Anyone investing in real estate needs an exit strategy for that investment. The exit strategy drives the type of loan needed as well as the budget for repairs and additional expenses. Investors need to determine if this is a property they want to hold to generate rental income or flip quickly for a fast profit.
What is an Exit Strategy in Real Estate? Why Do Investors Need One?
A real estate exit strategy is simply how an investor plans to get out of an investment property, pay off the property’s loan, and generate a return on that initial investment. With the right exit strategy in mind and proper execution of that strategy, the investor should be able to maximize profits or at least minimize any losses.
Investors should think of the exit strategy as the goal line they wish to reach. Every step in the purchase and rehab process is a step towards that goal line. The exit strategy should guide all the decisions the investor makes throughout the process.
The exit strategy also reflects the amount of risk the investor is willing to take. Some exit strategies are riskier than others. Some strategies generate potentially large profits if everything goes right. Other strategies generate smaller profits in the short term but more reliable profits over time. Choosing the right exit strategy for a given investment property is essential to the success of the project.
Top 3 Exit Strategies for Unfinished Properties
There are several ways to make money from real estate investments. With flip projects, the exit strategy typically involves selling the property – although there are many ways to do that. Here are the three most popular exit strategies for unfinished real estate properties.
1. Fix and Flip
A flip project involves buying a property with the intent purpose of selling it for a profit. Many such properties need some sort of repairs or renovations before the sale can be consummated; thus, the term “fix and flip” to describe the entire process.
The fix and flip strategy is the most popular exit strategy for real estate investors. According to CoreLogic, flipping accounts for more than 10% of all home sales in the U.S.
The fix and flip exit strategy starts by purchasing a property that needs rehab, ideally below market value. The buyer then completes the necessary repairs and sells the renovated home for a profit. This enables the investor to repay the loan and move on to the next property to buy and flip.
This strategy typically produces the highest profit margins – the selling price less the purchase price plus the cost of repairs. It does require work on the part of the buyer – either doing the rehab personally (saves costs) or paying for contractors (reduces potential profits).
Fix and flip properties are typically financed with short-term hard money loans. The faster the property is resold, the faster the loan can be repaid, and the profits realized.
2. Buy and Hold
The buy and hold strategy changes the end game of the fix and flip model. The goal with this strategy is not to sell the property after rehab, but to hold onto it and generate revenue from leasing.
As with the fix and flip strategy, buy and hold starts with the purchase of a property that needs fixing up, hopefully at less than market value. The buyer rehabs the property and then, instead of selling it, opens it to the rental market. The investor receives monthly cash flow in the form of rental income, ideally more than enough to make the monthly loan payments. If the property is held long enough, the rental income will pay for itself and generate an ongoing passive income for the investors. Equity continues to build over time, and if and when the owner decides to sell the property, more profit ensues.
Buy and hold properties are often financed with hard money on the front side, and then refinanced through the use of conventional mortgages or non qualified mortgages, also known as non-QM Loans. This process is usually a two step process, and its always good to make sure that the buyer has take-out financing in place before the hard money loan closes.
3. Wholesale to Another Investor
This wholesale strategy is much like the fix and flip strategy, except instead of selling the rehabbed property to a traditional homeowner, the investor sells it to another real estate investor, but at a higher price.
The key to this strategy, as with the fix and flip strategy, is to find an undervalued or distressed property that needs repairs. The buyer makes the repairs and then sells the property wholesale for a small profit.
Wholesale properties can be financed a number of ways including short-term hard money loans. The property may also be purchased under contract; the original buyer then assigns the contract to the new buyer upon purchase.
What is a Good Exit Strategy for Real Estate Investors?
What exit strategy should a real estate investor embrace for a given property? It all depends on the investor’s goals and risk tolerance. Investors should consider the following factors.
Investors need to determine how long they wish to hold the investment property. Does the investor expect to hold the property for an extended period of time, or do they want to get in and out quickly? Is the investor willing to sell the property for a lower profit or even a loss to meet a specific exit date?
Investors need to determine how liquid they need to be. Do they have an upcoming obligation or opportunity for which they need the cash from this investment? Do they have funds on hand to cover any unanticipated expenses for this investment?
Investors should consider what types of returns they expect. Do they want a quick return on their investment, or do they prefer a longer tail of returns? How aggressive is the cash flow they desire? Do they need a certain ROI, or will they be satisfied with something lower? According to ATTOM Data Solutions’ Home Flipping Report, the average home flipping project has an ROI of 39.9%. Is the investor’s desired ROI realistic compared to this?
Investors should determine how their strategy is affected by the type of financing arranged. When does the debt mature? Can the maturity date be extended if necessary? What are the monthly payments – and how does the investor intend to cover those payments?
Creating a Business Plan for a Real Estate Exit Strategy
After determining the desired exit strategy, investors need to plan on how to execute that strategy. This exit strategy business plan should be a step-by-step guide for navigating through the entire process.
A typical exit strategy plan involves the following steps:
- Find investment property. Look for a property that is currently undervalued but has resale potential.
- Calculate the cost of rehab. Determine how much renovation is needed to achieve the desired rental or sale price. Calculate the cost of repairs or how much of an investor’s own labor is necessary.
- Set ROI goals. Determine a target ROI and how fast the investor wants that return.
- Determine the exit time frame. Decide whether this is a short-term flip or a potential rental property.
- Choose the financing type. Based on the exit time frame, determine the best type of financing. Longer exit times can be financed with conventional loans or potentially the combination of hard money loans at the first part of transaction and then conventional financing as the second step. Shorter time frames can utilize short-term hard money loans.
- Set the exit strategy. Taking all the previous factors into account, determine the desired exit strategy.
Execute Your Exit Strategy Business Plan
With the exit strategy set, investors should now execute the necessary action items – arranging the loan, purchasing the property, performing necessary renovations, and so forth. The goal should always be to exit in the desired fashion in the predetermined time frame.To learn more about hard money loans for flip projects, contact Longhorn Investments today.