How We Know When to Sell | Episode 34

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Joe Muratore:
We work to buy assets that are selling off market for a reason, they aren't ready for prime time, they weren't managed that way. They weren't prepared for that. And then we work to make them market ready so that an auction can be created and they can be sold on market.

Moderator:
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Ryan Swehla:
So I was recently reading that Howard Marks' memo, his most recent memo selling off. And it was summarizing, it was kind of this idea of when is the right time to sell and how you look at selling, when do you exit a position? And I think it's important that we talk a little bit about how we look at selling, how we look at exiting a position.

And before we kind of get down into the asset level, which should really be what this subject is about, I think it's worth adding a little bit of framing on markets. Because our philosophy is not around entering and exiting markets. Our philosophy is not around the timing of, "Well, when do I go big in Austin? And when do I pull back? And when do I move over into Memphis?" We take more of a philosophical, a long term approach to a market. Which is we believe that a market we're operating in has long term tailwinds, and we can work through the cycles in that market.

Part of that goes around this idea that we believe one of our most important competitive advantages is that we have scale in the market, that we are one of the most active participants in the market. And so as we move into new markets, we really are making a long term bet on that market. So there isn't really a, when do we sell out of a market? So instead, what we talk about is when's the right time to sell for a given asset? You want to speak a little bit to that?

Joe Muratore:
Sure. I think for starters, I think we have to state that we're value add players. The question is, where are our margins of safety and what are our goals? Our goal is to deliver incredible IRR, certainly a 15 to 20% internal rate of return within a three to five year hold. And to do that, we need to go in and add value and move on. We may hold for a little bit, but we're not macro players. We certainly have an opinion about the macro environment, we have an opinion about the micro environment, that's our jobs. But our biggest margin of safety is our ability to go in and turn leases, enhance the asset and turn leases within our whole period and to exit at the most favorable time.

Ryan Swehla:
Well, and going back to the market timing aspect, I often say that we view value add space as actually the least risky in this sense. That there's three areas of investing. There's the kind of core stabilized, there's value add, which is kind of perceived as in the middle and then there's development or opportunistic. And with core stabilized, you are 100% betting on the market. And market timing is really important because if you buy high, then you have to ride through the next down before you get somewhere. You're not adding value, you're buying based on market appreciation.

And on development or opportunistic, their market timing is make or break. If you time the market well, you do extremely well, but because of long development cycles and things like that, if you time the market wrong, you have a lot greater downside. We're in that middle value add space, which since we're adding value, we should be able to navigate. And we have been able to navigate through any market cycle because we're more dependent on the value add play than we are on the market timing.

Joe Muratore:
So when do we decide to sell? I would start by saying there is some science to this, and there is some instinct to this. It's hard to tell when markets are fully cresting or when interest rates are about to rise. We sold some assets at the end of last year when there hadn't been announcements yet about interest rate increases, which would affect valuation. But we had an instinct that the market was high and some of the assets that we had added value to already were getting a lot of interest and we decided to sell a few.

Personally, I think that it there's safety in being a buyer and being a seller sort at all times. You don't know how you're about to get hit or when, so always buying and always selling, especially when you're buying with a value add plan and you're selling things that have already had value added to them, creates safety. You're harvesting, and you're investing.

Ryan Swehla:
Wholesale buyer, retail seller.

Joe Muratore:
Right. So on the multifamily side, my experience so far, and I think yours too, is there's somewhere around that 30 to 50% of the value add leases that have been turned and rents that have been brought to market. Somewhere in there is your greatest, most effective use of capital. You've enhanced enough of the units to prove out your business plan, but you haven't fully deployed all that capital, but you're still going to get paid through cap rate for the-

Ryan Swehla:
Part of the work you haven't done.

Joe Muratore:
.. business plan you've proven out. I would say on a small bay, multi-tenant industrial that's similar as well. Although I would think that more often we do 50 to 60% of the value add there. But usually the first part happens more quickly and you can create value more quickly by proving out, enhancing the entire asset, especially on the exterior, and then proving out the value add business plan as leases rollover for the first third through the second third.

Ryan Swehla:
Yeah. And on a quarterly basis during our investment committee meeting, we review asset by asset. Talk about what the duration of that asset looks like when it's gotten to what we believe to be kind of full stabilized or enough stabilized that it potentially has a market exit. So really asset by asset is the right answer to when exactly we sell.

Joe Muratore:
Well back to the wholesale and retail environment. We worked to buy assets that are selling off market for a reason. They aren't ready for prime time, they weren't managed that way, they weren't prepared for that. And then we work to make them market ready so that an auction can be created and they can be sold on market. And that's how we create value.

Ryan Swehla:
Yeah. And one of the biggest tests of that is this a property that can have kind of a fully marketed, fully bidded process?

Joe Muratore:
Yeah.

Ryan Swehla:
Because if there's hair on the deal... good example, we have an asset that we purchased that was built in 2008 and we purchased it in 2019. And one floor of that asset had never been built out. It was still in shell condition. We knew as a part of that business plan, it doesn't matter if we get to full occupancy on the remainder of the space. If that floor hasn't been built out, that's an explainer. That's a, well here's the business plan. We got all this done, but. And our goal, ultimately, is that when we're bringing an asset to market, there's no buts, there's no explainers. This is a-

Joe Muratore:
De-risk it.

Ryan Swehla:
Yeah. A de-risk asset that is clean, that has either a compelling forward business plan or the business plan has already been worked and it's a stabilized cash flowing asset.

Joe Muratore:
So when do we sell? We sell when we've substantially added value and we believe there's enough market interest to hold an auction and to sell at a very high price.

Ryan Swehla:
Yeah.

Moderator:
Thank you for listening to Durable Value an investors' podcast, where we demystify commercial real estate with safe, sound, investment strategies to help you balance your portfolio. If you enjoyed this podcast, be sure to rate it on iTunes or wherever you get your podcasts. To learn more, visit graceadapartners.com where you'll find more information, investors tools, case studies and more. This podcast is hosted by Joe Muratore and Ryan Swehla. It's produced, edited and mixed by Melodic with intro music by Ian Post. Thanks again for listening and we'll see you next time.

Summary
Knowing when it's time to sell a property isn't easy. Over the years we've fine-tuned our approach to knowing when it's the right time for us and our specific strategy and market.

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