Asset Management (Part 4)
Regarding asset management, every investment falls somewhere on the buy-hold-sell continuum. During each phase of the property lifecycle, asset managers have different priorities and responsibilities but are ultimately responsible for ensuring that all aspects of the deal are going smoothly from acquisition to disposition as well as throughout the entirety of the ownership period. Lease negotiations; Improving net operating income; Interfacing with property managers; and Updating investors - There’s a lot to do at every stage of the deal cycle and a lot of information in disparate places that you need to do it.
So, what is commercial real estate asset management? It is the process of buying, selling, and holding assets to maximize a property’s value and return on investment. In the previous posts, we covered the role of asset management during the acquisition and ownership periods. In this post, we cover the asset manager’s role when exiting the deal during disposition.
Maximizing the value of the property. When it comes time to sell, asset managers strive to secure high valuations and make properties as attractive as possible to potential buyers. They accomplish this through a mix of strategies that include expense reduction, curing deferred maintenance items, strategic lease structuring, and presenting a property’s upsides to potential buyers.
Disposition. There are several reasons to sell a property. The ownership group may want to free up capital for other investments or rid themselves of a property plagued by management headaches or partnership issues. With some properties, the internal rate of return may drop after a certain number of years, meaning there is a greater risk in holding on to it compared to selling. Generally, there are three primary strategies when exiting an investment.
Refinancing: Putting a new loan on the property can come with a lot of benefits. For one, there are no transfer taxes or brokerage commissions when you refinance a property and you can postpone paying capital gains taxes. A cash-out refinance puts more money in your pocket while simultaneously decreasing risk by reducing equity in a property. The downside is that this creates a higher loan-to-value ratio which can potentially increase your risk of defaulting on the loan.
1031 Exchange: This allows you to keep your existing investor base by selling your property and immediately trading into one of equal or greater value. You must identify the replacement property within 45 days of the sale and close on it within 180 days to avoid paying capital gains taxes.
Outright Sale: This can take three to 12 months and comes with a host of associated logistical considerations and costs such as brokerage commissions, legal fees, transfer taxes, and potentially a loan prepayment penalty.
While asset managers have an important role to play in all three of the scenarios above, selling a property outright requires the most operational savviness. Prospective buyers will look back at least 12 months of operating statements (T12 and rent rolls) and make assumptions about how the property will perform going forward. Ideally, you will have been optimizing building performance throughout your entire hold period but if not, you must begin 12-18 months before your property hits the market. Demonstrating that a property is operating efficiently is critical to securing a high valuation when you go to sell. Additionally, asset management will continue to touch base with the investors to facilitate distributions and upon sale final lump sum payouts.
