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Use Exit Strategies to Reach Your Investing Goals
By Joseph A. Roche
One of the best pieces of advice I was given early on as a real estate investor was to train myself to ask myself four questions of every deal:
o What is the ideal outcome?
o What is the likely outcome?
o What is the worst that can happen?
o Can I live with that?
To answer these questions, it helps to have an exit strategy. Not to be confused with an escape clause, an "exit strategy" is a simply the name for determining what you'll do with a property once you purchase it.
Before you purchase a property, you want to map out the exit strategies available to you for two reasons: One, you've anticipated potential opportunities and problems and how you'll deal with them; Two, you're better able to maximize profits since you're less likely to lose money should the worst happen.
* Next 37 17 investors only!
The various exit strategies can be placed on a time continuum (see the chart below) from short-term to long-term. Which exit strategy you use depends on your real estate investing goals and whether you're trying to build cash reserves or passive income.
The six most common exit strategies
- Wholesaling - You may have heard the terms "bird dog" or "wholesaler." Bird dogs are people who find deals and then earn a fee by bringing the deal to an investor. Wholesalers actually negotiate and get properties under contract. They then "flip the paper" or sell the contract to another investor because they may not have the necessary finances to close the deal, don't want to do the fix-up, or need quick cash for another deal.
I had a great deal come across the table last fall - a fantastic deal on a condo in Brockton - but I didn't want to add this property to my portfolio. Instead of closing on the deal, I sent an email to the 500 people on my investor list (which is another excellent reason for networking), then got on the phone and spent four hours calling every single person on that list. Two people were seriously interested and by the next day, I had assigned (sold) the contract. That next week, I had a number of people call about the deal, but it was too late.
- Property Listing - You can also take the property and simply list it for sale. It may be in as-is condition or with minimal clean up. Property can be listed on the MLS with a realtor or you can try to sell it yourself (for sale by owner or FSBO).
- Buy, Fix, and Sell (flip) - This is the most common exit strategy and the one where you get the largest amount of cash in the shortest amount of time. Basically, you buy the property, rehab it, and then sell it. In this market, however, you had better price it right or you can be sitting on it for six or more months (which means negative cash flow - the ultimate evil). This strategy also entails a lot more risk (thus the higher reward) - because sometimes, you never know what you'll find behind that wall.
- Lease Option - This is my favorite strategy. It sounds complicated, but it's not. You acquire a property, fix it up, and then put in a tenant-buyer. The beauty of this strategy is that you get the monthly positive cash flow for the term specified in the contract (usually one year), your property appreciates while someone lives in it, you can sell closer to market value, and you don't have to pay short term capital gains taxes.
The tenant has given you a deposit, which is used as their option to buy so no one else can buy the property during the option term. At the end of the term, the deposit is subtracted from the purchase price of the property so that the buyer doesn't need 100% financing.
When using this option, you have to ensure potential buyers can afford to buy the property - usually these people have some sort of credit problem they're trying to fix. A lease option gives them the time they need, and it helps get them into a house they otherwise couldn't purchase.
Again, having multiple exit strategies is key. What will you do if your tenant-buyer ends up not buying the property? Your options include finding another tenant-buyer, renting long term, or selling the property.
- Notes - When you do sell a property, you can always act as the bank. That is, you can hold the note and the mortgage and earn the interest on the note. Again, be careful. You don't want to go through the hassle of foreclosing on the buyer.
- Holding and Renting - If you want to build true wealth, buying and holding long-term is the way to go. Why? Because renters send you money every month - money you can use to pay your mortgage and property expenses, all while the property appreciates. Assuming you bought the property right (that is, like an investor - well under market value), you can refinance the property and use the equity you pull out to invest in another property.
In conclusion, real estate is a numbers game and yes, you do have to understand finance. Don't make the mistake of thinking you have to know everything before you get started (because then you'll never make that first deal) - instead, learn as you go, be proactive about learning, and be out there taking action. Know your options up front and build your system.
Once you have a system, you'll start to see the big picture, eliminate or reduce your fear, and learn how to handle circumstances as they arrive. You'll also make real money - which is the whole point of real estate investing.
Joseph A. Roche is an active real estate investor and President of East Coast Investment Solutions, a full service real estate firm located in Braintree, MA. He can be reached by phone at 781-789-7308 or via his website at www.ecishomes.com.
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