By Charles Sells
You have probably heard the real estate saying, “You make your money when you buy, not when you sell.” That is one of those things that real estate investors like to say because it sounds a little crazy but, in reality, it makes a lot of sense. It snags new investors’ attention and demonstrates that the person saying it has insight into the investing process. Unfortunately, this saying also dangerously oversimplifies a key component of your success in real estate.
On the surface of things, the concept that “you make your money when you buy” seems rational and clever. After all, if you invest too much capital into a property up front without the right strategy to increase the value of that property sufficiently, then you will not be able to generate returns regardless of how a great a job you do managing the logistics of the investment strategy. For example, if you spend $200,000 on acquisition and $150,000 on repairs and upgrades to make a single-family property look amazing but all the comps in the neighborhood are for $75,000, it is going to be nearly impossible for you to recoup your investment, much less turn a profit! You overspent from the very start. On the other hand, if you acquire a property in the same neighborhood for $5,000 and put $10,000 into repairs and upgrades to make it look amazing, you have a much better chance of generating a good return in large part because you bought at a low, competitive price that left you room to enact your investing strategy and turn a profit.
The problem with that saying is that it removes a very crucial part of the real estate investing process from the equation for new investors. Yes, getting a good deal on a property up front is very, very important. However, knowing what you are going to do to get your investment capital back out of the deal is equally important! This aspect of the deal is called your exit strategy, and in today’s real estate market it is more important than ever that you have more than one exit strategy and that your exit strategies be adaptable to a quickly changing marketplace.
The 3 Types of Exit Strategy You Need in 2020
Most real estate investors agree you need more than one exit strategy for any given deal. After all, if you only have one exit strategy, then you will likely find yourself in a position every so often where your initial plans simply do not work out the way you want. When this happens, if you have only one exit strategy identified for a property you will have to come up with a new strategy on the fly. This is time-consuming and can be very expensive. It is better to have your exit strategies planned out before you buy so that you can use those exit strategies to help you determine if the deal is a good and safe opportunity for your capital.
Over the last 10 years or so, many investors have had only one or maybe two exit strategies when they made investments. They have been able to “get away” with this because the market has been very, very good in most areas of the country. Because the housing market has been in a state of recovery or expansion for most of the last decade, it has been relatively easy to make a few mistakes on a deal and still make the initial plans for that deal work. Even when things went bad, investors tended to break even. That is going to change in 2020 and 2021 as the real estate market dynamics shift and the investing environment becomes a little less forgiving.
In 2020 and beyond, you will need to make sure every investment opportunity comes with three distinct types of exit strategies. Here they are:
- Your primary exit strategy
This is the strategy you will use to make money on the deal if all goes according to plan. If you are a fix-and-flip investor, then this strategy will usually involve selling the property at a profit at retail value. If you are a wholesaler, then this strategy will usually involve selling the property at a profit to another investor. If you prefer buy-and-hold, on the other hand, then your “exit” strategy will be much longer-term and involve holding the property, creating cash flow, and then possibly selling at some point far in the future. You can see that your “exit” does not have to be a traditional one, but you should have an ideal scenario in place that also makes realistic sense for the property and your wallet.
- Your secondary exit strategy
This is the strategy that you will leverage in the event that you are unable to execute your primary strategy immediately. You have probably heard of airplanes being in a “holding pattern” when conditions on the ground prevent them from landing immediately. Your secondary exit strategy may be a holding pattern, such as renting out a flip as an Airbnb property until the market improves, or it can be a lower price that you will be able to accept and still walk away from the deal unscathed. If your primary exit strategy involved a long-term hold, then your secondary strategy may involve a contingency that would enable you to sell before you ideally wanted to.
- Your worst-case scenario
This last type of exit strategy is one that is not fun to think about but that will give you a great deal of peace of mind in the event that things in your property start to go south. This exit strategy is not ideal. In most cases, it may involve making less profit than you really wanted or even just breaking even. In some cases, it could involve making no profit at all but cutting your losses in the event of a disaster in your deal. When it comes to this third and final exit strategy, you will need to evaluate the effects of enacting this worst-case action plan on your investing business. If the results will ruin you, then the deal is likely one from which you should walk away.
What is So Different About 2020?
As you read this, you are probably wondering what makes this year so different. What it is that makes it imperative that you have not one but three exit strategies in place at the start of this new decade? Well, there are a lot of uncertainties in our national housing market and in the national and global economies at the moment. For example, this year there is a presidential election in process with not one but likely two very polarizing candidates in the running. One candidate even wants to enact special taxes targeting real estate investors!
Election years are filled with uncertainty under the best of circumstances, and this makes the state of the housing market less predictable. When you have less predictability, the right way to accommodate this is with increased preparation for the unexpected. In this way, you can prepare yourself and your real estate deals for any eventuality that might come your way. For example, for experienced real estate investors working in the southeast at present, the entire fix-and-flip process might take between nine and 12 months from the due diligence to the sale of the property. However, imagine a worst-case scenario in which the market shifts dramatically and that timeline doubles. An investor who has a worst-case exit strategy already in place will be better equipped to deal with a sudden market swing than one who is simply counting on things staying the same.
As we move into this new decade, it is going to be more important than ever that newer investors work closely with experienced real estate investors when they do their deals. That might mean working as a passive investor on a bigger project or “partnering” with an experienced, active investor to try out a promising market. You can retain 100 percent ownership of properties in this type of partnership if you work with the right type of real estate agency, and this can be a great way to leverage experience and innovative exit strategies you have not already learned to implement on your own.
Charles Sells is the founder and president of Platinum Investment Properties (PIP) Group, the only agency that offers clients extraordinary returns on their investments while allowing them to retain 100 percent control and ownership of their investments. Learn more about exit strategies and the changing real estate market in 2020 by emailing Charles directly at Charles@PIPGroup.com or by visiting PIPGroup.com.