I'm assessing two separate held assets since 2012. I'm looking at different scenarios i.e. Sale after retrofitting (Scenario A), sale after stabilizing (Y3) - Scenario B, and hold and operating (10Y horizon) - Scenario C
Asset A the IRR profile is as follows:
Scenario A: Lowest
Scenario B: Higher than A
Scenario C: Higher than A / B
This intuitively makes sense. As in Scenario A you do not take on the lease-up risk. Relative to scenario B where you lease up and stabilize.
However, what doesn't make intuitive sense in Asset B is the IRR being the highest in Scenario A and lowest in Scenario C.
Any input to make this make sense would be helpful!
Growth rates and cap rates are all consistent.
Are you using a different set of retrofit, stabilization, and operating assumptions for asset B relative to asset A? I'd also check your rent, expense, and below the line (TI/LC/Capex) assumptions too to see if you're being overly punitive during your projected hold period (leading to lower returns under scenario C) - without enough information it'd be hard to answer this question, you'd be best serve going through the cash flows and seeing what assumptions are leading to increased/decreased values or timing
I will say though, for us at least, for most of our deals that require value-add or stabilizing, scenario B where we immediately flip out after we stabilize is where we see IRR maximized.
This is because for deals like this, all of your projected returns are being driven by your sale price at exit. It makes sense (at least to me) since you have large cash outlays at the start of the investment, which are a drag to your returns. We want to offset those early outlays by being able to sell quickly after stabilization. Often times, the additional cash flows you get from holding the asset aren't large enough to offset the return drag of selling the investment later leading to lower returns under a scenario like C (but your money multiple is obviously higher if you hold, plus it might make sense to hold out if you (1) anticipate more cash flow growth (2) have cap rate compression or (3) have cheap debt)
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