What exactly is meant by the term “exit strategy?” Is it just cool venture capitalist jargon as they take their billion-dollar start-up profitably public? No, the phrase accurately describes the process of knowing when and how “to cash out” a real estate investment.
An exit strategy is the method by which an investor cashes out of an investment. There are five main strategies in physical real estate investment, all of which involve different exits or realizing a return.
Usually an investor knows what he or she is going to do with a property before buying it. Everyone looks at cash flow, built-in equity and repairs. If it’s a flip, they’ll buy the property, rehab it and sell it:
- Flipping isn’t entirely dead across the country, especially in cities where inventory is beginning to tighten.
- Flipping and holding means rehabbing a house and renting it out.
- Holding involves buying investment property and renting it.
- A lease-option is selling the home to a tenant in place.
- Wholesaling is buying at a low price and then typically selling it to another investor.
But how do you know when to sell a property that is producing income?
Different investors work on different timelines. For one person, it might be time to sell when the kids head off to college. For another, he might want to knock Europe off the bucket list three years from now. Someone else might have retirement age looming. “You have to have a business plan and know the objectives of that business plan, then you’ll know the answer,” says Alan Langston, executive director of the Arizona Real Estate Investors Association. “When you should get out versus when I should get out are two different answers.”
During the boom in the first half of the 2000s, speculators bought houses in hyper-inflated markets like Phoenix and Las Vegas and resold them within days or weeks. That’s not intelligent investment, Langston said.
“Speculators I can’t speak to,” he said. “I don’t care about them. They’re going to do nothing but screw up the market. Investors add value in everything they do. Speculators do not. Investors earn their money.”
“If I see speculators over my shoulder, I run,” says Greg Rand, author, radio host and media commentator on real estate.
CREATING A TAXABLE EVENT
Rand’s exit strategy is simple: don’t have one.
“Never sell,” he said. “My experience in real estate both residential and commercial is that the people who really do well approach it like they are building a portfolio, not trying to arbitrage the market. They don’t take it off the table.”
Only sell in order to buy a better property, Rand said.
When an investor sells a property and takes a profit this creates a taxable event. Now the profits are taxed at the current capital gains rates. If it’s a flip and the sale occurs less than 366 days from purchase this may be defined as ordinary income and be subject to ordinary business accounting and tax rules.
It is customary to shelter capital gains when a true investment trade-up to better property is occurring. An investor can use an IRS Rule 1031 Exchange to defer the taxes, but must use a qualified intermediary to receive and disburse the purchase funds.
The investor must remain at arm’s length from the cash and complete the entire transaction within 180 days. Intermediary companies like IPX 1031 and 1031 Exchange Experts are ideal partners in understanding the details.
BUY, HOLD, RENT & RELAX
“That philosophy is serving us really well,” said Rand. Our philosophy from the ground up is aggregating a portfolio intelligently. Keep your eye on assembling your assets. It’s not about ‘how canI find something to buy so I can find a 15% equity position.’ Think of it as a little money machine. Pull the cord, start the engine and walk away from it.
What is the end goal? It’s to produce bulletproof wealth.
As Warren Buffett famously said: “Our favorite holding period is forever.”