there's all sorts of outstanding checks and different payments you'll have - maybe for taxes, or maybe a vendor hasn't cashed a check yet... So you're gonna have to keep something in the operating account, but you also want to distribute the chunk of what you're confident you can distribute to investors.
One mistake we made on a recent sale is we sent the large chunk distribution out after the sale, and it happens like two, two and a half weeks after you close, just to get everything tidied up as much as you can... And we sent out the distribution, but we didn't let them know that this was the first distribution of what we knew we could distribute... And when we did the distribution, because it was a large chunk of what we could do, we just made it an even number... So their profits from the sale was, say, a hundred thousand dollars and zero cents; it was exactly even. So we had one investor ask us "Hey, wait a second... This is a little weird. Why is my distribution exactly this amount with no pennies? It seems like it should be like 27 cents, or something like that..." And they asked to see the closing statements, and we sent them the closing statement, and then I finally asked "Wait, what are you asking about?" and he said, "Well, I just thought it was a little weird..." and I was like, "Got it. Well, here's what we did..."
I should have communicated that to them in the e-mail, that we're going to distribute a certain percent now, and then we'll determine once all of the vendor checks are cashed and once we're still getting some income from the city, from certain rent checks that were subsidized housing... And once all of that's done, then we'll give you, to the penny, the remaining distribution down the line, which can take up to 3, 4, 5 months.
Theo Hicks: So those are the 8 steps. One thing I did wanna mention is that starting in step 6, after you've negotiated your purchase sales agreement, that's the point where you want to start notifying your investors and keep them updated on the process; once you've accepted the offer you wanna let investors know that you're selling the property, and then you also wanna let them know when the closing date is. So if that changes, then you've gotta let them know when the closing date is.
Then once you actually close, you wanna send them an e-mail, letting them know about the successful close, and then kind of as Joe explained, about the distributions, explaining how that process is going to work... Because again, it's important to keep your investors updated and communicating with them, because that's how you build trust and relationships with them, and have them come back for future deals.
Joe Fairless: So to recap, here's the 8-step process for selling your apartment community:
- You need to know when to sell. That broker's opinion of value is helpful there; also, where is your business plan, also any other variables in play in your market.
- Be mindful of the sale, so position your property for a successful sale, meaning look at the renovations that you're doing - maybe hold off on them, maybe continue... It depends. Look at the marketing budget, collections etc.
- Send your lender a notification of the pending sale or the upcoming sale. Know what your terms are in the loan covenant, because you might need to notify them more days than what you have under contract or they have under contract. That should not be a surprise to you, so know that in advance, prior to putting your property under contract, know how much lead time the lender needs, and then take into account pre-payment penalty and yield maintenance.
- Start a bidding war.
- The best and final call, qualify the buyer.
- Negotiate a purchase and sale agreement. Provide them yours.
- Fulfill due diligence obligations. You need a timeline; print out a timeline, put it in your wall, and also provide that to your attorney and ask them to notify you prior to any major milestones or major deadlines in the contract.
- Close and distribute the sales proceeds while communicating with your investors the expectations for when they should receive their distributions.
Theo Hicks: Alright, so just to wrap up, make sure you guys and girls go to the Best Ever Community page on Facebook. Each week we post a new question, you guys provide your answers, and you get included in the blog post.
This week's question is "What is the biggest red flag for you when evaluating a potential deal?" This can be some sort of factor in your underwriting model... For me, when I saw this question, my first thought - and this is more specific to Florida... When I'm looking at deals down here, if they don't have a concrete foundation, I don't look at it. Apparently, termites are a huge deal in Florida, so if you have a wooden foundation, termites are attracted to wood, so it can open up a whole slew of problems in the future by having a wood foundation.
So if it doesn't have a concrete foundation I don't even look at it. That might be a unique approach on here... I was looking at some of the answers on the page right now, and someone said "A really low expense ratio. 30% in the proforma." Probably not realistic... Another answer was "Accidentally miscalculating the IRR", on the calculator, making sure that the formula is correct... So again, that's a pretty big deal, because that's one of the things you're using to determine whether or not to invest in the deal.
So make sure you guys and girls go to the BestEverCommunity.com, answer that question and you will be included in a blog post next week.
Lastly, make sure you subscribe to the podcast on iTunes and leave a review for the opportunity to be the review of the week. This week's review is by James Patrick JP. He had a short and sweet review, which was: "Great podcast, with high-quality guests, and a good mix of education and inspiration, covering a wide range of topics."
Joe Fairless: JP, thank you so much for that review and taking time out of your day to help the community get stronger. I really appreciate it. Everyone, please do a review if you haven't already, and we will showcase you in the review of the week.
Thanks so much for hanging out with us - 8-step process for approaching selling your apartment building - and looking forward to talking to you again tomorrow.