What Is a Real Estate Exit Strategy?
07 27 2017
Ultimately, real estate investing is a means of growing your wealth, and while some investors do hold on to income-producing properties indefinitely, most plan to sell at some point. There are several ways to determine a commercial property’s value, but planning a real estate exit strategy is more challenging.
While you should always speak with your financial advisor surrounding any investment decisions you’re considering, you should also evaluate potential exit strategies for a property before even initiating a deal. Not only does this maximize profits and help mitigate certain risks, it also gives investors the upper hand during the negotiation process.
Types of Real Estate Strategies
It is important for aspiring real estate investors to understand the range of exit strategies available to them and choose one based on the amount of capital and time they’re willing to invest in the project, as well as their level of experience. The real estate strategy an investor chooses to pursue will then determine the types of properties they acquire and the exit timelines they can expect. To get a good perspective on which real estate strategies are right for you, we’ll take a look at several, as well as the exit timelines for each.
Exit timeline: Very Short
Wholesaling is ideal for the investor who wants to make many small, lump sums in the shortest amount of time. In a wholesale deal, the investor acts as the middleman between the seller and end buyer. Wholesalers typically sell their purchase contract to the end buyer before even closing on the property, or they can resell the property once the deal has closed (known as a “double close”). The first option is preferred, as there are no carrying costs involved, and purchase contracts can often include a contingency that absolves the wholesaler from the deal if they are unable to find a buyer before the closing date.
The nature of wholesaling creates a very short timeline for the investor’s exit, as they’re often selling prior to closing on the property.
Exit timeline: Short / Varies
Rehabbing is similar to wholesaling in that the investor plans to sell the property to an end buyer in the shortest timeframe possible. Rehabbing – or flipping – involves purchasing, renovating and reselling a property at full market value. Rehabbing requires more upfront capital than wholesaling but can be one of the most lucrative exit strategies. It is also one of the most complicated – aside from purchasing a suitable property, an investor must also budget renovations, select a contractor, manage the rehab process and pay the contractor before they even have the opportunity to recoup the investment. But for those investors willing to put in the extra time, capital and elbow grease, the rewards can be great.
Aside from the potential upsides, rehabbing properties comes along with a (usually) short exit timeline. Investors are wise to consider the market, neighborhood, and other factors to improve the chances they have at finding a buyer for the home quickly – these elements can all impact your exit strategy.
Buying and Holding
Exit Timeline: Long / Very Long
Buying and holding is one of the most popular real estate strategies, where instead of selling the property immediately, the investor rents it to a tenant to create a monthly cash flow. Unlike wholesaling and rehabbing, buying and holding is a long-term strategy that can generate income over time and help the investor build up equity in an asset. It also can require more time and energy due to unforeseen tenant issues and maintenance costs. Investors may also opt to use a professional property manager rather than dealing with tenants firsthand, which can free up their time but comes with a cost.
Naturally, the exit strategy for holding a property through this method comes after a long period of time – if it comes at all. Many investors searching for consistent cash flow opt to buy and hold properties, rather than a quickly turn them around.
Exit Timeline: Long / Very Long
Seller financing also provides the investor with a monthly income, but unlike buying and holding, the investor is no longer responsible for the property. With seller financing, an investor essentially acts as a bank, selling the property to a buyer but carrying the mortgage. Typically, the buyer provides a non-refundable down payment and then makes monthly payments. The buyer also takes on full responsibility of the property’s maintenance, tenants, taxes and insurance. Seller financing has tax advantages, allowing investors to spread out capital gains taxes over time, but the investor also risks having the buyer stop making payments and being forced to foreclose on the property. To mitigate this risk, investors should carefully screen potential buyers, require a large down payment upfront and consult an attorney to ensure the sale is done correctly.
The exit strategy involved with seller financing is a slow one, as the investor is serving in the role of a bank over a mortgage term. While the length of the term may vary somewhat, it’s never going to be a quick turnaround for an investor.
Other Real Estate Strategies
While we’ve covered the most popular real estate strategies as well as their exit strategies, other, less common real estate exit strategies include using a lease option and prehabbing.
Exit Timeline: Long / Very Long
A lease option is also known as rent-to-own, where the investor rents the property to a tenant and gives them the opportunity to purchase it at a later date, putting the monthly rent payments toward the purchase price of the home. The investor agrees to not sell the property to any other buyer during a pre-determined time period, giving the tenant the sole “option” to eventually buy the property. Because lease option tenants ultimately plan to own the property, they typically take better care of it than a regular tenant would. Lease options also absolve investors of having to pay commission once the property is sold. However, investors are locked into the price agreed upon with the tenant, so if the real estate market goes up, they cannot sell the property at a higher price.
The exit strategy with a lease option is similar to that of seller financing, as regular payments are being made over time. The length of term may vary somewhat, but any real estate investor should be aware it isn’t a quick turnaround.
Exit Timeline: Very Short / Varies
Prehabbing strikes a middle ground between wholesaling and rehabbing, with the investor doing some light repairs on the property before selling it to the end buyer. This requires less time and capital than full-on rehabbing but also increases the value of the property and can expand the pool of prospective buyers.
The exit strategy associated with prehabbing has a variable timeframe, but it’s generally a short one. The repairs and renovations performed on the property are less extensive than with a full fix-and-flip, but can vary when securing an end buyer.
Which Real Estate Exit Strategy Is Right for Me?
Many factors influence which real estate exit strategy makes the most sense. First, investors should solidify their goals. Are they looking to establish a long-term, passive income stream, or would they rather receive a one-time, lump-sum payment? They should also determine the resources they are willing to put into the investment, including upfront capital and time.
Most investors have a few go-to exit strategies that fit their abilities and goals, but before purchasing their first property, aspiring commercial real estate investors must understand the requirements, benefits and disadvantages of each exit strategy. As with any type of investment, not having an exit strategy from the get-go can result in unpleasant surprises and losses.
Of course, you should always consider consulting with your financial advisor to determine whether any of these strategies make sense for your personal financial goals, and make sure your research and due diligence into any investment property—or financial opportunity in general—is thorough. Understanding the basics about each type of real estate exit strategy is just the beginning.
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