Real Estate Investors — Plan Your Exits Before You Buy
For real estate investors — and entrepreneurs in general — optimism is an important quality to have. It keeps you pushing forward, and expecting positive outcomes even in the face of challenges.
The most important time to be optimistic is when you’re acquiring a new rehab property. You’ve found an under-priced house, you’ve done your homework. Now all you have to do is get the repairs done, put it on the market, and boom — a nice payday.
However, the optimistic investor must also be realistic. Well before signing on the dotted line to buy a new property, you should ask the question: What could go wrong?
The basic plan of any house flipping project is to buy a property well below the after-repair-value (ARV), do the rehab, then sell at ARV, pocketing the difference between all-in cost (purchase price + rehab) and ARV.
But there’s an old saying that applies to all business, maybe especially to real estate investors: “The best laid plans of mice and men often go awry”. Your profitable exit at ARV may turn out to be unrealistic. Your estimate of costs may have been low, your estimate of ARV may have been high, the market can turn sour, your contractor can cause problems…the list goes on…
So, while many investors are focused on the buying decision of a real estate investment, the more important part of your investment strategy may be the exit strategy. Specifically, if things go wrong, how do I sell the property in a pinch?
Any veteran of the real estate business will tell you that you will eventually run into a bad deal; however, limiting the frequency and size of losses can be the difference between long term success and failure. Thus, how an investor plans for and manages when a bad deal does come around, will determine his or her success.
The time to create alternative plans for unexpected problems is before buying a property.
Here are 5 Exits for Investors When Things Go Sideways:
1. Drop the Price
Professional investors understand that there’s a time to make a little money or lose a little rather than holding out for top dollar.
It’s important to know what your break-even cost is on your property. You should also know your monthly carrying costs, such as the mortgage, utilities, insurance, etc. If the project is facing delays or difficulties, you’ll want to have thought ahead, and planned for price reduction strategies before any losses get out of hand. Consider having a plan in place with your listing broker to reduce the price after a certain number of days on the market.You should also know the maturity date on your loan and to have a plan for extending or refinancing should delays happen.
2. Rent It Out
Before buying a property, we suggest researching the rental market extensively for similar homes in the area. Renting out the property is a quick and easy temporary solution if you’re in a bind. You may find that renting is more beneficial to you as an investor in the long run, or may make the property easier to sell. There’s a big market for turnkey properties that are already rehabbed, tenanted and cash flowing.
If you’re financing the house with a hard money lender or some other kind of short-term financing where your monthly payment is fairly high, have options pre-set for refinancing into a long-term mortgage to lower your monthly costs.
3. Consider a Lease Option
In a lease option, the buyer makes a down payment to the seller, agreeing to rent the property until they have the money to purchase it. If you can’t sell to complete an intended house flip, consider offering a lease option to potential buyers with substantial income who currently can’t qualify for a traditional loan. In this way, you may be able to eventually get your desired sale price.
If you go the lease option route, you’ll have to make sure your lender is willing to extend your loan over a longer term, otherwise you’ll have to refinance.
4. Wholesale it to Another Investor
As a real estate investor, your goal is to buy a property, renovate it, then sell it at a profit.
However, if after buying you find a more attractive opportunity, you may want to consider wholesaling the property — simply sell it to another investor and move on. The term “prehabbing” — a combination of both rehabbing and wholesaling — is used to describe a house minimally repaired by an initial investor, which is then sold to another rehabber who will see the project through to completion.
5. Cut Bait
Inevitably–some projects will be losers. Dealing with an unprofitable investment is one of the hardest things for investors. Loss aversion is a well-known psychological behavior — we feel the pain of losing more strongly than we feel the pleasure of winning. Real estate investors are no different, and may be inclined to hold on despite evidence they won’t get their money back. That’s why it’s wise to plan one’s exits before emotion and ego set-in. Sometimes the best move is to cut bait on a loser and move your capital and efforts on to more attractive opportunities.
Planning for a project’s possible failure doesn’t mean you’re pessimistic. It means you’re smart. In fact, having a plan for when things go wrong should make you more optimistic about your long-term success as a real estate investor.
Our team at Aloha Capital values your success as a real estate investor. It’s our goal to service and support your acquisitions, closings and loans as well as possible, and to do this in the Aloha spirit. Regardless of the exact path taken to get there, seeing your deals through to successful exits works to create repeatable and profitable processes for everyone involved in the endeavor.