Selling Long-Term Assets
I manage a boutique real estate investment and management firm and we recently took over Asset Management for a family office that holds a variety of properties, including NNN single-tenant, land, hotels, medical offices, etc...
Several of the NNN single-tenant properties have been owned for 20+ years and are debt free. Is there a reason to sell these assets and pay large capital gains taxes instead of refinancing them? I have been evaluating the pros and cons in our discussions with the client but wanted to throw it to the forum to try and get more feedback.
Cheers
Are the NNN leases coming up soon, credit worthiness, options, likelihood of execution of said options? If not stable, can the sites be redeveloped or re-tenanted at the same or better level as now.
If the leases are stable for the long term in your estimation, refi only makes sense if you can reinvest the income above the loan rate (and predicted 5-7 yr refi) - not sure what market you are in but decent safe investments seem rarer and rarer for us in NYC. (again, those that I think will outperform on the eventual refi or based on buying now with growth to balance that.)
My 2 cents. We deal primarily with multi-family, office, and mixed-use retail - not NNN in our portfolio, but the analysis would be the same except for a heavier focus on tenant.
Of course, the other question to ask would be - are your clients interested in growing the portfolio itself? If they haven't done so to date via leveraging to unlock equity for reinvestment, why not?
Do you have somewhere better to put the money? Somewhere that would be profitable?
This is all you need to ask yourself. Or do they simply just want to cash out and no longer be landlords?
Thanks for the feedback. We are evaluating the properties on a case by case basis and will likely recalibrate their portfolio based on their desired risk profile. Redeploying capital isn't really an issue, ask any hedge fund. Unfortunately, in this situation, capital gains are a killer and the profits would need to be distributed in like (re) investments through a 1031 exchange. I am inclined to use the proceeds from sale to buy-out fractional partners on other investments with equal or higher returns.
Huh? I work directly for the principles of almost the exact same kind of organization and we have almost the exact same type of questions that you are asking. Deploying capital for decent risk-adjusted returns is extremely difficult for family organizations. If you're a REIT or other type of large firm, you're ok with buying into projects with 6, 5, and even 4% returns on cost (especially when you're feasting on development and financing fees as the main part of your business)--not so much with most family firms as the risk-adjusted return is simply not there at that level. If your interest rate on your loan proceeds is 5% then your loan constant is about 7%. If you're fishing for deals in this market for 4-6% returns then loan proceeds are dilutive to your family's cash flow, even though it may be Accretive to your family's net asset value (NAV). But you're saying to yourself, "Well, we can do a lot better than 5%--we can get long-term debt at about 4% (give or take)." Well, the point remains about debt constant--debt can be dilutive to your cash flow when your expected returns are low. Also, if you're doing a deal based largely on low interest rates, what happens if/when rates rise? And if you have "inexpensive" long-term debt, you're mostly going to get locked in with lock-out periods and expensive pre-payment penalties, which will necessarily reduce your organization's flexibility. I'm not saying buying and selling and using loan proceeds is bad necessarily, but that a lot of thought must go into it.
The question you have to ask and you have to find the answer to is, what are the goals of the family? The family I work for has about 25 or so members across 4 generations. Each has plenty of money and good cash distributions. The 1st generation is about to die off and its only goal is to transfer assets to the next generation. The 2nd and 3rd generations are more or less happy with the status quo and want to see net distributions after taxes increase at 3-5% per year--neither generation is interested in utilizing their current assets to maximize returns with potentially much greater risk. The 3rd generation, however, is also focused on setting up the 4th generation, so it wants to acquire new assets or redevelop old assets that will have low loan balances in 15-30 years.
Only with the answer to the "goals" question can you even begin to move forward on a plan. Your questions seem to be too focused on economically maximizing the portfolio and not on the goals of those in your charge. I can't speak to your family, but I would think most wealthy real estate-oriented families are most focused on net cash distributions and not NAV.
I just booked two NNN refi's (as a result of the new leases we closed concurrently) in November for a long term client with a 110 store user/tenant. What VirginiaTech is saying is real regarding deploying capital, say, post refinance. My client got a 4.5% rate (fairly poor consumer credit) but the amortization is 15yrs. This took their mortgage constant way up. If you have 5-10yrs left on an NNN lease, you're not going to get 25yr AM. 20yrs at best.
This very client of mine talks of selling in a few years and bringing their money back to CA...but for what? I sold them these buildings in 2007 at market peak. They were in an exchange. The values dipped tremendously but the cash flow from a strong tenant and a gravy NNN lease structure got my client through very tough times. There are sexier things out there than NNN deals. They aren't for everyone. But for the cash flow buyer who really needs that steady check, eventually they become harder and harder to justify selling.
As we examine my clients goals over and over again as they have been loyal to me since 2001, it comes back to cash flow and comfort with their investment. With the new loans and leases they're locked in on income for another 8-10yrs on each deal. With the 15yr AM, these buildings will be roughly halfway paid off by then. As they approach their mid 50's in age they are excited about having debt free buildings to one day pass on to their kids.
The idea of exchanging into a deal in SoCal gets weaker by the month...this client is watching their $2.1mil debt decrease by $8,000mo in month #1.
Are they high credit national tenants and how prime are the building locations? I'd personally just refinance and purchase another NNN or MultiFamily Asset.
@Virginia Tech 4ever, I agree with your analysis and really appreciate the detailed response. This family, however, is in a different situation. It is still in the hands of the 1st generation and they have a more aggressive outlook (perhaps too aggressive). The main priority is growing NAV with cash-flowing investments.
Their portfolio is a hodge podge of good and bad investments combined with these long-held debt-free assets that will need to remain the base of their portfolio in order to manage the higher risk spec and development projects they are invested in.
We aren't looking to liquidate all of them, it was more of a theoretical question as to what are the reasons for ever doing it? Currently, we identified one that recently signed a new 10 year lease with a lower quality tenant that has been giving the owner problems. It is located in a decent, growing part of the country and we can get a 6cap on it. If they can avoid the capital gains penalty, there is sound reason in redeploying the capital to buy-out fractional partners in similar investments. There are also plenty of reasons, including those you outlined, as to why you should not.
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