SS229: The Importance of an Exit Strategy in Real Estate

SS229 The Importance of an Exit Strategy in Real Estate

Having a clear exit strategy before investing in real estate is paramount to being a successful investor. In this episode, Charles discusses how to outline an exit strategy as a real estate investor.

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Talking Points:

  • Most real estate investing content is based on buying properties; however, one important and often overlooked element within real estate investing, or investing in general, is the exit strategy.
  • The exit strategy is a plan for how you will eventually sell the property you are looking to purchase. Exit strategies enable you to maximize your profits when you ultimately sell, and they become even more critical when you start including investors in your deal, as this is one of the first questions they will ask.
  • The exit strategy primarily focuses on repaying the investors’ money. Typically, this involves selling the property, although not in every instance. Let’s break down a few of the most popular exit strategies for investing in rental properties.
    • 1. Buy and Long-Term Hold. This is a traditional investment strategy where an investor buys and holds a property for 10 years or more. During the hold time, they pay down the mortgage while the property appreciates from regular market forces and sound property management. This is one of the least risky real estate investment strategies, but also ties up the investor’s money for many years.
    • 2. Value-Add. The value-add strategy is a popular real estate investing approach where investors identify an undervalued property and spend the next 3-5 years addressing management issues, making necessary repairs and upgrades, and then raising rents to market rates, ultimately selling the property.
    • 3. Refinance. This strategy is a hybrid of buy-and-hold and value-add, with a slight twist, and it is probably my favorite. An investor purchases an undervalued property and performs a value-add business plan. Instead of selling, they refinance, extract most or all of their original capital, and hold the property long-term. They now have a cash-flowing property and their initial capital available for their next property. This is not a cut-and-dry exit strategy, but it allows investors to recoup their capital if they make the correct purchase, and then it transitions into a buy-and-hold exit strategy.
    • 4. 1031 Exchange. This exit strategy enables the investor to sell their property or properties without incurring capital gains tax. It is the ultimate exit strategy, as it forces you to buy more property, while shielding your gain from your first property. This is an excellent strategy for investors trading up from smaller to larger properties. Many rules must be followed for a 1031 Exchange. If you would like to learn more about 1031 exchanges, you can refer to GI157 and GI173, where I interviewed some 1031 Exchange professionals.
    • 5. Bringing on Another Investor. This strategy is not popular, but it can be extremely rewarding if done correctly. A couple of partners of mine did this on a property in Oklahoma years ago, where they identified a large apartment complex comprising approximately 150 units that was owned by a single person. The property had under-market rents and deferred maintenance. It also had no mortgage since the owner had owned it for many years. Instead of buying the property outright, they suggested buying it with seller financing, making the current owner the sole limited partner in the deal, handling all the renovations, and addressing the management issues. When it sold, everyone made out better than they would have from an outright sale.
      • The current owner is not required to perform any work or pay taxes when initially selling, as the transaction is 100% owner-financed. He also doesn’t need to invest any more money. The new owners bring their own capital and make all the necessary corrections over a 3-year period, eliminating the need to go through the traditional mortgage financing process. When it sells, the previous owner, now a passive investor, reaps a substantial share of the upside, while the new owners receive their capital back and a significant portion of the profits they helped generate—a true win-win.
  • Two examples of exit strategies from my previous real estate investments come to mind, including two properties we purchased in 2019 and sold in early to mid-2022. After speaking with brokers, we noticed by the end of 2021 that we would exceed our target returns if we sold, so we listed the properties for sale. The better property sold faster, while the other property took several months to sell. Meanwhile, some passive investors in the deals wanted us to retain the properties, and we ultimately decided to sell them instead of holding out for possibly higher prices, as most people were unaware of what the end of 2022 had in store for the real estate market. Having a hold time of 5-7 years, while also setting target returns, made the decision to sell much easier since we had already exceeded our target returns. Other investors without a clear business plan and exit strategy might have just held out to see if they could get a better price.
  • As a side note, your plan, timeline, and exit strategy may change during the hold time due to factors beyond your control. Having a debt term longer than your hold term and maintaining a solid reserve fund can help mitigate most of these issues. Perhaps if you plan to own for 5 years, you should consider a 10-year term loan from your bank to protect yourself from potential problems refinancing if you find yourself in a recession within the next 5 years.
  • As a real estate investor, selecting your exit strategy is one of the most crucial factors to consider when purchasing a property. It is also important to note that you do not need to choose the same exit strategy for every property you invest in. However, having a detailed plan and timeline for how and when you believe you will sell a property will significantly increase your chances of success.

Transcript:

Charles:
Welcome to Strategy Saturday. I’m Charles Carillo and today we’re gonna be discussing the importance of an exit strategy in real estate. So most real estate investing content is based on buying properties. However, one important and often overlooked element within real estate investing or investing in general is the exit strategy. And the exit strategy is a plan for how you will eventually sell a property you’re looking to purchase and exit strategies enable you to maximize your profits when you ultimately sell. And they become even more critical when you start including passive investors in your deal as this is one of the first questions they’re gonna ask before investing. Now the exit strategy primarily focuses on repaying the investors money. Typically, this involves selling the property, although not in every instance. So let’s break down a few of the most popular exit strategies for investing in rental properties.

Charles:
Number one is buy and long-term hold. And this is a traditional investment strategy where an investor buys and holds a property for 10 years or more, and during the hold time, they pay down the mortgage while the property appreciates from regular market forces in sound property management. And this is one of the least risky real estate investment strategies, but it also ties up the investor’s money for many years. And number two is the value add. Now, the value add strategy is a popular real estate investing approach where investors identify and undervalue property and then spend the next three to five years addressing management issues, making necessary repairs and upgrades, and then raising rents to market rates, ultimately selling the property. Number three is the refinance. And this strategy is a hybrid of buy and hold in value add with a slight twist, and it’s probably my favorite.

Charles:
An investor purchases an undervalued property and performs a value add business plan. Instead of selling, they refinance extract most or all of their original capital and hold the property long term. They now have a cash flowing property and their initial capital is available for their next property investment. This is not a cut and dry exit strategy, but allows investors to recoup their capital if they make the correct purchase and then it transitions into a buy and hold exit. Strategy number four is the 10 31 exchange. And this exit strategy enables the investor to sell their property or properties without incurring capital gains. It is really the ultimate exit strategy as it forces you to buy more property while shielding your gain from your first property. Now this is an excellent strategy for investors trading up from smaller to larger properties and many rules must be followed for a 10 31 exchange.

Charles:
But if you wanna learn more about 10 31 exchanges, you can refer to GI 1 57 and GI 1 73 episodes where I interview some 10 31 exchange professionals. Number five’s, bringing on another investor and the strategy is not really popular, but it can be extremely rewarding if it’s done correctly. So a couple of partners of mine did this with a property in Oklahoma years back where they identified a large apartment complex comprising approximately of like 150 units that was owned by a single person and the property had under market rents and had deferred maintenance, but it also had no mortgage since the owner had owned it for many years. So instead of buying a property outright, they suggested buying it with a hundred percent seller financing, making the current owner the sole limited partner in the deal and handling all the renovations and addressing the management issues when it’s sold, everyone made out better than they would’ve if it was an outright sale.

Charles:
So the current owner is not required to perform any work or pay taxes when it initially sells. And as the transaction is 100% owner financed, okay, now he also doesn’t need to invest any more money. The new owners bring their own capital and make all necessary corrections over a three year period, eliminating the need to go through the traditional mortgage financing process, which also saves money and when it sells the previous owner. Now as a passive investor, reaps a substantial share of the upside or the new owners receive their capital back in the significant portion of the profits that they help generate. So it’s a true win-win for an owner that wants to maximize a return and doesn’t mind waiting a few years and for a group that wants to come in and split some of that upside with the previous owner while also not having to bring as much money to the table and not having to bring any other passive investors ’cause it was just their money to do it.

Charles:
Now, two examples of exit strategies from my previous real estate investment deals kind of combined during this is including two properties we purchased in 2019 and then we sold in early to mid 2022. So after speaking with brokers, you know, we noticed by the end of 2021 that we had exceeded our target returns if we were to sell these properties. So we listed the properties for sale and the better property sold faster while the other property took several months to sell. Meanwhile, some passive investors on a deal, they wanted us to hold the properties and they didn’t want to sell. You know, they wanted to see if there was gonna be any more money in the market that they could sell the properties for in the future. And we ultimately decided to sell instead of holding out for a possibly higher price as most people were unaware of what the NF 22 had in store for the real estate market with the interest rates that went up now having a whole time of five to seven years while also setting the target returns made the decision that much easier because we already had exceeded our target returns.

Charles:
Other investors without a clear business plan and exit strategy might have just held out and see if they could get a better price thinking that real estate always goes up. But once you really hit those targets in your plan, you know that you can sell it ’cause that was what the plan was from the beginning. Now as a sign note, your plan timeline exit strategy may change during the whole time due to factors beyond your control. Having a debt term longer than your whole term and maintaining a salt reserve fund can help mitigate most of these issues. Perhaps if you plan to own for five years, you should consider a 10 year term loan from your bank to protect yourself from potential problems refinancing if you find yourself in a recession within the next five years. So as a real estate investor, selecting your exit strategy is one of the most crucial factors to consider when purchasing a property. It also is important to note that you do not need to choose the same exit strategy for every property you invest in. However, having a detailed plan and timeline for how and when you believe you will sell property will significantly increase your chances of success. So I hope you enjoyed, please remember to rate, review, subscribe, so become sometimes we’ll show topics at globalinvestorspodcast.com. If you’re interested in actively investing in real estate, please check out our courses and mentoring programs at syndicationsuperstars.com. That is syndicationsuperstars.com. Look forward to two more episodes next week. See you then.

Links Mentioned In The Episode:

  • GI157: 1031 Exchange Explained with Dave Foster
  • GI173: How Does a 1031 Exchange Work with Alex Olson

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