One of the many advantages of real estate investing over other investment strategies is having a plethora of decision options for how the investment is to be operated. This includes how to get out of it.
Getting out of anything is called an exit strategy. With stocks, there is only one way to exit: sell. The only alternative is to continue to hold. With real estate, there are significantly more options available for an investor to decide from. This is true for most real estate investment strategies, but rental properties in particular come with a long list of exit strategy options.
At any given time, the dynamics of a rental property investment can change, or the dynamics of your life can change in such a way that you may need to offload that rental property or adjust how it’s being operated.
Knowing your exit strategy options before you ever invest in a rental property can help you not only make better buying decisions on the front-end, but it can alleviate a lot of strain should the time come that you need to use one of the option.
What are those options, and how do you know which one is best for your particular situation?
You can hang on to a rental property not only for your lifetime, but it can be passed down through generations, offering continued financial support for your heirs. The primary criteria that should be looked at when deciding to continue holding a rental property is profitability. As long as a rental property is putting money in your pocket, rather than costing you money to hold it, holding onto that rental property may be the wisest decision. Or if the property is not profitable, you may still want to hold it if selling it would cost you more than holding it, such as when the market is recessed and property values are low.
There can be any number of reasons why it may be smart to sell a rental property:
- Selling would bring significant profit to the investor
- Life or family situations causing a need to offload the property
- You want to use the money to invest in another property
- You need to pay for unexpected life expenses
- You want to sell before major maintenance items start needing replacing
- You no longer want the responsibility of owning a rental property
The key with selling is to realize there is nothing that forces you to sell when values are low. Inevitably during a market crash, homeowners freak out and sell their properties out of fear. When they do this, however, they are likely selling at a loss.
The value of a property doesn’t matter unless you’re buying, selling, or refinancing.
It’s important to understand the financial implications of selling a property, as well as how to sell it to possibly avoid capital gains taxes, such as with a 1031 exchange.
If you decide to hold onto a rental property, there may be an opportunity to renovate the property to help out the numbers.
Renovating can do three primary things for a rental property:
- Increase the value of the property
- Increase the amount of rent you can charge tenants
- Attract higher-quality tenants
Renovating the property won’t work for every situation. For example, if the cost of the renovation is higher than what it provides in property appreciation, it may not make sense. Or if the property is located on a rough street surrounded by distressed houses, you aren’t necessarily going to be able to bring in higher-end tenants or charge more in rent all of a sudden.
Every situation needs to be assessed individually to determine if renovating the property is what makes the most sense. However, renovating is always in the arsenal of options.
As with anything involving the cash flow of a rental property, refinancing should be done with caution and only when you know the potential repercussions of doing so. However, when used correctly, refinancing can be extremely advantageous for rental properties.
Here are several ways refinancing can be used on a rental property:
- Refinancing may give you an opportunity to lower your interest rate, at which point your monthly cash flow will increase. This is assuming current interest rates are lower than what you got on your original loan.
- Doing a cash-out refinance means you get to keep the difference, as cash in your pocket, between what you owe on the property and the new value of the property. This only works if the value of your rental property is higher than what it was when you purchased it. But if it is, being able to pull out this lump sum allows you to now have capital that you can invest into the current property or use to buy another property, while still maintaining ownership of the current rental property. The advantage to keeping the current property is to continue to profit from future tax benefits, appreciation, equity paydown through the tenants’ payments, and additional cash flow if applicable.
- A home equity line of credit (“HELOC”) is essentially a second mortgage that you can take out based on the equity of your house. The benefits and limitations of taking out a HELOC are the same as with a cash-out refinance.
Note: You should always consult with your accountant before making any major refinancing moves so you can be sure that what you’re planning is the most advantageous for your situation and that it won’t hurt your investment instead of helping it.
Refinancing options do depend on the current real estate market—interest rates, appreciation, equity values, etc.—but when they are available, they open up the door to investors to be able to get creative with their rental property and find ways to snowball their money into additional profitable investments.
Selling, renovating, and refinancing can all be considered ways of restructuring a rental property investment. There are also ways to restructure a rental property that you are holding, as well.
For instance, if you are acting as the landlord on the property—screening and placing tenants, handling maintenance calls, and handling any required paperwork or other logistics—you can always switch to using a property management company to oversee the property for you.
There are so many ways to invest in real estate and ways to manage an investment that it makes restructuring how the property is run a viable option should a change be needed.
How to choose a rental property in order to maximize exit strategy options
Many investors don’t realize that one of the best ways to ensure having as many exit strategies available in the future is by being strategic when deciding which rental properties to invest in.
How does your rental property buying decisions impact future exit strategy options?
- Price of the property. If you buy a rental property at peak value, there isn’t as much room to build equity or gain appreciation. If you buy a rental property when prices are cheap, there’s more room for equity and appreciation. Many of the exit strategies are reliant on having equity in the property.
- Macro-market. This is the bigger city that the rental property is located in or near. A city needs to be continuously be growing in order for property values and rental demand to increase. If a city is in a serious decline, this will limit options for a property owner later in terms of: what price they can sell for or what value they can refinance at, who they can sell the property to, tenant options, and possible limitations to increasing values via renovating due to lowered market rents.
- Micro-market. Individual smaller cities located around the bigger macro-markets can appreciate or depreciate at their own rates, regardless of what the larger market is doing. The same emphasis here applies though—is the city growing or declining?
- Neighborhood. Even the neighborhood can dictate exit strategy options. For example, a primarily owner-occupied neighborhood is likely going to offer much better exit strategy options than a renter-heavy neighborhood. With the owner-occupied neighborhoods, prices tend to stay higher, there will be a greater pool of people you could potentially sell to—both primary homebuyers and investors—and there will be more options for restructuring potential due to higher demand. Similarly, if you invest in properties on dangerous streets, you’re going to severely limit your exit strategy options down the road in terms of both value and who you could potentially sell the property to.
- Type of property. Single-family properties tend to appreciate more than multi-family properties, and they also have a larger pool of people to potentially sell to—both primary homebuyers and investors. Multi-family properties tend to only sell to investors and they don’t appreciate as quickly as single-family properties.
There is no requirement for what kind of rental property you invest in. All properties come with pros and cons, but at a minimum, part of your analysis on any property should always be to look at potential exit strategy options should you ever need them.
How to choose the best exit strategy
With all of the possible exit strategies on a rental property, how do you know which one is best for your situation?
Here are some questions you can ask yourself to help assess what might be your best option:
- Is the property currently profitable?
- If the property is profitable, how profitable is it as compared to other potential investing options?
- What is real estate market doing? For example, is it closer to peak or is it closer to the bottom?
- What are current available interest rates?
- How much equity is in the property?
- What are the different financial scenarios? For example, how much could be made my selling? How much could a renovation bring in appreciation? What are the potential returns on a new investment if capital from a refinance were to be used?
- Are you losing sleep at night because of this rental property?
- How does the rental property fit into your goals, if at all?
Part of being a real estate investor is about applying creativity to a deal. This is where profits get maximized. Having so many options available to real estate investors is extremely advantageous when adjustments need to be made in order to increase profits. The best thing any investor can do is to know all of their options, be able to compare each option with the goals for that property, and creatively problem-solve their way to profits.