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capital as well as the withdrawn capital from the investment.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.
