As an investor, you should always plan your real estate exit strategy before buying your first property. Planning ahead can lead to greater profits because you’re setting goals with the end in mind and working toward your desired outcome. It also helps you avoid costly mistakes and time when you’re ready to move on. There are many real estate exit strategies like leasing or a 1031 exchange, but you need to decide which is the best strategy for your business.
Choose the right strategy by evaluating your short- and long-term goals and aligning them with your exit plan. Read along as we guide you through what an exit plan is and why it’s important, provide exit plan strategies and when to use them, and give you key mistakes to avoid in your planning.
What Is a Real Estate Investing Exit Strategy?
A real estate investing exit strategy is a predetermined plan of how you will exit your real estate investing business. It is written into a strategic business plan before investing. Starting with the objective in mind, your strategy serves as a roadmap emphasizing short- and long-term profitability and a return on investment (ROI). It also helps build a portfolio of rental properties that create income if that is your objective.
Your real estate business plan, which includes an exit strategy, establishes a road map and the actions you must take. It’s critical because it gives you a timetable and will keep you on the course when it’s time to sell.
Finding investors for your real estate holdings doesn’t have to be difficult. Roofstock, a leading platform for buying and selling investment properties, lets you list your rentals with or without tenants in place. It also provides qualified property managers, so you can be hands-off while you’re focusing on your investment property exit strategy.
Why Is Having an Exit Strategy Important?
Real estate exit strategies are essential because they guide investors toward their goals while remaining profitable and provide a framework for exiting. For example, if the goal is to build wealth and retire early, the exit strategy in real estate would include the retirement date and the steps investors must take from the start of investing in real estate that leads to the retirement goal.
Real estate exit strategies are also vital because they reduce risk, maximize profits, and limit losses, but they should remain flexible. For example, if the goal is to retire in 10 years and the real estate market is in decline leading up to year 10, a flexible exit strategy would allow the investor to either wait for the market to rebound or find another way out, like using a lease option or offering seller financing.
7 Real Estate Exit Strategies for Investors & When to Use Them
Depending on your goals, you can use one exit strategy or employ multiple strategies throughout your investing lifetime. For example, if you’re a fix-and-flip investor, you can have an exit strategy for each property you rehab and flip and an overarching plan for retirement. If you use a 1031 exchange, you can create a plan for perpetual reinvestment until you retire. However many strategies you use, the end game is to stop investing at some point in time.
To better your understanding, here are types of exits to consider as you make your plan and when to employ them to capitalize on profit:
1. Seller Financing
Who seller financing is best for: Investors who want to earn interest income
Seller financing is when a property owner acts as a lender to a buyer. Seller financing can cover the entire purchase price minus the down payment or act as a secondary lien on the property when a buyer gets a primary mortgage for a portion of the purchase price. Being a first or primary lien holder is always the better position because, in the event of a foreclosure, the primary lienholder is paid first.
Instead of giving the buyer cash, the seller extends credit to the buyer for the purchase amount minus the down payment. The buyer makes mortgage payments to the seller with interest. The buyer and seller negotiate the interest rate and terms. Sellers can charge a higher interest rate since buyers seeking seller financing typically have been denied by lenders.
A seller might give a buyer a 10-year loan amortized over 30 years with a balloon payment at the end of the 10th year, where the buyer pays off the balance. If current mortgage rates are 5%, a seller may charge 6.5%. A credit and background check should also be done, as a lender would do. With seller financing, sellers assume the risk and must foreclose to recover the property if a buyer defaults on payments.
When to use seller financing for an exit: Use the seller financing exit strategy when you no longer want to manage rental property and want to earn interest income for a period. Seller financing works best when you no longer have a mortgage or substantial property equity.
2. Lease Option & Rent-to-own
Who a lease option and rent-to-own is best for: Investors who plan to sell within three years
A lease option is when an investor rents the property to a tenant for an agreed-upon time period until the investor is ready to sell. This could be one to five years. When the owner is ready to sell, the tenant is given a “right of first refusal,” meaning the tenant has the option to purchase the property before it is opened to other buyers. The lease option agreement includes the purchase price and terms and is executed at the beginning of the lease period.
The difference with rent-to-own is the seller deducts all or a portion of the rent from the agreed purchase price, so when it is time for the tenant to buy the property, the tenant is credited the rental amount paid to date. There is no right of first refusal, the tenant is the buyer, and it is not opened to other buyers (unless there is a clause in the purchase agreement). In a lease option, rent payments can be counted toward the purchase price, but it is not always the case.
When to use a lease option and rent-to-own for an exit: A lease option and rent-to-own is a good plan for selling within one to three years while collecting rental income. You may give a lease option to an existing tenant who needs time to save a down payment or to a prospective buyer who plans to buy the property within a few years.
If you’re looking for a rent-to-own opportunity, check out Foreclosure.com. You can search by city or state, and it includes tips and steps when looking for a rent-to-own property. Foreclosure.com also curates an up-to-date directory of preforeclosures, foreclosures, short sales, bankruptcies, and properties sold “as-is,” if you’re in search of a new investment property.
3. Real Estate Wholesaling
Who real estate wholesaling is best for: Investors who don’t want to do repairs or want a quick sale
Wholesaling is an investment strategy where an investor finds a property well below market value to sell to another investor at a (slightly) higher price. In traditional wholesaling, the investor doesn’t take possession of the property. Instead, they flip the title to another investor or new owner. Wholesaling is illegal in some states, so check your state’s laws.
Another way to wholesale property is to sell it below market value to another investor or buyer. This strategy works if you need to exit quickly, but it is best used as an exit strategy for sellers with distressed properties with some equity in them. Keep the price below market value to entice buyers. Investors whose properties aren’t in distress, but have deferred maintenance, are also good candidates to sell at wholesale without making repairs.
Do your market research to ensure you can still profit, and you’re not pricing too low. How deep you cut the price depends on how fast you need to exit.
When to use real estate wholesaling for an exit: If your property needs repairs and you don’t have the resources to fix it up, selling at a reduced price can get you out of the property quickly without sinking more money into it.
Who liquidation is best for: Buy-and-hold investors whose properties have increased in value over time and fix-and-flip investors who have timed their purchase, rehab, and sale for maximum profit
Selling your rental properties may seem like a simplistic exit strategy for real estate. It’s another common way to exit real estate investing by listing the investment properties on the market and selling them to the highest bidder with the best terms. The key to making this a profitable strategy is timing.
Investors also want to consider if they’ve built a business that can be sold. If you’ve built something substantial, you can sell your entire investment practice. Some investors also start property management companies and manage other people’s rental properties in addition to their own, or they start a real estate brokerage. There’s opportunity in each.
While a real estate comparative market analysis (CMA) can determine selling prices for rental properties, a business needs to be evaluated differently to determine its value, and is best done by a professional. A business valuation specialist weighs a company’s assets, market competitiveness, and the financial contribution of investors when determining the business value. Since taxes directly impact profit, valuers must also estimate the company’s tax burden.
When to use liquidation for an exit: Selling the entire portfolio as a single entity, or unloading individual properties, is a solid exit strategy to use when you’ve substantially increased the value of the assets.
When you’re ready to sell your investment properties, list them on syndicated sites like Zillow to get them in front of as many eyes as possible. Whether you’re a seller with a real estate agent or a for sale by owner (FSBO), Zillow makes it easy to market your home on its platform. If you’re an agent, Zillow Premier Agent actively advertises your listing in front of buyers with potential.
5. Estate & Succession Planning
Who estate and succession planning is best for: Buy-and-hold and fix-and-flip investors with good timing
Succession planning is when an investor passes their real estate investing business on to future generations to continue growing and managing the business. Estate planning leaves all the assets in the investor’s estate to heirs, including any ownership interests in their real estate investing businesses, whether alone or with partners.
Investors often hope adult children or family members will take over the property, but this isn’t always the case. In more recent years, children have chosen other career paths, or investors may have no heirs. Sometimes partners or key employees will become the new owners, or the business is purchased by new investors. The main focus should be on what is in the best interest of the business.
Investors need to talk with the next generation when creating their exit strategies about succession and estate plans if they choose this strategy to ensure the next generation wants to carry on the business. Many businesses close because future generations have chosen other career paths and don’t want to run the family business. If heirs don’t want to run the business, the investor would then create an estate plan exit strategy so heirs can liquidate assets and sell any business interests.
When to use estate and succession planning for an exit: This strategy goes into effect when you pass or at your chosen retirement date.
6. Exiting a Partnership
Who exiting a partnership is best for: Real estate investment partners
Real estate investment partnerships are often created between partners who each bring different skills and resources to the business. For example, one investor may have cash and little time to work on the business, and the other may have more time or the skills of a general contractor and plan to invest sweat equity. Other partnerships develop because of the size or structure of the deal, and more hands are needed in the business.
Before investing in property together, investors must create an LLC operating agreement or other partnership agreement that includes exit strategy planning. The partnership agreement must include what will happen if one partner wants to exit sooner than others or if a partner passes away, who will inherit their share of the business.
A partnership agreement needs to be reviewed by an attorney to ensure all parties understand and agree with how the business will operate during its lifetime, including how partners will exit. When investors enter a partnership without a written legal agreement, it can create an exit strategy nightmare, so getting appropriate legal counsel cannot be understated.
When to use exiting a partnership for an exit: If you have partial ownership in a real estate investing business and portfolio, how and when partners plan to exit and what happens to their shares must be decided ahead of time and written into the partnership agreement. You should also have a written backup plan if some unforeseen occurrence happens before the exit date.
7. IRS 1031 Exchange
Who IRS 1031 exchange is best for: Investors who reinvest and avoid some taxes
Internal Revenue Service (IRS) code Section 1031 exchange (1031e) allows investors to use profits from the sale of investment property and reinvest it in another investment property, avoiding paying capital gains and depreciation recapture taxes on the profits from the sale. The government created this tax code to encourage investment in real estate.
Investors can sell their rental properties and reinvest profits in other investment properties and only pay taxes once they sell and take the profits out. It requires investors to hold the property for at least 12 months, so this is not a strategy for fix-and-flip investors who rehab and sell properties in less than a year.
The property has to be “like-kind,” meaning it has to be another investment property. An investor can sell a residential rental property and purchase commercial real estate using a 1031 exchange, but they cannot buy a primary residence. A 1031 exchange is an excellent real estate exit strategy for buy-and-hold investors who want to build wealth over time, create a succession plan, or leave a legacy to heirs.
When to use IRS 1031 Exchange for an exit: Selling a property and moving the money into another investment property without paying capital gains.
Helpful Tips About 1031 Exchange for Investors
A 1031 exchange allows investors to avoid paying capital gains tax on the sale of investment property when they reinvest the profits. If an investor doesn’t want to use section 1031e, they need to plan their residential or commercial exit strategy for paying a capital gains tax on any profits earned from the sale. How much capital gains tax an investor will pay is based on their income tax bracket.
Each year you file your taxes, the IRS allows you to take a depreciation deduction on your investment property. Rental property depreciation is calculated using a “useful life” of 27.5 years for residential and 39 years for commercial investment properties.
If you sell the property, the IRS may assess a depreciation recapture tax, which gets reported in your tax filing as ordinary income. When the sale price of your investment property exceeds the purchase price minus the accumulated depreciation, you may be assessed the depreciation recapture fee. You can avoid depreciation recapture by doing a 1031 exchange.
For more in-depth information, read about it from our financing experts in the article What Is a Section 1031 Exchange, and How Does It Work?
Choose a Strategy & Plan Your Exit
In addition to the exit strategy you choose, you need to decide when you want to employ your exit strategy. Consider the short- and long-term goals that you have for your business and include them when writing your initial business plan. For example, a succession planning exit strategy requires a successor to your business and activates when you retire from real estate investing or after death.
Your investing goals will help determine which real estate exit strategy is right for you. A fix-and-flip investor needs an exit strategy for each property and an exit strategy for the real estate investing business as a whole. Buy-and-hold investors developing their long-range exit strategy need to consider how many properties they intend to buy and decide how long they plan to hold each property.
The most important aspect of determining which exit strategy is right for you is to begin with the end in mind, review your goals periodically, and adjust as needed.
Some questions to consider while planning your exit strategy include:
- Have you developed your timeline for leaving real estate investing? If so, when will you exit, and what steps must you take?
- If you’re succession planning, have you identified and spoken with someone who will replace you? Do they need training or other development?
- When you’re ready to implement your exit strategy, do you plan to transition quickly or slowly?
- Do you have a backup plan? Have you decided what’s next after leaving your real estate investing company?
- What knowledge and resources do you need today to help you reach your goals?
Which Real Estate Exit Strategy Is Right for You?
This quiz is for entertainment and should not be considered legal or financial advice. Please consult with your legal and financial advisers.
After you’ve decided on your exit strategy, include it in your business plan. Review your goals and the various residential and commercial real estate exit strategies covered, and write the steps of your business or a strategic plan with the exit strategy as the outcome. Starting your business plan with the end in mind will keep you on track.
However, you must remain flexible since the future is not guaranteed. Real estate markets shift. Businesses fail. Staying flexible will help you prepare for all potential outcomes.
Take a look through How to Write a Real Estate Investment Business Plan (+ Free Template), where we break down the steps to writing a business plan for your investing business.
Real Estate Exit Strategy Mistakes to Avoid
The most common mistake in developing a real estate exit strategy is not having one in the first place. Some investors think it is unnecessary since the future real estate market can’t be predicted now, and they can’t guarantee their real estate investing activities will be a success. However, having a clearly defined exit strategy is critical for success. Creating a goal-driven exit strategy will result in maximized profits.
Here are five real estate investment exit strategies mistakes to avoid:
Rental properties require routine and preventative maintenance and repairs. Busy investors sometimes overlook fixing something immediately because they don’t want to spend the money or wait because it is not an emergency.
Failing to maintain your property may impact its sale value compared to being well-maintained. Deferred maintenance reduces the property’s value in a sale because of how the property competes with well-maintained properties and contributes to costly repairs or having to sell at a reduced price. Investors either pay now or later when they avoid repairs, so it’s best to keep up with maintenance and repairs.
When some investors sell a rental property and have vacancies, they sometimes rent to the first applicant without proper screening to show more rental income. However, this mistake can result in lost rent, property damage, and tenant issues. Showing a vacancy rate in your financials is better than sticking a new owner with bad tenants.
Additionally, some buyers want to handpick their tenants, so having a vacancy is OK as long as the landlord can show rental history for the unit and comparable market rents. Investors should continue renting vacant units to maximize profits but avoid skipping tenant background screening to fill a vacancy quickly.
If you spent an afternoon in housing court, you would see eviction after eviction where the landlord handed keys to a tenant with no lease or rental agreement and asked only for the first month’s rent. Think of thoroughly screened tenants in 12-month leases as money in the bank to a potential buyer. Leases need to be renewed annually. Tenancy-at-will agreements typically only renew if there is some change to the rental agreement, such as a rent increase or adding tenants.
Some landlords don’t want the hassle of setting up separate escrow accounts for the last month’s rent and security deposits. However, having signed leases, collecting security deposits and security deposit statements, plus signed lead paint notifications and statements of condition for each unit shows a diligent landlord and adds value to the property.
Keeping records of all investment property income and expenses, property repairs, and upgrades is vital. If the property has certificates showing lead has been removed and other hazardous materials mitigation, investors must pass this on to a buyer to evaluate which repairs are needed and if the property is worth the price.
Mortgage expenses don’t need to be reported to a prospective buyer since a new owner will have a different mortgage payment. However, you should offer information on property taxes, municipal expenses, and utility bills. You should also provide routine maintenance such as snow and leaf removal and inspection reports.
In most cases, a property doesn’t sell because it is overpriced. An investor who has put a lot of time and money into caring for their properties may let emotions rule when pricing at fair market value. Inexperienced real estate agents may accept whatever price a seller dictates so they can secure the listing.
Investors might think if the agent advertises their property where homes sell significantly higher, they will attract a buyer willing to pay their hefty price tag. This is a big mistake. Most buyers need a mortgage to buy a property, and a lender will not lend above appraised value. Mortgage loan-to-value ratios generally cover from 60% to 95% of the purchase price.
A great way to prevent these mistakes is by using property management software that tracks and manages records and maintenance. Property management software tools like DoorLoop help with listing vacant units for rent, managing leases, and performing applicant background checks. It also allows you to collect rent and late fees and communicate with tenants.
We’ve identified seven different types of exit strategies for investors in various situations. Some investors have exit strategies for individual properties as well as their real estate investing business. Other investors have exit strategies that move them from investing in residential two- to four-unit properties to apartment complexes or commercial real estate. Your chosen strategy will depend on your short- and long-term goals and business plan, but you should always have an exit strategy prepared to achieve maximum results for your real estate venture.