We've said it before and we'll say it again. Tackling real estate investing without research and an investment plan makes you your own worst enemy. What investors often forget about when it comes to proper planning is what their end game and real estate exit strategy should be. Despite what some may think, it is neither taboo nor jinxing to plan for the end of a long-term commitment — when it comes to real estate that is — with real estate exit strategies.
Why Having an Exit Strategy is Important
While the exit strategy seems like the final hoorah in an investment journey, it actually guides and influences every single decision made from the very first moment you lay eyes on a potential real estate purchase all way up until the final sale. How much time, money, elbow grease, and heart you put into your real estate purchase is all decided by what exit strategy you have.
Preparing for your real estate exit will allow you to maximize your real estate investment return. Not preparing will reduce potential profits and increase potential risks. You exit plan for your small business, so would you not exit plan for your real estate as well?
Types of Exits
Luckily there are many ways to go about leaving your real estate investment. We're diving into just a few of the most common strategies for all real estate investment avenues — commercial, single-family, multi-family, short-term rental, and more.
Wholesaling real estate is essentially an investor selling a property to another investor at a higher price. They act as a liaison between a seller and end buyer, usually earning a profit through a wholesaler or assignment fee. Think of it as selling the right to buy a property to someone else rather than selling the actual property itself. The only reason that would not be the case is if the investor decides to close on the property themselves and immediately resell to another investor in what is called a "double close." Wholesalers typically do not invest personal capital to facilitate transactions and tend to target distressed and discounted properties. While it may feel like you are acting as a real estate agent, a real estate license is not required; however, having specialized knowledge of the home selling and buying process is helpful. This real estate exit strategy tends to be the most enticing to investors beginning their real estate investing journey due to its potential high-profit return and absence of personal stake.
Fix and Flip
Fix and flip involves buying a property under market value in an area where demand is high, renovating it with a reliable team of contractors, and selling it as quickly as possible for more than the original purchase price, holding costs, and renovation expenses. It is one of the real estate exit strategies that can yield the largest profit margins, but only if done right. Fix and flip has a greater amount of risk due to various factors that could impact your rehab budget and timeline.
Buy and Hold
Similar to Fix and Flip, you are rehabbing a property to increase its value, but instead of selling, you are holding onto it to rent out and receive a monthly cash flow. This exit strategy is also known as The BRRRR Method, which you can find countless books on. Different than just buying and renting out, renovating is an added extra step that will not only boost quality and appearance but also allow you to boost your property rental rates. This is a popular real estate investment exit strategy for those looking to build equity in an asset but be prepared for the added responsibilities of being a landlord.
1031 Tax Deferred Exchange
The last thing investors are thinking about when they are walking away from a property sale with a pocketful of cash is the taxes required to pay on that pocketful of cash. A way around paying these capital gains taxes at the time of sale is moving all of your equity into a like-kind property through a 1031 exchange. (Sidenote: the IRS will expect like-kind properties to allow for capital gains tax deferral). Long story short, a 1031 exchange is a swap of properties held for business or investment purposes only. By doing this, you — and in the eyes of the IRS — are not recognizing any capital gain because it is rolling over into new properties, even if you are getting a profit on each swap. If done correctly, you will pay one long-term capital gains tax when you sell the property for cash later. This exit strategy is best suited for investors looking to move into larger real estate properties or into a different investing market that more closely aligns with their desired portfolio.
If you feel you are eligible for a 1031 Tax Deferred Exchange, consult with a CPA on this type of real estate investment exit strategy.
A cash-out refinance is replacing an existing mortgage with a new one of a larger amount that can potentially give you access to spare cash to cover renovations, repair bills, or even eliminate other loans. This is done to extend more favorable terms to the borrower including lower monthly mortgage payments, and an opportunity to renegotiate interest rates and loan terms. What that refinance amount will look like is up to a lender analysis of your property's cash flow, loan-to-value ratio, your credit score, and overall bank standards. That difference in the existing and new mortgage amount is where the excess cash comes in.
How to Choose the Right One
Real estate investment exit strategies are not a one size fit all. There are several key factors to take into consideration when choosing the exit strategy that best suits your short-term and long-term goals. A lot of those factors can be found by doing your research with rental comps including property location and value, market conditions, purchase price, and supply and demand. Factors that hold more sway over your exit strategy choice are the ones that are individual-specific. This includes your financing options, investor liquidity, risk tolerance, minimum targeted return on investment, tax considerations, and real estate investing experience level.
Real estate investing is a long-term commitment that starts with an inquiry and financial backing, and ends with an exit strategy and payout. So when it comes time to love and let go of your property, you'll be ready.
For more tips, tricks, and information on real estate investment exit strategies and more, download Flagship's Investment Real Estate Guide today.