Over the weekend, I read the book Who’s Got Your Back by Keith Ferrazzi and I found an interesting point Keith cited from one of his business mentors. His point was that you should always map out an exit strategy before even deciding to start a new business, investment, or venture. It quickly reminded me of Stephen Covey’s Habit 2 “begin with the end in mind” from Seven Habits of Highly Effective People. This is a somewhat novel idea, as it is typical to get wrapped up in a new, exciting venture and lose sight of the end goal. However, developing an exit strategy will always be beneficial in making a thorough, informed, and robust decision when pursuing something new.
Applying this idea to Menlo Atherton Capital Partners, we have given a lot of careful thought to our investment strategy. First and foremost, we give all of the power to our investors, who have voting rights to decide exactly when and how to exit an investment. Let’s dive into the factors which shape our investment exit strategy:
- Speed of repositioning – how fast can we get the asset renovated and performing at the highest level possible?
- Tax implications, such as available depreciation and de minimis safe harbor election
- Cash flows
- Market conditions and timing
- New opportunities
Here is an example which will explain how these factors all come together to determine the best exit strategy. A property requires 18 months to be fully repositioned and stabilized (90% occupancy for 90 days is the requirement for commercial refinancing from Freddie Mac). After 18 months, a group of investors interested in getting substantial equity back could vote to refinance the property, reducing the cash flows but returning most, if not all of their principal investment. Next, if the market has gone up during the life of the investment and we are at or near the top of an economic cycle, investors would be encouraged to vote to sell the property and 1031 exchange into a property with more potential upside. On the other hand, if the market has not improved or values have decreased, investors could opt to hold onto the property to collect strong, stable cash flows and patiently wait for the market values to increase. The beautiful thing about multifamily investing is that investment properties are chosen on the basis of cash flows, not on speculative assumptions about future values. Lastly, after six or seven years, investors should be conscientious of tax implications by selling the property because, by that time, most of the available depreciation will be gone, making the passive income thrown off by the property taxable. To avoid this, investors are encouraged to sell and once again protect THEIR money from the IRS by 1031 exchanging into the next best opportunity to continue to grow their portfolio wealth as well as their passive income.
Quick video on the subject: https://www.youtube.com/watch?v=KzfRZawDuvs&t=45s