What’s the difference between selling or financing a multifamily property, and what’s the better option?
As with many things the answer is, it depends. It comes down to entirely what the business plan was initially when the deal sponsors were buying the property. Before we get into that, let me define the difference between a sale and a refinance.
- Selling: Very simply, what happens in the event of selling the property if the investment performs well is that all investors get their invested capital back, and on top of that a portion of all the profits the property has made in appreciation over the years, depending on how the deal is structured.
- Refinance: During a refinance, the sponsor aims to return as much of the invested capital back to investors and then keep the property for a longer period of time. Generally speaking during a refinance investors get the vast majority of their investment money back, yet the property is still held and investor shares remain the same, so you can proceed to reinvest your money in other projects while continuing to hold interest in the project you invested in.
- Prepayment Penalty: Predetermined penalty set up front by the lender in case the investor group prepays the loan faster than expected. Many times this penalty can go up to many millions of dollars.
Now let's get back to what is the better choice, to refinance or sell a property. Whenever you’re investing in multifamily property, the sponsor is generally locking in a loan anywhere between 3-10 years, sometimes longer. In most of these commercial loans, there is a very large prepayment penalty that is to be paid if the debt is paid off faster than expected. The financing agencies expect the loan to go up to the full term, so if a sponsor decides midway through the holding period to sell the property or refinance, they may incur a very heavy penalty that can go into the millions of dollars for the early payoff.
If the loan term is nearing its end, usually the prepayment penalty we discussed earlier is a lot lower, which gives the sponsor the flexibility to decide to either refinance or sell the property. Generally speaking, the sponsor would decide to refinance and hold on to the property if they’re achieving high cashflow that they don’t want to let go of. On the other hand, if the sponsor would like to achieve higher cash flow by renovating the property but has run out of rehab money, it may be best to sell it to someone else, get the profits out, and let the next person come in with a new batch of investor capital to upgrade the property and increase cash flow.
It mainly depends on the cashflow and the sponsors’ cash reserves to be able to improve the property further or not. Generally speaking new buyers usually come in with enough money for the purchase of the property plus a rehab amount to be able to improve the asset and increase its value, while someone who’s been holding on to the property for a few years may have already exhausted all their capital.
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