Every property investor should have an exit strategy for their real estate deals to maximize profit and minimize risk.
While it may sound strange to think about exiting a deal before you’ve entered it, having a well thought-out exit strategy simply makes good business sense for real estate investors.
What does it mean for a real estate investor to have an exit strategy?
An exit strategy should be part of every real estate investor’s business plan. After all, an investor is often relying on a property sale (or exit) to make money. Even if an investor’s business strategy is to hold the property to make passive income, it’s still important to know when exiting the investment makes sense. Whether that exit is for financial reasons or as part of life or business goals.
Exit strategies can depend on many factors. An investor may decide to use an exit strategy on one deal to make another deal. Some exit strategies are short-term, while others are long-term. Some exit strategies are property specific. Others might involve an entire portfolio of property investments. Here are some common exit strategies and when an investor might use them.
Common real estate investment exit strategies
Fix and flip
In most cases, investors know that the flip comes after the fix—the exit strategy is all part of the original fix and flip plan. Flipping as an exit strategy requires more time, labor, and investment than others. When purchasing a property, you need to identify which exit strategy works for which property and at what price.
Buy and hold for equity
A common strategy for real estate investors is to buy property and rent it out. Ideally, rents increase as property values go up, pushing up profitability. The increased monthly cash flow can be used to buy additional property. Or, the equity in the property might be used to buy new property investments. In a buy and hold strategy, an investor might have an exit strategy to sell a rental property when the property values reach a certain peak. Timing is key to make the most profit.
Owner or seller financing
With owner financing, also known as seller financing, the seller finances a purchase directly. The buyer then repays the seller instead of repaying a bank via a traditional mortgage. The payments aren’t usually long-term. Instead, they include monthly payments over a shorter term and a balloon payment at the end. This exit strategy works best once the seller owns the home outright. Homeowners who want to give up responsibility for caring for a property but still receive monthly payments may find owner financing to be a helpful exit strategy.
If you own an investment property that you want to sell and a tenant wants to buy, a lease option can be a viable exit strategy. In this scenario, a tenant is given a first right of refusal before the property is put up for sale. Included in the lease agreement is the sale price of the property and any terms. In some cases, rent paid during that period goes to the purchase price. This exit strategy works well in a slow market over a relatively short time period (usually no more than two to three year). It’s also possible to include seller financing in a lease option.
If you’d like to get rid of a property for another real estate investment opportunity, a 1031 exchange might be a good exit strategy. This is a tax provision (December 2020 updates) that allows an investor to sell one investment property and buy another, while deferring capital gains tax. As long as the properties meet federal requirements, an investor can trade one property for another and not pay capital gains at the time of the exchange.
Cash out refinance
Sometimes your exit strategy isn’t about selling a property but using it to acquire more real estate investment property. In that case, you can use a property to free up cash by doing a cash out refinance. With this type of refinance, you get money back at closing. There are usually rules about maintaining a certain amount of equity after refinancing. And you’ll want to make sure the numbers make sense. Can the rental income support the new mortgage payment?, for instance.
If your final exit strategy is to pass your properties on to heirs, then you need to have a rock solid estate plan in place, usually involving a trust and will. You also need to communicate with those to whom you want to pass on your real estate investments. If they don’t want to run your business, you may decide to create a plan to liquidate and sell your real estate investment assets. Consult an attorney and accountant on the specifics because in some cases it’s better to liquidate after a death than before due to capital gains tax.
Every investor’s exit strategy is going to look different (and they might look different for different properties), but every investor should have one. Based on your business plan, your exit strategy will depend on your goals, your appetite for risk, the condition of the market, your access to financing and overall financial stability, and the types of property you hold and what condition they’re in.
Erin Behan is a writer and editor covering real estate investor strategy for Sundae. She’s lived in L.A., New York, and Atlanta and currently resides in Portland, Oregon, where she writes and edits for a number of outlets, including WebMD, Farmers Insurance, and Vox Creative. She spends her free time hiking with her two boys, snuggling with her cat, and enjoying the best of the Pacific Northwest.