Which Exit Strategy is Right for Your Real Estate Investments?
Residential real estate investing has increased in popularity over the past few decades – in fact, close to 20% of U.S. homes1 were purchased by investors in 2021. If you were to ask a real estate investor why they got into the business, chances are they'll answer that their primary goal of purchasing investment properties is to achieve financial freedom. However, to be truly successful in real estate investing, before purchasing a property, an efficient business plan should be established that includes a researched, tried and tested exit strategy that aligns with your goals. Determining your real estate exit strategy will help you maximize the total return on your investment (ROI) when that time comes.
Here's what you need to know about the various exit strategies, including what they are, what options to consider, and how to evaluate risks.
What Is a Real Estate Exit Strategy?
Simply put, a real estate exit strategy represents the investor's plan to remove themselves from a deal. To maximize possibilities and minimize risk, having an educated plan – how to move forward, when to move forward, who to include, and how to manage the process, among others – is a must.
Real estate exit strategies come in a few different forms and functions, providing investors with many options to consider and helping to prevent them from settling for a less-than-ideal way forward. Making the right choices can streamline the process, reduce risks, and improve the odds of desirable profits. However, there can be a downside to having too many options, particularly for investors who aren't educated in the options or are new to the real estate space.
Considerations in Choosing an Exit Strategy
So, you know you need to choose an exit strategy, but for those new to real estate investing, that brings a fundamental question to light: how do I do that?
There are a few different things to keep in mind when choosing your exit strategy. These include:
Experience level
Consider your own experience in real estate, as well as the connections you have and the resources you can leverage. Some exit strategies are more complicated than others, and the last thing you want is to discover you're in over your head when it's too late to pivot.
Purchase price, condition, location, and property value
How you move ahead will always depend on what you've already invested, the particulars of a location, and the value of your assets. Always keep in mind what you paid for the property and what its true worth is now, as well as the property's condition and location. Things like upgraded amenities and a desirable neighborhood can expand your options, while the opposite can limit the choices you have available.
Market conditions
Not all exit strategies will be a viable option in the current market; some may be a better consideration in the future. If, for example, the rental market isn't strong in your area, fixing and flipping may be a better approach.
Financing options
If part of your exit strategy includes obtaining rental property loans or bridge loans, knowing your available financing options and finding a solid lending partner are a must.
Supply and demand
How many other properties are out there like yours? Is high demand driving up rates in your area, or will you be facing headwinds as a unicorn property? Understanding supply and demand can help guide your hand in the selection process.
Above all else, however, should be your financial objectives. What do you want to achieve in exiting a real estate investment opportunity? What kind of yields do you want to see, and what responsibilities do you want to be left with when the process is complete? What level of involvement do you want to maintain in previous investment activities, if any?
Your own preferences, tolerances, and needs may occasionally outweigh financial gains. While it's best to let market knowledge and education drive your decision-making, your future investment plans should carry significant weight.
Common Real Estate Exit Strategies
There are plenty of exit strategies, some more popular than others. Determining an appropriate real estate exit strategy will provide you with a plan of action and minimize forthcoming risks. Here are some of the most common and accessible options for investors seeking exit strategies.
Fix and Flip
Fix-and-flip is an excellent way to use a property to turn a profit in a short amount of time. Under this method, you'd look for undervalued properties that you can then repair and update. Key areas to improve, like renovating kitchens, adjusting to a more open floor plan, and updating bathrooms, can help you command a higher price when you go to sell the property. The recent pandemic has driven home prices up – 13.7% in 20212 – but it's important to note that some markets are better than others for this option. From January to April 2021, home flipping was up 23%, so there's clearly demand, but be sure your area can sustain steadily increasing prices.
Buy and Hold
For those who want to take advantage of both home price appreciation as well as make a passive income, buying and holding the property as a rental may be the best option. Under this method, investors hold on to an existing property and rent it out to tenants. Rental investing is rising in popularity, in part due to high purchase prices many younger buyers can't afford but also due to the temporary nature of rental housing. The pandemic highlighted just how uncertain life can be, which has made some potential homebuyers hesitate to commit. The numbers support this as well; rental properties last year were up 6%3 – the highest growth rate in the last several decades.
In evaluating this strategy, confirm that your area isn't already oversaturated with rentals. In addition, take stock of current pricing trends. If you would need rents far above the average in your market to keep the lights on, you may not have an appealing property. This is especially true if you require a rental loan to bring your property to the market.
BRRRR
BRRRR, which stands for Buy, Rehab, Rent, Refinance, Repeat, is a hybrid approach that combines flipping, renting, and holding. Effectively, an investor starts by buying a distressed property, rehabs the home to bring it up to current standards, and rents it out to generate steady income. Then, once the property is up to par and investments have been recouped, the investor takes a cash-out refinance loan on the property to transform equity into cash. This cash can then be used to purchase a new property, thus restarting the cycle.
The logistics can be a little complicated and require a higher risk tolerance, but this can be a highly profitable route for those willing to learn from the experts and stretch themselves. This strategy involves buying the right property from the start and committing to a long-term investing goal. If you simply want to flip a home and move on or focus on a single rental property, this may not be the right path. However, this is a great road to building a rental portfolio with little funds to start with.
Want to learn more about the BRRRR method? Check out Kiavi’s new eBook, Breaking Down BRRRR. In it, we deep dive into the strategy and walk you through the financing of BRRRR and illustrate the cash-on-cash return of BRRRR vs. turnkey. Get the eBook
Wholesaling
Wholesaling is one of the most accessible exit strategies. It's not necessarily a recipe for the highest possible profits but is often used to build up initial funds to take on larger investment strategies. In wholesaling, a real estate investor will contract a property, generally a distressed one in need of repairs. Then, in turn, contract it to another investor or seller who will then search for buyers. This investment strategy aims to sell the home before the contract with the original property owner closes for a small portion of the proceeds. Success in this space can take significant patience and effort but does offer great potential.
Researching Exit Strategies
As with many things in real estate, most research will be centered around the state of the market. This means evaluating trends both nationally and in your local area, looking at patterns within the real estate market, like pricing and buyer demands, and estimating changes in both the short-term and long-term economy.
As renting out property can be considered an exit strategy, evaluating tenant laws and the current rental market may also be an area to explore. Even if you don't think renting is the right choice for you, it's best to be aware of all facets of the industry. After all, it's not uncommon to discover that opportunities previously overlooked are a wise decision in the end.
Financing is another area in which to research. If you need additional funding, like rental loans or bridge (fix and flip) loans, it's essential to know your options and qualifications.
Risks in Selecting a Real Estate Exit Strategy
Of course, the most significant risks in any investment option are financial. The risk of losing money may be an investor's worst nightmare, but it can and does happen – both to investors who make the wrong choices and investors who find themselves in an inopportune position. Financial damage can come in a few different forms, however.
First, a sale may simply fail to turn a profit, which effectively means you spent more to purchase and rehab the property than you were able to generate in a sale or via rental income. This can also apply to expensive financing you're now stuck with. If, for example, you took out a rental property loan with less than ideal terms or that wasn't necessary, you may find yourself with steep monthly payments that exceed any amount of profit generated.
Find Success as a Residential Real Estate Investor
As with all things in the real estate investment world, due diligence, risk tolerance, and education play a steep role in success. Whether you choose to hold a home and rent it out, fix and flip, or implement the BRRRR method, there's a right exit strategy for every investment property. Pick the perfect avenue, and big profits are in your future.