Let’s talk about exit strategies.
An “exit strategy” is a plan that an investor develops to exit a deal, hopefully a profitably. In real estate and tax lien investing, exit strategies range from receiving a redemption check for a tax lien to fixing up a property and selling it.
We always encourage investors to invest with the end in mind. That means that before the investor even makes the purchase, he or she needs to have already formulated how he or she will make a profit on the deal and how to execute that exit in order to realize the profit. The surer the exit strategy and the surer the details are surrounding it, the better off the investor will be and the fewer hiccups he or she will have.
Also note that an investor should have backup plans in case the primary exit strategy doesn’t pan out exactly as planned. A “plan b” may end up more appealing than “plan a” once the investor gets into the deal.
A few details to gather before an investor can decide on an exit strategy are the following:
- The property type.
- The current property value.
- The current condition of the property and necessary fixes.
- The after-repair value (ARV) of the property.
- Comparable sales and/or rents.
Let’s look at some common exit strategies.
When purchasing tax lien certificates, the most common exit for investors is a redemption, or the paying of the delinquent property taxes plus interest in fees by the property owner to the county, then the county pays the investor.
If this is the investor’s primary objective, the investor should consider the following details for the tax lien investment:
- The state-mandated interest rate
- The property type
- Single-family residential with a homestead exemption are the most likely to redeem. If the property owner lives in the property, then chances are very good that they will want to pay their taxes to keep their property.
- Check the previous tax years’ payment and redemption history. If there is a history of redemption, then chances go up of redemption for your certificate.
- The redemption period
- It’s common that property owners will not pay their delinquent taxes until absolutely necessary. This could come towards the end of the redemption period when foreclosure is becoming possible, or even when they receive notice that the tax lien investor is beginning the foreclosure process.
When the property owner redeems and the investor receives his or her money back plus interest, then the exit strategy is executed and the investor moves onto the next deal.
Quick Flip or Wholesale
If the investor has acquired the property through a tax lien certificate or through a low-priced tax deed, one option for the investor is to sell the property quickly to another investor or property owner.
Like we mentioned above, answer the question, “What is the condition of the property?” Is it in need of repair or rehab? If it needs repair, then you will have to price the property lower to sell it. There are investors that specialize in fixing homes and reselling them so get connected with them through real estate clubs and sell to them at a discount and let them deal with the repair.
What is the investor’s margin on the investment? If the property is worth $50k and was purchased at a tax deed auction for $25k, then the investor may want to consider selling it for $30k – $35k to sell it quickly to another investor or someone interested in a fixer upper. If the property is in great shape, then the investor can sell it closer to market value.
The best-case scenario would be to have the buyer lined up before the investment is made. So if you have contacts in a specific area that are interested in a fix and sell, show them the property and beforehand and line up the deal.
Maybe you don’t need to rehab the property at all; maybe it’s ready for a homebuyer to live in. Or maybe it’s land that is ready to be built on. Either way you can sell it near or at retail without any work. What now? It’s possible to put the property on the market at retail and wait for a buyer, or you can price it low to sell it faster. We call that selling at wholesale price.
A property that is worth $150k that is in good condition, that the investor bought for $50k, could be sold at wholesale price of $100k to sell quickly.
An investor would want to do this if he or she wanted to cash out quickly and get their money into another investment as fast as possible.
Fix and Sell
If the property needs work and the investor would like to sell the property at retail, then the investor would use this strategy. Before purchasing, the investor should take a close look at all of the work that needs to be done and get accurate estimates on rehabilitation. The investor needs to work those numbers into the equation when considering the investment. A $25k investment that is worth $50k and requires $20k in rehabilitation might not be worth it. The numbers might be too tight.
Once again, the best way to work this deal is to have rehabilitation contractors, cost structure, and a buyer lined up before making the investment.
Fix and Rent
This is very similar to fixing and selling, except the investor is planning to rent the property. Before making the investment, the investor should know what comparable properties are renting for in the area and what costs are required to rehabilitate the property.
One thing that’s important to consider when you’re thinking about renting is your break-even point, cash flow, and return on investment. For example, if you’re buying a home for $25k, and it will require $15k in rehab, you’re spending $40k total. What kind of return do you need to make for that deal to be worth your time and money?
Let’s say the home will rent for $700 a month or $8,400 a year, which is about 25% of the cost that the investor incurred. It’s fair to say that that is a 21% return on investment. Your break-even point on that investment is about 4 years and then the rental property will be all cash flow forever after.
Sometimes the investor’s exit won’t come until after they have foreclosed and executed one of the previously mentioned strategies.
There are other creative exit strategies, but the ones mentioned here are the main ones. So pick an exit strategy that makes sense for any particular investment before you buy.
If you have questions about exit strategies, please let us know.