The decision to maximize profits in the sale of a building is a critical task. There are factors that one has to examine before concluding whether to sell a building, refinance or hold in anticipating for higher returns in the future. These factors include;
- The measure of the attractiveness of future cash-on-cash return.
- The suitable choice with the highest returns. The investor has to evaluate these three situations; whether to refinance, hold or sell the building.
- The value created by the building.
- The anticipated market trends. One has to ask himself whether the projected market values will be higher or lower.
For example, in a situation where an owner of a building wants to sell a building, to maximize his capital he must have in mind the initial total cost of the building, the number of years the building has generated income, and the actual income realized.
Given a case study where an owner bought an apartment with rents below the market price. Within a span of 3years, the income rises to 35% with an estimation of 95% value creation. The future cash-on-cash return is an approximation of 7% yearly. Looking at the market, it seems stable with no projected rise in value. As for the interest rates, if they increase the valuations will go down as the cap rates will increase. However, the demand for multifamily assets may cross check any positive growth in the interest rates. These are the factors contributing to an unchanging market. Based on this case study it is important to examine the IRR before making the decision to refinance, to sell now or later.
The internal rate of return is not necessary when buying and selling buildings, but in investments where there is capital involved, it is a fundamental determinant. In a case where you want to refinance your building that has partial returns and sale in the eventuality IRR is a compulsory determinant. For example, if one invests $100,000 into a building with the help of an investor, then considers to refinance it after 3years of value creation and give back $75,000 to the investor. The debt service reduces owner's cash flow by $75,000. The remaining $25,000 becomes owner’s capital, and cash-on-cash return serves no use even if it shoots up. In this, it is only the IRR which seems useful as it takes into account the passing of time, cash inflows of the investment and the injected capital as well as the withdrawn capital from the investment. Money loses value over time, and this loss is usually accounted for by IRR as the passing of time. This passing of time is also necessary for making decisions regarding buildings. Being given $10,000 today may be more valuable than the expectation of $50, 000 or even larger amounts in some years to come.
First one needs a financial model that computes the cash flows and any other proceeds. From there you now determine the IRR for the three probable scenarios. Refinancing sounds the best plan but could give a lower IRR like if maximum value has already been created in the past years. Choosing to hold may also result into low IRR because of the passing of time that reduces returns. However, selling now after the project has created most of the possible value gives the most favorable IRR.