Real estate investors have been facing uncertainty from many directions since the Fed began increasing interest rates to combat rampant inflation since last year. As investors, we try our best to underwrite conservatively and predict what might happen towards the end of our property’s business plan. We also plan for different exit strategies, some more ideal than others. The changing environment is making it much more difficult to find new deals, as reflected in the 74% decline in multifamily real estate transactions seen earlier this year.
These changing circumstances have only made it more critical that investors have solid business plans, with viable exit strategies on the backend.
Below, we’re breaking down some of the common exit strategies used by multifamily investors, and why anticipating the exit is not just recommended, but vital to success.
Why Do We Need An Exit Strategy?
An exit strategy is exactly what it sounds like. It’s the route an investor intends to take to sell a property at the end of the business plan. An exit strategy is essential. Not having an exit strategy is a lot like getting in the car and driving without a GPS or a destination in mind. The exit strategy provides a timeline, and a clear goal. Not having an exit strategy would hinder an investor’s ability to maximize profits at the sale of the property.
What Goes Into An Exit Strategy?
An exit strategy doesn’t just include the final, long term objective. It should also include the short-term steps needed to get there. Different short term, medium, and long-term goals will require a different exit strategy.
Multifamily Exit Strategies - From Best to Worst (...Just Kidding)
Buy and Hold: Similar to single family investing, multifamily investors can choose to purchase an investment property and hold it for a longer period of time. These hold periods tend to range from 10 years or more. This exit strategy is clearly a wealth play. An investor may opt to use this exit strategy if they want to build equity and sell it for a sizable profit in the distant future. However, buy and hold properties tie up the capital, meaning you can’t take that money and buy more properties with it.
1031 Exchange: This exit strategy is also popular among single family investors. It allows investors to defer their taxes by moving their capital from one investment property to another “like” property. As mentioned, a massive advantage of this strategy is that investors can postpone having to pay capital gains tax on the sale of the initial property. However, this means the investor must find another property that is equal to or worth more than the initial property, and they have a fixed amount of time to do it. This can be a daunting task, especially with a challenging market.
Refinance: Refinancing isn’t technically a complete exit, since you’re not selling the property. But it does allow you to take your equity out of the property, and multiply your money by reinvesting it into another property, or updating the initial property to force appreciation. You can also pay off the debt to increase the value of the property. Refinancing is a good option for anyone who wants to take advantage of lower interest rates in the market or buy a cap rate, especially if market conditions are uncertain.
Bring On An Equity Partner: This exit strategy is used by investors who are willing to give up equity in the property in exchange for additional capital. The new partner brings money to help to fund more renovations, pay off the debt, etc. This frees up the investor’s own capital so they can use it to go do more deals.
Value-Add: This is a very common strategy in multifamily real estate. Value-add investors like us purchase properties that are outdated or being inefficiently managed. We go in and improve the physical condition of the property, and reduce expenses by improving management and maintenance. This allows us to increase the NOI of the property, which increases the value of the property. The timeline is typically 3-7 years. You can think of it as a “flip” but on a longer timeline and a bigger asset. The end goal is to sell the property. However, if market conditions aren’t suitable during the time the investor planned to sell, then this might not be a viable option.
In the market we find ourselves in today, investors have had to learn to become comfortable with levels of uncertainty that are unprecedented. Rising interest rates and declining commercial real estate transactions have only intensified the importance of having a strong business plan with a realistic exit plan for multifamily investors.
Not having a solid exit strategy is a major risk factor, and investors may not be able to achieve their desired profits when they go to sell.