Whenever you consider buying an apartment in need of major repairs, a key element is a thorough business plan that includes your exit strategy. Your exit strategy is just as important as the reasons to buy.
In the current economic climate, the future is relatively uncertain. An uncertain future is the premise of risk. Having a sound and well-thought-out exit strategy helps you prepare if any of these risks come to light.
The first step towards a concrete exit strategy is to have a sound plan for your investment. You can refer to our previous checklist, which highlights 40 questions that you should answer before buying a multifamily property. In this post, we dig deeper into the specifics for having a well-planned exit strategy, beginning with this checklist:
Exit Strategy Checklist
- How much money will I need to fix it?
- How much value will that create?
- Will I sell it after I’m done?
- How much would my potential buyer pay?
- If I don’t plan to sell, will I refinance it?
- What are other options for this property if I have trouble leasing it?
Why are these important?
Going through this checklist and understanding your exit strategy early on is crucial. Your options may be limited if you don’t plan accordingly. Here is an overview of the most common exit strategies:
This strategy is to rehab, re-tenant, and subsequently sell (also colloquially called a “flip”) the property to the next investor. Consider your IRR and cash-on-cash return for this strategy. Speed is crucial for yielding a higher internal rate of return, but it’s more important to understand how much cash you will get back relative to the amount you invest. Be sure to check out this quick refresher on IRR and cash-on-cash metrics.
Refer to the questions asked at the beginning of this blog because “adding value” may be easier said than done. You must consider how much your rehab to the building will translate to the actual value.
Also, consider a 1031 tax-deferred exchange to avoid capital gains when you sell. This strategy is great for maintaining and generating wealth.
Holding for cash flow rather than a value-add flip is also an equally viable strategy. A strong team (i.e. property manager, accountant, lawyers, etc.) is advised here. While it depends greatly on the property type, managing CRE for a long-term hold will require a more hands-on approach in the beginning to set up the team and operational processes.
There are many things to consider for a successful exit, one being the location of the property. Figuring out an exit strategy also means considering how location demographics will change over time. For example, I recently traveled to Austin, Texas, and it’s amazing to see how much it has changed since I last visited five years ago. There is a new tech workforce that has helped lead to increased CRE development in the region.
Here are just a few things you may want to consider for a long-term hold:
- Changing regulatory environment
- Environmental concerns
- Demographic changes
- Access to schools and school ratings
- Proximity to transit
Refinance and Hold
Consider refinancing (and potentially cashing out) if your property’s value has increased and you’re approaching loan maturity. With this extra cash, you’ll be able to invest in other properties or potentially increase the value of the current property even more.
There are various types of exit strategies depending on your business plan. Having a plan in place is imperative but also being flexible to changing market conditions is key.
Special thanks to Hector Gomez for contributing to this post.
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