As a private money lender, my underwriting team (my wife) must sift through dozens of applications weekly. As our loans are mostly repaid from a resale or refinance of the property, one important check mark needed on all applications is a valid exit strategy. For the strategy to be valid we place ourselves in the borrower’s shoes, with their capacity, character and capital and walk through the process, in the current market (as that’s the best predictor we have for the next few months), and see if we could duplicate the flip or refinance.
If their stated plan A appears to work, that’s great, how about their plan B? That needs to work also. As investors, it’s critical that we have planned an exit strategy and contingency plans in case our plan A doesn’t go as planned. There are a plethora of unforeseen circumstances that can happen during the investment that will drive up costs, extend time frames and potentially eliminate the feasibility of plan A. Therefore, we always require a contingency plan B. But, you don’t have to stop there, the repeat borrowers we work with frequently have three exit strategies.
Planning your exit strategies isn’t just needed for getting a loan or selling a property but having plans for negotiating with sellers and buyers can also affect how you may pursue each of your exit strategies. Negotiating without a plan, just shooting from the hip, can lead to disaster as you may be giving away your best hand and there’s validity to the argument “you make your money when you buy”. Planning can not only save your current deal thousands but, perhaps, save you millions over the course of your entrepreneurial career!
“A goal without a plan is just a wish.”
― Antoine de Saint-Exupéry
As a real estate investor, you have quite a few exit strategies:
Sell the Investment. The granddaddy of real estate exit strategies is the fix & flip where you purchase a below-market property with a value add component to it. Before you even entered the investment though, you planned for predictable expenses and came up with your breakeven amount needed. You then efficiently (cost and time-wise) rehab and resell the property, often to a retail buyer, for an attractive profit. Duplicating this process correctly a few times can add massive income chunks to your investment business.
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Cash Out Refi – Long-Term Hold & Appreciate. The second option we like is cash out refinancing your loan via a conventional lender which allows you to hold the property for positive cash flow and appreciation. If you own the property in cash then there is no need to do the cash out refi.
Long term holding of your asset may not add huge chunks of cash, immediately, to your pocket but this builds wealth over time. If you buy a property and then rent it out you may be able to create positive cash flow, when factoring in all your property’s expenses. In addition to that extra cash flow, you now have an asset that will build equity. In the future, you could either cash out by selling all your properties and profiting from equity gains or you can continue to build it alongside your other passive income rentals.
Lease Option. You can do a lease option as well. The property can most likely still be leveraged with another loan in this scenario but you would need to make sure your rental income meets or exceeds your debt service. Check to see if your mortgage allows this–most private lenders would not allow this as a balloon would probably be due before the lease was up or the option was exercised.
I would suggest not combining the lease and option like some do. You want to have a lease so you can evict if necessary and a separate option agreement which gives them the option to purchase at your agreed upon terms. Though, an attorney may be needed to legally delineate the specifics such as purchase price, option fee, percentage of rent going toward purchase and time frame of option.
Wholesale. Typically reserved for properties you don’t fully own, rehab or finance, is the wholesale exit strategy. You may not own the property but you have negotiated an assignable contract which gives you, or your assignee, the right to purchase the property within a certain time frame for a specified price (usually under market value). You find a buyer willing to pay that specified price plus your assignment fee. You can close this in a few ways but your result should be a win/win/win situation for your seller, your buyer and, of course, yourself.
Seller Financing. You can always seller finance your investment property, yet the property may need to be owned in full before you could do that because your title would be clouded. Also, any title transfer may trigger the due on sale clause in your mortgage. I would also recommend doing seller financing paperwork through an attorney due to Dodd Frank regulations which govern that type of transaction.
Raise money from partners and investors. You can get money from investors or partners to pay off your investment property’s debt and get more time for other exit strategies. Before you do this, please check federal, state and local laws before you start soliciting for money from investors. The SEC dislikes when you do not have the proper instruments drawn up for solicitations. In either case, I would target accredited investors as they have more funds available for investment, are typically more savvy with their investment decisions and can stand to lose a few dollars more than the average non-accredited investor. The aforementioned is definitely in a security specialized attorney’s domain as they can draw up the legal offering documents necessary for your investment you wish to solicit.
That being said, instead of immediately seeking out passive investors you can also seek out active partners, who can not only provide you with cash, but help on some areas of decision-making that you may have been struggling with.
Nuclear Option. Talk to your lender. If you need to exit quick and your other exit strategies are not working out, what do you have to lose? You never know, they may want to partner with you, extend, or modify your loan to fit your unique situation.
There are plenty of options available for the lender to assist you with. However, I’ve noticed the correlation of how big the bank is to how little they are willing to assist the borrower. Yet, if you succeed you could get a forbearance and pay a bit later, lower your payments for a certain amount of time or modify your mortgage. Lastly, if the property has very little equity, the lender may consider a short sale, which they will NOT like but may need to do.
Pro Tip: Pay on time and communicate. As a lender, I know I’m more willing to listen if you haven’t missed any payments yet and have communicated effectively throughout the loan process thus far.
Before you enter into an investment, try to come up with your exit strategy. Here are a few questions which may help you decide on exit strategies for current and future investments:
- What are your goals? Do you want to build wealth or a larger amount of income right now with long-term appreciation?
- What is your knowledge and experience in the various exit strategies?
- What is the time frame you need to exit by? Time is money and you can run out of both.
- What is your negotiation strategy with your buyers and tenants?
- What profit, future rents or appreciation are you predicting on the deal?
- To whom will you market this exit strategy to, what kind of buyer? How will you market the exit strategy? Don’t rely “only” on the MLS. What are the current sale and rental market conditions like? How are supply and demand in your market?
- One question often neglected is how will the exit strategy affect your taxes? Capital gains? If you don’t know I would suggest you question your CPA.
Knowing most of these can help you decide on an exit strategy that’s correct for your investment and your business’ needs. Nevertheless, if you don’t know the answer to a lot of these you may want to take some time, gather more information on your investment, and attend a few local REIAs to network with like-minded individuals to get more perspective.
TL;DR ~ Make sure you have multiple exit strategies.