So many times as I talk with people about exit strategy this topic comes up. How does one know when to sell their park? to really get our arms around this topic we should start by identifying some terms. First there is lots of talk about CA P rates. A Rate is really only an indicator used in the first year of ownership. There is also much talk about cash on cash return. Again this is a first year financial indicator. After the first year we can still use the same formulas but we need to change some of the values. If, like me, you are buying value added parks, is necessary to understand how to evaluate your assets from year to year. The valuation will give you a great snapshot as to whether you should be selling the property or holding it. First let’s look at the cash on cash return. Really after your first year the return should be called cash on equity. To determine the equity you will take your new net operating income divided by your capitalization rate percent and it will give you a new total value of the property. Take the total value minus what you will and the fees to sell the property and you will have your equity position in the property. now you can take a real look at your cash on equity. If the property is operating with a much stronger cash flow that was you purchased it you will probably find that your cash on equity return is not near as good as you think it is going to be. Let’s look at an example:
let’s say you purchase a park for $450,000. For this example let’s say you put $120,000 down on the park. Let’s also assume that the net operating income for the first year was scheduled to be $45,000. Now let’s say you added value to the park and the net operating income went up. So at the end of the first year instead of having 45,000 you had 70,000 in net operating income. let’s also say you project the second year’s net operating income to be $85,000. Your first year’s cash on cash return was just over 25% after expenses and debt service. Now when we readjust using the net operating income dividing it by the CAP rate percentage we have a new value of about 850,000. From our first numbers we can see the debt service on this property is 330,000. When you subtract 330,000 from 850,000 you have an equity position of 520,000. So even if you are cash after debt service was $50,000 the second year, your cash on equity return is now under 10%. So even though this property has great cash flow, it is probably a nonperforming asset.
So we get back to the question when you sell? there are many factors and Equity Is Only One.ultimately you will have to determine your own threshold of pain for underperformed assets. There is clear safety in owning a property that is equity heavy in spinning out great cash. The question for you will be, if I were to reapply this equity into the marketplace today, what would it be worth a year from now.
Happy figuring!