By Andy Miles, Senior Analyst, Asset Management
It is not uncommon for one to think a suspended distribution is the result of poor performance, as it very well may be the case. If a property struggles with occupancy, for example, a sponsor may decide to suspend distributions to have enough cash on hand to cover financing costs and operating expenses. Although if this is the case, RealtyMogul has experienced real estate professionals on its Asset Management team that can step in to help stabilize the property.
The Asset Management team will analyze the property to understand where operational inefficiencies may be occurring or if poor performance is related to market conditions. If operational inefficiencies are identified, the Asset Management team will troubleshoot internally and with the sponsor on how to increase revenue and occupancy or control expenses, to give a few examples. The team can make recommendations to the sponsor(s) on actions to take to improve the cash flow of the asset. However, if mismanagement of the asset is the underlining issue, RealtyMogul may be able contractually to remove the property manager or sponsor.
But it is important to understand that not all suspended or late distributions are a result of poor property performance.
There are many factors taken into consideration when deciding whether or not to distribute cash flow from a property. Some factors may be a result of poor performance as demonstrated above, but there are factors correlated to potential positive performance as well.
The business plan is an important factor to consider when setting your expectations, as an investor, for distributions. When investing in a stable asset with potentially stable cash flows, one can expect to receive distributions in line with the proforma as property operations are not expected to change significantly. Although, when a business plan incorporates turning the rent roll, renovating units, or other capital improvements, cash flows may fluctuate during the period in which improvements are made. This is because there is much more uncertainty during construction and there are many elements that can slow down or speed up the progress of the business plan when compared to a stabilized asset.
When renovating units, the timing of such renovations can affect the timing of distributions. For example, renovating units quicker than expected can result in higher than anticipated expenses for a period. A sponsor may decide to withhold a distribution to maintain higher operating cash to pay for the increase in expenses. If the property is achieving higher rents for renovated units, the sponsor may then be inclined to continue flipping units rather than maintain stable occupancy levels. If this is the case, investors need not worry about a missed distribution as it may not correlate to poor performance. In this case, the property may reach stabilization faster than expected and potentially benefit from renovated units achieving higher rental income. It is quite common for distributions to be delayed within the first year when a unit renovation program is progressing faster than expected.
Delays in distributions are also common when a large tenant or several tenants are expected to vacate. When a tenant vacates there are generally significant costs associated with releasing the space. For instance, leasing costs can be paid to a broker for signing a new tenant and tenant improvements can be awarded to the tenant for make-ready expenses. As a precautionary measure, a sponsor may decide to suspend distributions in order to prepare for the upcoming costs associated with new tenants absorbing available space.
Overall, distributions are not always the best way to judge a property’s performance. As displayed above, an investment can be over-performing while not distributing cash. Positive momentum sometimes requires more capital, therefore decreasing the amount to distribute to investors in the short run. Always remember to tailor your expectations to best fit the business plan related to your investment and that all investments come with a degree of risk.