Question for the acquisition and development monkeys: My group is looking at a 135 unit multifamily acquisition in a third tier suburban market. The broker is marketing at a favorable cap rate for new, luxury, amenitized multifamily. Here is the rub - construction is still ongoing, the owners are at 50% occupancy and have made the commitment to sell the project once construction is complete and at 70% occupancy. We toured the property and there were not glaring signs of shoddy construction - in fact the property looked pretty good, lots of high end finishes. The developers are historically condo builders - this is their first foray into multi-family. We see this as an opportunity to take advantage of a hairy situation at a reasonable price but I am wondering why would anyone ever look to sell prior to stabilization and leave money on the table? Are there any red flags to look for here?
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You’re more educated on this topic than me, be here goes my thoughts. A lot of times developers are in the business of building then selling at a reasonable profit to finance the next project. Could just be that they want to sell off quickly and value the “liquidity”. My dad had built a small commercial retail location marketed for sale at around a 7% cap rate and ~ $2.9M. Many offers came in almost immediately at $2.5M and high upfront payment. The broker suggested they are just testing our need for cash and lowballed with a high upfront payment for that reason. One potential red flag would be the occupancy rate, in my third tier home city, rates rarely go above 50% for any extended period of time. Lack of demand due to cheap single family developments and lack of “working age, non home buying” population are probably to blame. Hope my limited knowledge provided any benefit.
I wouldn't necessarily see it as a red flag. A few reasons off the top of my head from the developer's standpoint:
When I was on the acquisitions side we did this once and it ended up being a steal - leased up way faster and at much higher rates than anticipated. Had they waited to sell until stabilization we would have easily paid a few million more.
These two ring especially true. The hardest units to lease are the last 10-20%, which no one wanted in the first place.
Right now, the owners can tell you they have perfect comps for the unleased inventory, so even if they tell you that they'll sell you the other half of the building for 80 cents on the dollar, they're still coming out ahead, because those are the units that need time or concessions to move. And they get the liquidity.
Also, at 50% lease up they're probably still sitting on a very expensive construction loan. Now they save on carry as well, since they aren't going to get to stabilization, pay all the costs necessary to close on perm financing, only to turn around and pay all the transaction costs to sell. May as well give up a couple points to avoid the cost and hassle involved.
They're cashing out and moving on. If they or their investors are IRR driven then exiting early is an easy way to pump up the returns. The longer they stay in the deal the harder it gets to keep that IRR above 30%. I doubt they're leaving that much cash on the table by exiting at 70% occupancy, at least that's what their broker told them. Plus, as was stated above, they remove lease-up risk.
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