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 an essential component of any investment plan, as it lays out how an investor plans to realize their profits and exit the investment. An effective exit strategy helps investors manage risk, avoid losses, and make informed decisions about their investments.
There are various types of exit strategies, including selling to a third party, taking a company public through an initial public offering (IPO), or liquidating assets. Regardless of the type of exit strategy, investors need to have a plan in place that aligns with their investment goals and risk tolerance. In this article, we will explore the importance of an exit strategy in investing and guide how to develop a comprehensive and effective plan.
An exit strategy is important for a number of reasons:
- Manages risk: Having a well-planned exit strategy helps investors manage their risk and avoid potential losses. By setting clear goals and considering all potential outcomes, investors can make informed decisions about when to sell and how to realize their profits.
- Maximizes profits: An exit strategy enables investors to maximize their profits by providing a clear plan for realizing gains and selling investments at the right time. This can help investors avoid missed opportunities and capitalize on market trends.
- Increases flexibility: With an exit strategy in place, investors have more flexibility in their investment decisions. They can make quick, informed decisions about selling, holding, or reinvesting in order to take advantage of market conditions.
- Reduces stress: Selling an investment can be a stressful process, but having a clear exit strategy can help reduce this stress by providing a roadmap for how to proceed. This can help investors make calm, rational decisions, even in uncertain market conditions.
- Facilitates better decision-making: An exit strategy provides a framework for making informed investment decisions. By considering potential outcomes and planning for different scenarios, investors are better equipped to make decisions that are in their best interest.
Exit Strategy in Real Estate
An exit strategy is a method by which an investor cashes out of an investment. In real estate, an exit strategy is a plan for how you will sell your home, either in the short term or long term. It's a crucial step in the process of owning a home, as it can help you maximize your profits, reduce your stress, and make the transition to your next home as seamless as possible.
Preparing for your exit strategy involves researching the housing market, understanding your goals, and making any necessary repairs or upgrades to your home. By taking the time to plan and prepare, you can ensure that you sell your home quickly and for top dollar. In this article, we will explore the importance of an exit strategy and how to prepare for it.
A real estate exit strategy is a plan for selling a property, whether it be a single-family home, a rental property, or a commercial property. 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.
Here are a few examples of real estate exit strategies:
- 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 an 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 to 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 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 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 the better property is occurring. An investor can use an IRS Rule 1031 Exchange to defer the tax 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 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 can I 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.”