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Wharton Emeritus Professor Dr. Peter Linneman discusses exit strategies.
Bruce Kirsch: When we talk about exit strategies, we’re really talking about investing in general. And when people talk about investing, they say you should never go into an investment without understanding upfront how you could potentially exit it. And so this naturally applies for real estate as well.
But when people talk about this notion of exiting, what exactly do they mean? Does it only mean to completely sever all of your financial and legal ties to a property? Or does it also sometimes mean simply recouping your original equity and making some profit on top of that and potentially maintaining some ownership stake going forward?
Dr. Peter Linneman: Yeah I think when people use the word exit, they certainly include getting completely out of the property in every way, shape, and form or out of the investment in every way, shape, and form. But they also include partially doing so. How do I get my money back? How do I get my money back and some of my profit? How do I get out if I want to get out? And if I want to get out of it completely, how do I get out of it completely? It’s that whole set.
So it is not just sale. If you think of the thing most students are probably most familiar with is owning maybe I go buy a million dollars in stock in a company, well, what’s your likely exit strategy if you own a million dollars of stock in a company that has a market cap of $5 billion? Well, the likely exit is I sell some or all of my shares when I decide to do so.
And I may not get the price I want. I may get better than the price I thought I’d get. But that’s what I can do with a public company is sell all or part of my shares when I want. As you go away from public companies, and in fact, even with small, illiquid public companies, you have to consider other alternatives than just this nice, little sale of the paper.
If I own a property, it may take me a while to put together a sales document, get the contracts and the leases together for people to evaluate. They’re going to do due diligence. It’s going to take a while to get everything worked out. I have to negotiate. Meanwhile, things can go wrong. They take time.
Also, even to get a loan, I suppose I’m going to get a loan to partially take some or all of my money out of the property, it takes time to negotiate a loan and get the documents done to get a loan and so forth.
So my exit strategy is really saying, look, I don’t know really when I’m going to want my money or how much I’ll get. But at least you force yourself to go through the mental discipline of if I were to sell this, who’s going to buy it? Will they buy all of it? Will they buy part of it? What kind of pricing will they give me? Could I borrow against it to provide some liquidity? Could I borrow more than I have invested?
It’s those kinds of questions. So when you talk about exit strategy, you’re talking about you start that even before you buy it. It’s part of your due diligence, and then it’s an ongoing matter as you manage the asset.
Bruce Kirsch: One thing that might not be visually apparent to folks but I think is quite common is let’s say in an urban environment, the prototype is to have a building with the primary use above. And at grade, you have retail and below grade potentially income-producing parking. And so what typically happens for a sophisticated owner or sophisticated developer is when they set up the legal status of that project, they will, in fact, set up a condominium regime that will carve out the parking separate from the rest of the building and carve out the retail separate from the rest of the building. And in so doing, they create this tremendous option value for themselves and different ways to exit or perhaps not exit the property as a whole.
Dr. Peter Linneman: To that point, the ideal buyer for an urban parking lot may not be the same as the ideal buyer for, say, Fifth Avenue retail. And it may not be the same ideal buyer as for office building space above. You can imagine a parking company that specializes in owning and operating parking might want the parking component, be the highest value bidder, while a retail company might be the highest value bidder for the retail piece and an office party for the office.
And so if you start out saying, gee, as my exit strategy, am I better off cutting this up into three ownership slices, which the way entails some legal work and some costs associated with that and some brain damage, or am I better off to leave it all together as one? And you have to make those kind of business decisions. Do you really think that the buyers that are out there are going to value it a lot differently? If you think they’re going to value each of those components a lot differently, then you break them up. If you think they value them about the same, save the legal brain damage.
But that’s part of exit strategy. You have to anticipate, and you have to have a view. You’re not always right in your view. But you have to have a view and, like any part of business, adopt strategies and implement strategies that you think will generate the best return.