If you’re thinking of selling or to refinance an apartment building, it’s a given that you’ll want to make as much money as possible from doing so. One of the biggest questions on your mind is probably: Should you refinance or sell now or wait? Another option is to cash-out refinance the apartment building Not to be a cop-out, but that depends on a few factors.
Some of the considerations you should run through are future market conditions, the level of value you’ve added to your property, the likely returns from each option, the potential cash-on-cash return (the ratio of income earned to money invested) and the return on investment from a cash-out refinance. Let’s run through each of them in turn.
A quick example why to refinance an apartment building
Let’s say that you owned an apartment building with under-market rents five years ago, and since then, the yields increased by 40%. This sounds good so far, but there are a few more factors to consider.
In this case, the cash-on-cash return is projected to be 5% per year, you’ve already created about 90% of the value, and the market seems more or less stable (interest rates and cap rates could increase but demand is expected to counteract this effect).
To compare the impact of selling the building in the next few years, selling it now, and refinancing it, we need to work out how much each option would yield.
To figure out the returns that are likely from each option, you need to compare them in a meaningful way. And to do that, we need to take a look at the internal rate of return (IRR). Yes, that might sound like a scary piece of terminology, but bear with us.
Also, before we get into it, you’ll need to have a financial model detailing the cash flows from your investment, including any money from a refinancing or sale. Once you have that ready, you can get started.
Using the internal rate of return
Unlike the annual return (the usual metric used), the IRR accounts for the time passed since an investment was made, the cash flow generated, and capital involved in the investment (as both an input and output).
This needs to be used in place of the annual return in the case of refinancing, because you invest in the capital (when you first make a purchase) and then return it (when you refinance), before selling. As we’ve seen, the cash-on-cash return is the ratio of income earned to money invested — but since refinancing means you have less money invested, it artificially inflates the cash-on-cash return. The annual return also loses meaning.
Through complex calculations, the IRR also accounts for how the value of money changes over time. Even putting aside considerations of inflation, most people would rather have $10,000 today than $10,000 in ten years time — scratch that, most would have a strong consideration for $1000 today versus $1000 in ten weeks.
Yet since the IRR accounts for these inherently human preferences, it makes it possible to compare investments over different time periods in a more realistic way. Sure, something might offer a higher return in theory, but most people wouldn’t find that as valuable if they have to wait a long time for it.
Finally, to compare the yields of different circumstances, you’ll need to calculate the IRR for each scenario:
- Sell now
- Sell later
Analyzing the results
To finally calculate the IRR for each case, you’ll need to get the data from your financial model and create an Excel table. This should contain cash flow distributions, your initial investment, and any capital returned along the way (such as through refinances or sales).
Let’s return to the example we examined at the start of the article — what would be the results if we decided to refinance after three years and sell after seven years?
These were the results:
- Selling after three years resulted in an IRR of around 13%
- Selling after five years resulted in an IRR of roughly 10% (lower because of the passing of time)
- Refinancing after three years, returning the capital invested, and then selling after seven years results in an IRR of 9% (due to the low cash flow)
Since it’s at year three that most of the value has been built into the property, this analysis suggests it would be better to wait to get as much value as possible out of the apartment building and then sell it. In this case, waiting longer to sell or refinancing wouldn’t be as profitable due to the poor cash flow. However, for a property with better cash flow, the opposite would likely be true, and the pendulum would swing toward refinancing.
But these results are far from universal — they depend on the numbers of a particular property investment. Now, it’s time to work through your own scenario by putting your results into an Excel sheet. How do your results compare?
Is there ever a right time?
Carrying out the analyses above is a priceless tool for working out the optimal time to sell, although you might still find it emotionally difficult to act on the results. Taking the plunge and making a sale is a huge move, and it can be difficult to adjust to not receiving the income from your property (even if you know it’s better to sell in the long run).
However, there’s always a little room for maneuver depending on your personal circumstances — maybe passive income is more important to you than optimizing for returns. But just remember to crunch the numbers first so you can make an educated choice as to whether to sell or refinance an apartment building.
If you are not sure whether you should refinance an apartment building or sell it, contact New City Financial for a free consultation by phone at (855) 848-2862 or by email click here