When it comes to real estate, putting an exit strategy in place is the same as having a backup plan. An entrepreneur would likely not enter into a business deal without a plan B, so investing in property should be no different.
In many ways, deciding on your exit strategy before you invest is key to determining your business plan for the property, and therefore making or breaking success of your investment deal. Here at We Lend, one of the first questions we ask our real estate borrowers is about which one they have chosen.
When it comes to pinpointing a real estate exit strategy, however, there is by no means a generic technique that will work for everyone or for every property — this very much depends on your investment experience and the state of the property market at the time. It’s therefore very important that you take the time to research and weigh up your options.
Why is it Important to Have a Property Investment Exit Strategy?
When investing in real estate, the vast majority of your liquid capital might be tied up in your asset until you sell it on. That being said, before you purchase any property it’s vital to have multiple exit strategies in mind so that you can pivot if you encounter an extended period of time where you’re short on cash.
However, if your exit strategy is a fix and flip, having a robust one in place before you invest will give you access to instant equity as soon as you have paid off your hard money loan.
Most importantly, a well-thought out exit strategy will minimize your losses, securing as much of your original investment as possible and avoiding tax ramifications. This is why knowing the downside of any deal is far more important than knowing the upside of the deal.
There are several different exit strategies in real estate investing to consider, so it’s important you pick the right one for you. The decision you make depends on a few factors, including:
- Your liquidity as an investor
- Your debt-service coverage ratio
- Your short-term investment goals
- Your long-term investment goals
- Your risk tolerance as an investor
So, which one is right for you? Let’s take a look at some of the most-common real estate exit strategies to help you decide.
Wholesaling real estate essentially involves selling the entire property to an end buyer — usually another investor — at a higher price. What this exit strategy allows you to do is act as the middle person, saving investors time, and quickly generate high profit margins on property deals.
This can be done via two different methods. The first involves closing the deal and immediately selling it onto another investor, which is known as a “double close.” The second method allows you to “assign” your purchase to another buyer before closing the contract, but with the addition of an assignment fee. Most hard money lenders don’t cover this, but We Lend does!
Does this exit strategy sound like it could work for you? Apply for one of our real estate investment loans now
2. Bring in Another Investor
If you’re not keen on selling your whole investment, an alternative way of cashing in on your investment property could be to sell a share of it to another investor.
Although forming a joint venture means you’ll be sharing the profits, it’s an easy way to reduce your exposure to investment risk, while still making a substantial ROI.
If you opt to go down this route, you should be prepared to offer a higher cut of your profits in order to make the investment worthwhile for your partner. Also, make sure you choose your investment partner wisely, as inexperience can be costly. Remember, a problem shared is a problem halved — so look for a skillset that could complement your own.
3. Buy and Hold
Another real estate exit strategy is to purchase a property and then keep hold of it in order to earn regular, monthly income from renters. If you’re doing this with a property that you’ve gutted and renovated, this is known as the BRRRR method.
If you’re looking to build up equity in assets, buying and holding is a good option. That being said, you’ll also be taking on the task of property management, which comes with a range of different responsibilities.
If you don’t like the idea of self managing your rental maintenance, operations, tenants, income, budget, and so on, you can outsource these responsibilities to a property manager. And, if you’re planning on renting out the property, it’s also wise is to hire a real estate tax advisor to help manage your taxable income and keep your side hustle as close to a source of passive income as you can get.
4. Sell and Do a 1031 Tax Deferred Exchange
One of the biggest disadvantages of selling a property and walking away are the capital gains taxes you’re forced to pay.
However, a way around paying these taxes is to conduct a 1031 exchange and move all of your equity into a like-kind property. This defers your capital gains taxes and leaves you with more liquid cash for your next property investment.
This exit strategy is a convenient option for anyone looking to build up their investment portfolio and move into investing in larger real estate properties. For investors thinking of passing on property assets to their heirs, they can also do a 1031 exchange in order to bypass heavy taxation.
One point to bear in mind with this exit strategy is that the IRS will expect both real estate assets to be “like-kind” in order to allow capital gains tax deferral.
Looking for some creative tax strategies for your next fix and flip? Check out our expert tax strategies for flipping houses.
5. Fix and Flip
A final real estate exit strategy is to fix and flip your property. This is when you buy a run down property, maximize its value, and then sell it on for a higher price than the original investment costs
Given its high profit margins, this strategy is a popular option for those who don’t mind a challenge. However, the complexity and level of undertaking involved in house flipping should not be underestimated. So, if this is your exit strategy, make sure you surround yourself with a team of experts, including:
- A real estate agent you can trust
- A contractor that comes highly recommended
- An experienced hard money lender
Like all of the strategies on the list here, flipping houses requires a lot of planning beforehand. This exit strategy is only recommended if you’re confident in the property and you’re able to make the necessary renovations that maximize your ARV. If so, go for it! As this is the most-lucrative of all the exit strategies on this list.
If house flipping is new to you and you’d like to find out more, have a read of our beginner’s checklist.
Deciding Which Property Investment Exit Strategy is Right for You
Regardless of the method you choose, the most important part is to nail down your exit strategy before you begin the investment process. And there’s no doubt that the more experience you have, the more deciding on a real estate exit strategy will go on to come naturally for you, even if it does seem daunting at first.