I used to be a religious reader of the Howard Marks memos, but at some point they started to get a bit repetitive…“move forward, but with caution…” However, his most recent, Selling Out, really resonated with me.
I’ve always believed real estate is best held long-term (although easier said than done) as long as you structure deals in a fashion that enables you to do so, the asset/submarket has long-term upside potential, and there aren’t better opportunities to re-invest proceeds.
At Atlas, our biggest investing mistakes came by selling multifamily assets too early. We sold three high-quality deals located in strong/high-growth markets that generated solid net investors, however they’re worth considerably more today, with room to run.
Selling these deals when we did, because they were up in value and we could lock in the profits, was a mistake. As Marks says, “if you sell an appreciated asset, that puts the gain “in the books,” but it can never be reversed.”
Once an asset is sold, you’re sitting on taxable gains, trying to figure out what to do next. Yes, these are real gains, but those proceeds are typically reinvested and put back at risk. In the case of the multifamily deals I noted above, we reinvested into a few commercial deals that ultimately underperformed, compounding our error of selling.
In today’s environment of high asset prices, especially multifamily real estate, how do you justify not selling? It’s tough. I talk with brokers constantly who throw out lofty values and assets within the comp set are trading for big numbers. It’s hard not to run a hypothetical sale scenario, see the returns, and list the property for sale, but selling because values are high is not always the right decision.
But how do you know if it’s the right time to sell?
Marks recounts a conversation with his son, Andrew. While the discussion was related to the stock market, it can easily be applied to real estate.
“If I owned a stake in a private company with enormous potential, strong momentum and great management, I would never sell part of it just because someone offered me a full price. Great compounders are extremely hard to find, so it’s usually a mistake to let them go. Also, I think it’s much more straightforward to predict the long-term outcome for a company than short-term price movements, and it doesn’t make sense to trade off a decision in an area of high conviction for one about which you’re limited to low conviction. . . .”
We own multifamily assets throughout the Southeast which we believe will continue to generate strong cash flow, grow in revenue, and provide tax advantages over the long-term. Although we can sell them at a proforma 4 cap today, we’re likely better off holding for another 10-20 years, refi’ing opportunistically, returning tax-advantage cash to our investors, creatively adding value, and reaping the benefit of holding quality assets long-term.
Marks includes a great quote in the letter from Bill Miller, “we believe time, not timing, is the key to building wealth in the stock market”. I think “stock market” can easily be replaced by “real estate market”.
When you sell a real estate asset, several things can happen.
- The asset continues to go up in value and you lose out on the continued appreciation.
- The asset value declines, but you have to determine when the right time is to begin buying again.
- You receive sales proceeds and have to decide what to do with them; 1031, pocket the cash and pay taxes, pay taxes and re-invest in other opportunities etc.
As usual, The Real Estate God says it best. “In a long term/permanent hold model, you hold your best deals forever, which means you can keep profiting off your best deals forever – this is a very good thing. Instead of having to strike gold 100 times, you only have to strike gold 1-5 times in your entire career.”
If your at a firm that has the ability to hold long-term (and potentially forever) the right thing to do, in most instances, is to hold.