Why would a multi-family developer look to sell a project prior to stabilization?

Subscribe

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?

Comments (5)

 
Feb 11, 2020 - 10:41am

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.

Array
 
Most Helpful
Feb 11, 2020 - 11:01am

I wouldn't necessarily see it as a red flag. A few reasons off the top of my head from the developer's standpoint:

  • Liquidity Needs - they've had money tied up in this for a couple years now and are looking to cash out to fund next project
  • Internal Business Plan - maybe they are getting a lot of pressure internally to exit by a certain date to hit business plan targets and stay on budget.
  • Capital Partner - maybe their equity partner decided they don't like the submarket anymore, needs liquidity, has an internal mandate to exit multifamily or suburban markets, etc.
  • Removal of Lease-up Risk - they are currently leasing their best units at the highest price points, and can probably get a buyer to pay a stabilized price on those rents. The last units are always the hardest to lease and would likely go at a discount, dragging down their average rate.
  • Removal of Market Risk - maybe they think market cap rates will move against them, recession is imminent, etc.

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.

Array
 
Feb 11, 2020 - 11:28am

peremium:
  • Removal of lease up risk - they are currently leasing their best units at the highest price points, and can probably get a buyer to pay a stabilized price on those rents. The last units are always the hardest to lease and would likely go at a discount, dragging down their average rate
  • Removal of market risk - maybe they think market cap rates will move against them, recession is imminent, etc

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.

 
Feb 11, 2020 - 1:20pm

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.

Start Discussion

Popular Content See all

Received my PWP rejection email!
+92IBby Prospective Monkey in Investment Banking - Mergers and Acquisitions">Prospect in IB-M&A
Is Evercore the next Bulge Bracket bank?
+24IBby Intern in Investment Banking - Mergers and Acquisitions">Intern in IB-M&A
Biggest Regret in Undergrad
+21IBby Prospective Monkey in Investment Banking - Mergers and Acquisitions">Prospect in IB-M&A
Is Liontree the next bulge bracket bank?
+17IBby 1st Year Analyst in Sales & Trading - Equities">Analyst 1 in S&T - Equities
Virtual Summer Interns - which banks sent you WFH gear?
+15IBby Intern in Investment Banking - Industry/Coverage">Intern in IB - Ind

Total Avg Compensation

October 2020 Investment Banking

  • Director/MD (17) $704
  • Vice President (49) $326
  • Associates (264) $228
  • 3rd+ Year Analyst (36) $168
  • 2nd Year Analyst (147) $159
  • Intern/Summer Associate (136) $141
  • 1st Year Analyst (579) $130
  • Intern/Summer Analyst (555) $82

Leaderboard See all

1
LonLonMilk's picture
LonLonMilk
98.4
2
Jamoldo's picture
Jamoldo
98.3
3
Secyh62's picture
Secyh62
98.2
4
CompBanker's picture
CompBanker
97.8
5
redever's picture
redever
97.7
6
Addinator's picture
Addinator
97.6
7
Edifice's picture
Edifice
97.6
8
NuckFuts's picture
NuckFuts
97.5
9
frgna's picture
frgna
97.5
10
bolo up's picture
bolo up
97.5