Is It Time to Sell Your Multifamily Investment Property?

Multifamily buildings have long been a favored vehicle for commercial property investors. They historically produce reliable income and consistently increase in value over time. This in turn means that they retain value in a variety of market conditions and may even rapidly increase in value in some circumstances. Financing is typically readily available on favorable terms, and it is generally not difficult to find willing purchasers when it’s time to liquidate the asset.

But when is it time to sell?

In the vibrant New York City market, many multifamily owners have been considering this question carefully over the past several months since New York State enacted a sweeping package of new laws governing landlord/tenant relations. As we have detailed in a number of articles, these new laws have shifted the landscape sharply in tenants’ favor (or rather against the landlords because it is unclear whether tenants will actually benefit from the reforms in the long run), particularly in buildings with rent-regulated apartments. This is quite a change from recent decades, when investors could count on rapidly-increasing returns. It is unlikely that the value of properties will continue to increase. There are even indications that some long term property values may actually decline.

Evaluate Your Situation

Investors in the financial markets can readily track their gains and losses by the minute, and many do so. It is comparatively easy to identify potential weak points in a financial portfolio and move to correct them. Real estate, by its nature, is a longer-term commitment and many investors are drawn to its apparent stability. It is important, though, not to allow stability to become stasis. Like other investors, real estate investors should get in the habit of periodically reviewing the performance of their properties and ascertaining whether they still align with their longer-term goals and needs. There are five key questions every real estate investor should ask on an annual basis:

What is my actual return?
When expenses go up, you probably notice them. Similarly, you are likely aware of the income trajectory. Evaluating the actual return on an investment property is a more complicated process that should be undertaken with your CPA. Your accountant can help you get a much more detailed grasp of the big picture. Tax considerations should factor into this assessment, including available and expiring tax incentives, remaining depreciation, and the potential impact of increasing or decreasing your basis. Looking at these and other components, your advisors can help you make near- and mid-term projections on how your asset will perform.
How long do I plan to hold the asset?
Few people consider how their assets can support or hinder their overall life plans. Being stuck with a building when you were envisioning a carefree retirement is no fun. Even if you are contemplating a generational transfer, it should be planned meticulously. We regularly help investors who find themselves mired in unfortunate family situations due to inadequate preparation. As Winston Churchill famously quipped, “He who fails to plan is planning to fail.”

Sometimes the senior generation is not ready to relinquish control, while other times, junior generations are not ready to assume it. Having a careful transition strategy is as essential for real estate investors as for any business. Finally, in the absence of a plan, you could bequeath a monolithic asset to multiple heirs, who would then be in the often contentious position of determining how to divide it and pay for the potentially devastating estate tax bill!
Should my management strategy change?
Nobody ever said being a smaller-scale landlord is easy. Something is always coming up: a leak in an apartment over a weekend requiring a pricey visit from a plumber; a police incident; a problem with the boiler in the middle of winter; a lawsuit by a cranky tenant who never pays the rent on time. Even if you are working with competent management, there are some decisions that you cannot delegate. You also have to be constantly aware of the tools available to you; several recent articles have noted that NYC landlords are increasingly reluctant to bring eviction proceedings because the new rent laws have simultaneously increased the downside and decreased the potential upside.
Could I benefit from diversifying my investment portfolio?
Many smaller real estate investors are so dedicated to the New York City market that they have few assets that are not committed to it. We have seen people with tens of millions of dollars’ worth of real estate who are not readily able to assemble the cash required to make capital repairs or put a contract deposit down on a replacement property during a like-kind exchange.

This, of course, introduces any number of vulnerabilities. As noted by legendary hedge fund manager and philanthropist Ray Dalio, “diversifying well is the most important thing you need to do in order to invest well.” For a real estate investor, diversification does not have to mean selling all – or even a significant number – of your properties. If you have four multifamily buildings in New York City, it may be prudent to liquate one, use the proceeds of the sale in a tax-deferred exchange and purchase a replacement property that is a NNN leased necessity based retailer in a secondary market. At the same time, you can pull some equity out and invest it in other assets classes.
Is the market favorable for a sale?
This is perhaps the most difficult question of all. In the recent past, real estate investors could generally count on rapidly-climbing property values and the ability to increase the rent roll (through vacancy decontrol, capital improvements, etc.), so there has been a tendency to buy and hold. As noted above, with the new rent laws, returns are much less certain. This is likely to be the case for at least the next 5-6 years, as legal challenges wend their way through the courts and as legislators reevaluate the impact of the laws on the market. Certain circumstances make the current environment potentially a good one for sellers. Interest rates are still relatively low, allowing prospective buyers to obtain favorable financing and still realize a return. Growth has slowed tremendously in other parts of the world, particularly Europe, so investors are looking for other places to park their money.

When It’s Time to Sell

If, after a careful review of the above questions, you have decided to sell one or more of your properties, there are two more significant considerations:

Team

Depending on the type and scale of the transaction, your team can consist of several players or just a few. It always starts with a capable broker who understands the ins and outs of the multifamily market in your area. Most investors find it helpful to simultaneously retain the services of a real estate attorney with multifamily experience. Together, your attorney and broker will lead your team, bringing in other professionals – such as a qualified intermediary for §1031 exchanges.

Timing

Unlike investments in the financial markets, real estate investments cannot be bought and sold quickly. Sellers should be realistic in their expectations in order to give themselves plenty of room to maneuver and achieve the most favorable outcome. While every transaction is different, the following timelines are typical:

Straightforward sale: 3 – 6 months
Sale with §1031 like-kind exchange: 6 – 12 months

Keep in mind that it will likely take you a month or two to prepare your building for sale, making improvements, assembling the due diligence that will be required by prospective purchasers, closing open permits, and wrapping up any other loose ends.

The real estate attorneys at Holm & O’Hara LLP stand ready to assist multifamily investors with their real estate transactions. We have substantial experience in the New York City market and are versed in §1031 like-kind exchanges and NNN lease properties. We can also help you integrate your investment strategy with your estate plan for longer-term peace of mind.