Suneet Singal on holding period and exit assumptions

Suneet Singal has a published background in real estate and corporate finance, which is why a holding period is explained as a model choice rather than as a promise. Filings on this site record a chief executive officer departure from FC Global Realty Incorporated effective 2 January 2018 and an acting chief executive officer appointment at First Capital Investment Corporation effective 12 September 2017. A role with a date is not a sale of a building. A holding period is the number of years a projection assumes you own the property before a sale or a refinance. The exit price, in a simple income model, is a later year's income divided by an exit capitalization rate, minus selling costs. This entry computes a labeled hypothetical, separates that price from cash the equity actually receives, and lists what the assumption cannot prove.

The year is an assumption

A pro forma is a set of projected years. Someone chose how many years to show. Five years is common in offering memoranda because it fits on a page and because many loans are written with a five-year term. Common is not the same as required. A tenant with a twelve-year lease and a loan due in three years will not be well described by a five-year sale that nobody has tied to either date. Start by writing down why the model sells or refinances in the year it uses. If the only reason is that the template came with five columns, say that, and then decide whether the template fits the leases and the loan.

The holding period also decides which risks fall inside the model and which are pushed past the edge. A roof replacement in year six is invisible in a five-year sale unless the buyer of your exit would deduct for it, which means it should affect the exit price or the capital plan. A loan that matures in year three, inside a five-year hold, is not an exit. It is a refinance that the model must either assume or treat as a failure to reach year five. Put maturity dates on the same timeline as the sale. The debt stack is where the balances come from.

Nothing in the choice of year creates a buyer. The year is when the spreadsheet converts an income figure into a price and pretends the price is received. Label that conversion as an assumption. You can still use it to see how the rest of the model behaves. You should not describe it as a plan the market has agreed to.

How an exit price is built

In a simple direct-capitalization exit, you take the income a buyer would use and divide by an exit cap rate. The first modeling choice is which income. Some models use the hold year's net operating income. Some use the next year's, on the view that a buyer prices the income they will receive after closing. Say which you did. Using a higher year because it makes the price larger is a choice with a direction. Disclose it.

Here is a labeled hypothetical. Purchase price $10,000,000. Year-one NOI $600,000, so the going-in cap rate is 6 percent. You hold five years. The NOI you capitalize at exit is $650,000. The exit cap rate is 6.5 percent. Because $650,000 divided by 0.065 is $10,000,000, the gross exit value is $10,000,000. Income rose, and the cap rate you assumed also rose, and the two movements offset. That is the lesson of this particular sketch. It is not a forecast that income and cap rates move that way.

Selling costs are not optional in a cash sense. A hypothetical 2 percent cost on $10,000,000 is $200,000. Net sale proceeds before the loan are $9,800,000. If the loan balance at exit is a hypothetical $6,000,000, cash to equity from the sale is $3,800,000. If equity invested at the start was $4,000,000, the sale returns less cash than the equity check, before counting any cash flows during the hold and before taxes. A model can show that result even though NOI never fell. The causes in this sketch are the higher exit cap rate, which kept the gross price from rising with income, and the selling cost. Name those causes. Do not call the result a mystery.

One change in the exit rate

Keep the exit income at a round figure and change only the rate, so the sensitivity is visible. Suppose exit NOI is $660,000. At a 6 percent exit cap rate, the gross price is $660,000 divided by 0.06, which is $11,000,000. At a 6.5 percent exit cap rate, the gross price is $660,000 divided by 0.065, which is about $10,153,846. The difference is a bit more than $846,000, from one half of one percentage point, on income that did not change. Round numbers are the point. A small movement in the exit rate is a large movement in price because you are dividing.

This is why a page that shows a single sale price has made a quiet decision. Ask for the exit cap rate and the income it divides. Then ask for one case with a higher rate. You do not need a full forecast of where rates will be. You need to see whether the equity result survives a rate you would not enjoy. The capitalization rate entry explains why today's going-in rate and the exit rate are different assumptions. Using the going-in rate as the exit rate without saying so is a special case. It can be a reasonable base. It is still a choice, and it should be labeled as the case in which the buyer of the future uses the rate you used.

Selling costs scale with the price. Two percent of $11,000,000 is $220,000, not the $200,000 from the earlier sketch. If you copy a dollar cost from one case into another, fix it. A loan payoff does not scale with the price. It is the balance the note says is owed. A higher sale price increases equity cash by the price increase minus the extra selling cost, not by the full price increase. In the $11,000,000 case, net of 2 percent is $10,780,000. Minus a $6,000,000 loan, equity cash is $4,780,000. Compare that with $3,800,000 in the first sketch and you can see the whole exit case in two lines.

Cash flows during the hold, and a multiple

The sale is not the only cash to equity. Each year's cash after debt service, capital items, and reserves belongs in the timeline. A labeled hypothetical: equity in is $4,000,000, cash flow after debt is $100,000 a year for five years, and exit equity cash is $3,800,000 from the first sketch. Total cash back is $500,000 plus $3,800,000, or $4,300,000. The equity multiple is $4,300,000 divided by $4,000,000, or 1.075. That multiple is an output of these assumptions. It is not a market result, and it ignores the timing of the dollars except that all of them are counted once.

Timing still matters if you later compute an internal rate of return. A multiple of 1.075 over five years is a different story from the same multiple over two years, because the same cash took longer to arrive. This page does not print an internal rate of return for the sketch, because a single rate would invite a false precision the assumptions have not earned. If you compute one, use dated cash flows, including the initial check as an outflow, and show the exit cap rate beside the result. A high internal rate driven by a low exit cap rate is the exit assumption in disguise.

Taxes sit after this arithmetic. A like-kind exchange under the Internal Revenue Code can change whether gain is recognized on a sale. The IRS explains the current real-estate limits of that idea on its like-kind exchange page. This entry does not give tax advice, does not say anyone qualifies, and does not treat an exchange as the base case. If a model assumes an exchange, it should say so, and the reader should open the IRS page rather than rely on a footnote that says "1031" as if the footnote were the statute.

What the model page should show

A usable exit page shows the year, the income being capitalized, the exit cap rate, the gross price, the selling-cost percent and dollars, the loan payoff, and the equity cash. It shows at least one sensitivity on the cap rate. It states whether income taxes are ignored. It states whether a reserve or a capital item was deducted in the exit year's income. Those are the same boundary questions as in any cap rate, applied to a year that has not happened.

It should also reconcile the exit with the loan. If the loan matures before the sale, show the refinance as its own assumption: new loan amount, new rate, new payment, and what happens if that loan is unavailable. If the loan prohibits prepayment, or charges a fee, the sale case needs the fee. A model that pays off a loan which the documents say cannot be prepaid has assumed a negotiation. Label the negotiation. Do not label it as the note.

Tie the income to the rent roll at exit, not only to a growth rate. "NOI grows 2 percent a year" is a shortcut. It may be fine for a sketch. It is a poor substitute for leases that expire inside the hold. If half the rent rolls in year three, the exit income depends on the rents you assume after that rollover, the downtime, and the costs to re-lease. A smooth growth rate hides the rollover. Show the rollover as its own lines, then let NOI be the result.

Usual mix-ups

People quote the gross exit price as if it were cash to the partners. In the first sketch the gross price is $10,000,000 and the equity cash is $3,800,000. Those are both real outputs of the arithmetic, and they are not interchangeable. A slide that says "we exit at $10,000,000" without the loan and the costs has stopped halfway. Finish the subtraction before you compare the exit with the equity that was invested.

People also treat the equity multiple and the annual cash yield as if one could stand in for the other. Five years of $100,000 on $4,000,000 is a 2.5 percent cash yield in this hypothetical, and the multiple was 1.075 only because the sale returned most of the equity. A reader who hears "2.5 percent" and a reader who hears "1.075 times" are hearing different slices. Print both, with the sale separate, so neither slice pretends to be the whole.

A third mix-up is using a cap rate from a different property type, or from a triple-net sale, to exit a gross-lease building. The property type and the lease change what the income means. An exit rate borrowed from a different pattern capitalizes the wrong kind of dollar. If you borrow a rate, describe the sales it came from in a sentence. If you cannot describe them, you do not have a comparable rate. You have a number that fit the cell.

What the exit cannot prove

An exit assumption cannot prove that a buyer will appear, that the buyer will use your cap rate, or that the income will be the income you capitalized. It cannot prove that the loan balance will be the balance you typed if the loan floats, amortizes on a different schedule, or is refinanced. It cannot prove that selling costs will be 2 percent. Those are all inputs. The outputs are only as calm as the inputs. A model that shows a single price to the dollar has usually rounded past that fact. Prefer a case and a sensitivity to a false-precise single price.

The exit cannot prove that the hold was wise. A multiple barely above 1.0 can be the honest result of a thin cash flow and a sale that does not clear the equity check by much. The model has done you a favor by showing it. Raising the exit price until the multiple looks impressive undoes the favor. If the honest case is thin, the next step is to revisit the rent, the debt, the price you pay at entry, or the decision to go further. It is not to shop for a lower exit cap rate until the page smiles.

The exit cannot prove a personal result. Suneet Singal is not the seller or the buyer in this hypothetical, and the page does not report a sale, a multiple, or a holding period from his record. The career record is the place for dated roles. Use the exit math on a model you are actually reviewing. If the model will not show the income, the rate, the costs, and the loan payoff, it has not shown you an exit. It has shown you a headline.

What this entry does not claim

Suneet Singal’s published professional background is in real estate and corporate finance. Company filings linked from this site record a chief executive officer departure from FC Global Realty Incorporated effective 2 January 2018 and an acting chief executive officer appointment at First Capital Investment Corporation effective 12 September 2017. The Suneet Singal Scholarship, Grant and Giving websites describe him as the founder of those programs. This entry explains a general subject. It is not a private track record, a current job title, an investment result, or a quote.

This page is a reference, not investment advice. The rate used at the exit is the same kind of ratio explained in what a capitalization rate measures, and an outside opinion of the price is a different document, covered in appraisal, price and value.