In my previous post, I talked about the value of compounding which results over holding multifamily real estate assets long-term. While that’s great in theory, it’s difficult to hold older vintage multifamily assets long-term (longer than 10 years).
At Atlas, our business plan typically entails renovating and repositioning assets to bring them in line with other recently upgraded communities in the area. We rebrand the property, correct operational deficiencies, clean up deferred maintenance, improve curb appeal, and upgrade amenities and unit interiors; all of which typically result in significant NOI growth and value creation. We underwrite a 10-year hold period and expect to exit investments within 8-15 years.
Once the asset is stabilized, we usually refi and put on long-term fixed-rate agency debt, with the intention of holding the asset for cash flow and future appreciation. At this point, usually 3-5 years into the hold period, the asset is in great condition. The new landscaping and amenities look great, the freshly painted façade and resurfaced parking lot show well, and the newly renovated interiors are in line with the latest market trends. As such, value is essentially maximized.
At this point, many owners opt to sell. Given the relatively short hold period, the IRR looks great on paper, even if the equity multiple and gross dollars to investors aren’t as impressive. However, we prefer to hold the asset and benefit from the consistent and predictable cash-flow typical of stabilized multifamily properties. With the physical work completed, the tenant profile improved, and long-term fixed-rate debt in place, much of the risk is off the table. Assuming we remain bullish on the local submarket, we believe it’s best to continue to hold the asset, even if selling could result in putting a win on the board.
However, older vintage multifamily assets are inherently capital intensive. HVAC’s reach the end of their useful life, the façade needs to be re-painted every 5-7 years, the plumbing lines require ongoing repairs, and roofs and windows constantly need work. By years 7-10 of our hold period, the property begins to look tired and in need a facelift. This requires us to either eat into our reserves or use property cash flow to make improvements. Alternatively, depending on the market cycle, we can exit the investment.
Our 10-year hold strategy is driven in part by the ongoing capital needs and in part by debt. Agency debt typically carries onerous prepayment penalties which make it cost-prohibitive to exit early. When we refi, we typically trade-off a few points in rate in exchange for more flexible prepay. For example, on a recent refinance, we accepted a 20 bps higher rate for open prepay beginning in year 7 of the loan. For us, the flexibility to exit within a 5-year window is incredibly valuable.
By years 7-10 of our hold, we’re faced with a decision; do we exit the deal or reinvest in the property to bring it up to current standards and refinance with the intention of holding another 7-10 years?
While there is no straightforward answer, the decision is driven in part by the real estate cycle and in part by the ongoing capital needs of the property. In general, the capital intensity of multifamily assets makes it extremely difficult to hold properties for longer than 10 years. It requires holding significant reserves, using relatively moderate leverage, making strategic long-term focused capital improvements, and structuring debt/equity strategically.
What do you think? Have you seen investment strategies structured to hold multifamily properties for 10+ years?