The price you paid is not in the decision. Today's net realisable value is the investment, and the forward IRR on it is the only return that counts.
A hold vs sell analysis treats today's net sale proceeds as the amount you are reinvesting, projects the hold from that figure, and compares the forward IRR with the fund's cost of capital. On an illustrative multi-let office worth 46,000,000, the net realisable value is 45,310,000 and the forward IRR of holding five more years is 6.43 per cent against a 7.0 per cent cost of capital: sell, because holding is worth 1,076,672 less than the cheque on the table. Leave out the lease event in year three and the same hold shows 7.12 per cent and looks like a keep.
Worked in full in The Real Estate Asset Manager by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Every hold decision is a fresh purchase at today's price. The owner who keeps the building is choosing not to bank the net proceeds, so those proceeds are the investment, and the only return that matters is the one earned on them from here. What the fund paid, and the IRR since acquisition, belong in the history of the deal, not in the decision.
| Input | Value |
|---|---|
| Price paid five years ago | 50,000,000 |
| Market value today | 46,000,000 |
| Sale costs, today and at exit | 1.5% |
| Net operating income, year 1 | 2,850,000 |
| Year 3: lease expiry, void and incentive (NOI falls to) | 2,250,000 |
| Year 3: re-letting capex | 900,000 |
| Year 6 NOI, capitalised at exit | 3,100,000 |
| Exit yield | 6.50% |
| Fund's cost of capital (hurdle for the hold) | 7.0% |
Today's income of 2,850,000 on the market value is a 6.20 per cent yield, so the exit yield assumes a 30 basis point softening over five years for a building that will be five years older. That is a modest, not a punitive, assumption.
NRV = market value × (1 − sale costs) = 46,000,000 × 0.985 = 45,310,000
The 690,000 of sale costs is the difference between what a valuer says the building is worth and what the fund would actually receive. That net figure goes in year 0 as a negative cash flow: it is the money the fund declines to take by holding.
| Year | NOI | Capex | Net sale | Cash flow |
|---|---|---|---|---|
| 0 | −45,310,000 | |||
| 1 | 2,850,000 | 2,850,000 | ||
| 2 | 2,900,000 | 2,900,000 | ||
| 3 | 2,250,000 | −900,000 | 1,350,000 | |
| 4 | 2,980,000 | 2,980,000 | ||
| 5 | 3,040,000 | 46,976,923 | 50,016,923 | |
| Forward IRR | 6.43% |
The exit is the year 6 NOI of 3,100,000 divided by 6.50 per cent, a gross value of 47,692,308, less 1.5 per cent sale costs: 46,976,923 net. The cash flows add up to 14,786,923 of undiscounted profit, which is why a hold rarely looks bad on a summary page. The rate tells the story.
Decision rule: hold if forward IRR > cost of capital, equivalently if NPV at the cost of capital > NRV
In Excel, with the year 0 to 5 cash flows in B2:G2: =IRR(B2:G2) returns 6.43 per cent, and =NPV(7%,C2:G2) returns 44,233,328 against an NRV of 45,310,000.
Holding is worth 44,233,328 to a fund whose capital costs 7.0 per cent, and selling is worth 45,310,000. The difference, 1,076,672, is what the fund gives up by keeping the building. The forward return is positive and close to the hurdle, which is exactly the zone where a hold drifts through committee: 6.43 per cent sounds like a performing asset. It is a performing asset that would be better owned by somebody else.
The break-even exit yield, at which the forward IRR equals 7.0 per cent, is 6.30 per cent: the hold works only if the market prices the building in five years within 10 basis points of today's yield, with five more years of age on the plant and the lease profile. The break-even exit yield article sets out that solve in detail.
| Exit yield | Gross exit value | IRR, full model | IRR, no lease event | Hold minus sell |
|---|---|---|---|---|
| 6.00% | 51,666,667 | 7.88% | 8.56% | 1,714,487 |
| 6.25% | 49,600,000 | 7.14% | 7.82% | 263,084 |
| 6.50% | 47,692,308 | 6.43% | 7.12% | −1,076,672 |
| 6.75% | 45,925,926 | 5.75% | 6.46% | −2,317,186 |
Each 25 basis points of exit yield moves the forward IRR by roughly 70 basis points, because the exit carries most of the value in a five-year hold. The lease event is worth about the same: taking out the year 3 void and the 900,000 of capex, 1,600,000 of cash in a single year, lifts the IRR from 6.43 to 7.12 per cent and flips the decision at the base exit yield. A hold model that runs income as a smooth line will always say keep.
Put net realisable value in year 0, model every lease event and capital item through the hold, and compare the forward IRR with the cost of capital. Here 6.43 per cent against 7.0 says sell, by 1,076,672, and only an exit yield of 6.30 per cent or tighter says otherwise. The hold, refurbish and sell options are projected side by side from the same NRV in the free workbook for this case, and how long a landlord can hold out for a higher rent works the void decision that sits inside year three.
The current value, net of sale costs. Holding means declining to bank today's proceeds, so those proceeds are the investment. Illustratively, a building bought for 50,000,000 and now worth 45,310,000 net returns 6.43 per cent forward from the net figure; measured from the price paid the same cash flows show 4.13 per cent, which answers a question nobody is asking.
The fund's cost of capital or the return it could earn redeploying the proceeds into an asset of similar risk. In the illustration the hurdle is 7.0 per cent; the hold's NPV at that rate is 44,233,328 against net proceeds of 45,310,000, so selling is worth 1,076,672 more even though the hold earns a positive 6.43 per cent.
Because it concentrates cash loss in a single year inside a short hold. In the example a year-three void and 900,000 of capex remove 1,600,000 of cash. Taking them out lifts the forward IRR from 6.43 to 7.12 per cent and turns a sell into an apparent hold.
Chapter 6 of The Real Estate Asset Manager sets out the hold, refurbish or sell decision; the free companion workbook projects all three options from the same net realisable value. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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