Developing Your Commercial Real Estate Exit Strategy
A friend of mine recently reached out to me and asked me for my opinion on an apartment building that he was planning on purchasing. He sent me the property details shortly afterward. As I started to look at it, there was one question that immediately came to mind.
“If you buy this, who is going to be the buyer on the backend of this deal?”.
In simpler terms, how do you plan on exiting this property?
The apartment was in a pretty rough area. The tenants were similarly rough. I knew immediately upon acquisition, my friend would be operating an extremely management intensive property in a submarket that has a limited pool of potential buyers.
Although there was the option of increasing cash-flow upon acquisition and then refinancing the equity out of the property in a couple of years, this represented the absolute best-case scenario.
This strategy isn’t an inherently bad idea by any means.
However, owning this property would have been a complete headache from a property management standpoint throughout the entire hold period.
Even if my friend followed through with the equity refinance, the property would still be a nightmare to manage. If my friend decided to sell this property at any given point, I am not even sure who would even want to buy this.
Even if he ended up cleaning the property, evicting the non-paying tenants, and seasoning the rent-roll with more reliable tenants, it would have likely taken close to a year to sell this specific property – even in a hot market.
In a soft market, this commercial property would have sat idly indefinitely - continuing to be a headache for its owner(s).
Having a clear exit strategy and understanding your prospective buyer is a critical consideration that investors should make before deciding to invest in a commercial property.
If nobody wants to buy a property now, it is imperative to consider what will change in the near future that will make this property more appealing to prospective buyers in the future.
Rough properties in otherwise good locations may warrant attention from an investment standpoint. However, if the location is mediocre and the neighborhood has little to no momentum, I would advise investors to steer clear.
Although this may seem obvious, I am consistently surprised by the number of investors who decide to go into challenging deals on the front end without having a defined strategy for exiting the property.
When syndicating capital for my own investments, my primary focus is on investing in properties located in neighborhoods and submarkets that attract other sophisticated investors.
This approach maximizes my odds of success by giving me a plethora of buyers to choose from when it is time to sell my commercial property. One of my previous deals that shows this exact approach on a 13,000 square feet retail development in the Calgary area.
This property was located in a desirable submarket but was also tenanted by several AAA-credit tenants – one of which had a six-billion-dollar balance sheet and is experiencing tremendous levels of growth in Western Canada.
Based on the proforma rents, the subject property is projected to sell for anywhere between $7,800,000 – $8,600,000.
In this case, I entered into this project with a defined exit strategy. I knew that selling to a REIT – a large company that owns and operates income-producing real estate – was out of the question.
Although the return profile was appropriate for a large institutional group, the deal did not make sense from a size standpoint. REITs typically seek to acquire retail properties that are at least 50,000 square feet in size.
Although selling to a REIT was not a feasible option, there are several groups of high-net-worth individuals and syndicators that are in the market, looking to acquire “low-maintenance” retail properties with strong cash flow and reliable tenants.
When deciding which property to invest in, these buyers will examine my retail property alongside more management-intensive properties such as an apartment building.
For this particular property, I knew that the exit cap rate or yield on my retail property would be a full 100 basis points (1%) higher than a comparable apartment building.
For investors, this means that they would likely be getting a higher return on their capital alongside dealing with fewer headaches.
As a developer, it gives me confidence that this retail project, upon competition, will have a relatively large pool of buyers once I decide to move forward with the sale and market the property.
- In summary, when purchasing commercial real estate, always begin with the end in mind and ask yourself who will be the potential buyer on the backend of the deal.
- I generally advise against buying properties that attract a limited pool of buyers, including properties located in undesirable areas or other very niche property types.
- If you are going to buy a rough property in an otherwise good neighborhood, consider what change will take place between now and the day you sell that will make this property more valuable.
This change may be the development of a nearby school, hospital, or university campus that would drive demand for real estate in the area. Alternatively, this change could be an aesthetic or structural change that makes the property more appealing to better-quality tenants.
4. Lastly, consider why a potential buyer would purchase your commercial property on the backend instead of other alternative real estate investments.
Depending on the property and submarket you are looking at, this analysis varies substantially.
In my case, a fully leased, low-maintenance retail property, with higher projected returns when compared to an apartment, was an inherently more attractive investment to my target buyer.
Last thing - if you want to grab a copy of my book, Club Syndication, you can do that below.