Common exit strategies for buy and hold investors

Starting Out
10yFollow

Common exit strategies for buy and hold investors

Charles Marshall
Hingham, MA · Member since 2015 · 78 posts · 21 votes

What are come common exit strategies for a buy and hold investor?  Considering investing in properties with little or no money down.  If I need to sell, I'll incur the typical closing costs which would essentially make the deal a loss even if I could sell for the what I paid.  Is this the only feasible exit strategy for buy and hold investors?

0Reply
116 views

Most Popular Reply

Steve Vaughan
Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
10y

When we buy right and add value, either through increasing income, reducing expenses, or improving the paper, we have equity and multiple exit strategies. If everyone bought at FMV and there was no appreciation or value added, we would lose money with transaction fees.

7Reply
See this reply in the discussion

28 Replies

Jump to latestLatest
  • Steve Vaughan
    Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
    10y

    When we buy right and add value, either through increasing income, reducing expenses, or improving the paper, we have equity and multiple exit strategies. If everyone bought at FMV and there was no appreciation or value added, we would lose money with transaction fees.

    7Reply
  • Michael Boyer
    Investor · Juneau, AK · Member since 2015 · 980 posts · 741 votes
    10y

    with no equity and a quick sale with no chance for appreciation to work and no strategy to add value, the prospects on exit look dim as Steve mentions... You may get a tax write off or something at best.. 

    Add value, experience appreciation, pay down the debt, etc and the prospects improve... There is the easy button of a for sale sign in the yard, or handing over management for more passive cash flow, or even owner financing (one I like for paid off properties).. Best of luck

    0Reply
  • Jeff B.
    Buy & Hold Owner · Redlands, CA · Member since 2015 · 5k+ posts · 2k+ votes
    10y

    By and hold and  yet  so short term as to have no appreciation???

    To me, B&H means to operate for a few years at least, and as already noted, your profits at exit time should have been well estimated at the purchase time.

    In 2016, I'll be exiting my MFU and will sell as 

    • a turnkey investment which will cash flow some 43k 
    • with a cash/cash return of 17.2% 
    • and that's running with a PM expense of 10%

    My problem will be the CG taxes :oh sigh:  what a greedy capitalist (that's economic satire if you didn't catch it)

    0Reply
  • Jeff Rabinowitz
    Investor/Landlord · Farmington Hills, MI · Member since 2011 · 1k+ posts · 1k+ votes
    10y

    If you buy a property, lease it out, and then sell it for what you paid for it--that isn't the most profitable way to invest but it may not always be a loss. Consider a property that you leased profitably for 5 years. Even if you sell it for what you paid the monthly profit might easily exceed the transaction costs you would pay. I am actually considering selling a couple properties I purchased before the melt down for less than I paid for them. I have owned them for 10 years or more and they have been profitable almost every year. Even at the lower sale price they will still be a gain for me. These are financed so I will have to repay the depreciation and pay tax on the gain even though the sale price is lower than I paid.

    There are ways to lower the transaction costs. You may not always need the services of a real estate agent and may be able to save the commission. If you own the house in an LLC (and the house is the only asset of the LLC) you may be able to find an investor who would be willing to buy the LLC instead of the house. That could save the expense of paying real estate taxes that would usually be due on the sale (you haven't sold the house, just the LLC) and may remove the expense of providing another title insurance policy to the buyer (the policy that the LLC has should still be in effect). Real estate laws are State specific so make sure you have a discussion with a local lawyer and/or accountant before you attempt to implement any strategy.

    1Reply
  • Charles Marshall
    OP
    Hingham, MA · Member since 2015 · 78 posts · 21 votes
    10y

    I appreciate the feedback.  Obviously the goal with buy and hold is to "hold".  Everywhere I read and listen, they talk about having exit strategies.  My goal with buy and hold is to hold long term.  Do I really need alternative exit strategies with buy and hold?  Holding seems to be the only real exit strategy.  Selling is the next best exit strategy.  I guess my real question is do I really need to have an exit strategy with buy and hold?

    1Reply
  • Account Closed
    Investor · San Jose, CA · Member since 2012 · 2k+ posts · 3k+ votes
    10y

    Charles,

    In addition to what Steve and Michael said, here are some typical exit strategies for buy-and-hold investors:

    1) Buy at a discount, do a cash-out refi, get your equity/investment back. Rinse and repeat.

    2) Sell, collect your gains and pay taxes

    3) Sell and trade up to bigger and/or better investment. 

    For buy-and-hope speculators, who are paying retail prices, they're at the mercy of the market. The greatest investor of all time, Warren Buffett, tends to buy investments with a margin of safety so should us if we plan on playing and staying in this game for the long haul. 

    The beauty about buying properties at a discount is that if you change your mind the next day, you can sell and make a profit instead of taking a loss.

    Best of luck.

    3Reply
  • Curt DavisBusiness Member
    Flipper/Rehabber · Memphis, TN · Member since 2008 · 5k+ posts · 2k+ votes
    10y

    @Charles Marshall

    The hard reality is for investors who buy and hold, you may need to hold onto them for a very long time before you plan on selling in order to make a profit or in some cases break even.  If you purchase the homes without an affiliate or TK provider you might create a little more roof if you needed to sell.  

    I know things can happen but hopefully investors who plan to buy and hold will look at it as at least a minimum 10yr plan. 

    Good luck

    Curt Davis - KAIZEN Realty538 Reviews
    WebsiteView Page
    1Reply
  • Jeff Rabinowitz
    Investor/Landlord · Farmington Hills, MI · Member since 2011 · 1k+ posts · 1k+ votes
    10y
    Originally posted by @Charles Marshall:

    I appreciate the feedback.  Obviously the goal with buy and hold is to "hold".  Everywhere I read and listen, they talk about having exit strategies.  My goal with buy and hold is to hold long term.  Do I really need alternative exit strategies with buy and hold?  Holding seems to be the only real exit strategy.  Selling is the next best exit strategy.  I guess my real question is do I really need to have an exit strategy with buy and hold?

    Nope. You could hold until you die and let your heirs decide what to do with the property if you wish. If the property is very profitable, you are in a financial position where you do not need to cash out, and a sale would trigger a large tax that may be a great choice. I hope your investing career leaves you in such a position.

    0Reply
  • Jeff B.
    Buy & Hold Owner · Redlands, CA · Member since 2015 · 5k+ posts · 2k+ votes
    10y

    Hear of 1031???  Trade up one property for another with capital gains tax deferred.

    Of course, at the end of the day, the chicken still comes home to roost.

    0Reply
  • Jeff Rabinowitz
    Investor/Landlord · Farmington Hills, MI · Member since 2011 · 1k+ posts · 1k+ votes
    10y

    1031s come with a big gotcha at the end if you want to cash out. Using them can lock you into a strategy that may not be as attractive down the road as it can seem up front. The Government usually offers strategies that look like they help the taxpayer but often cost them more in the end. 

    3Reply
  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    10y
    Originally posted by @Jeff Rabinowitz:

    1031s come with a big gotcha at the end if you want to cash out. Using them can lock you into a strategy that may not be as attractive down the road as it can seem up front. The Government usually offers strategies that look like they help the taxpayer but often cost them more in the end. 

    Hi Jeff,

    This is not necessarily true.  If the investor holds until death, their heirs get a step-up in cost basis and pay no capital gain taxes or depreciation recapture taxes.  If the investor continues to 1031 Exchange but pulls some cash out or trades down in value each time (taking some of their chips off the table so to speak), they do not get the big gotcha.  If they combine the final sale with a seller carry back note, they can spread the tax over a period of time.  The big benefit is that you continue to build wealth faster because you have more net cash to invest as opposed to paying it to the government.  The investors net worth at the end of the day will be much greater than if they paid taxes as they went.  In short, the big gotcha is not always a big gotcha, is a good problem to have and can be planned for and managed. 

    Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
    WebsiteView Page
    3Reply
  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    10y
    Originally posted by @Jeff B.:

    Hear of 1031???  Trade up one property for another with capital gains tax deferred.

    Of course, at the end of the day, the chicken still comes home to roost.

    The chickens do not still come home to roost.  There are more investors that buy and hold and exchange and hold until death, and they will receive a step-up in cost basis at date of death.  They will never pay their taxes.  The only time that the chickens come home to roost is IF the investor sells and cashes out before death, and there are ways to manage the tax liability with proper advanced planning.

    Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
    WebsiteView Page
    1Reply
  • Jerry W.Pro Member
    Moderator
    Investor · Thermopolis, WY · Member since 2012 · 4k+ posts · 4k+ votes
    10y

    @Charles Marshall, when it comes to buy and hold, especially for SFRs, you should consider a different strategy than multi or commercial units. Truly professional investors have figured things like the present value of money returns from future investments and internal rates rates of return. In SFR investing I probably would not consider selling my rental unless one of several things occurred. If something has happened in that local to drive housing prices up but not rental rates it may be time to take a profit, and look for a better cash flow for the buck. A downward market value on both prices of houses and rent might make me want to unload a property as well. If I had a property that I was able to fix up to dramatically increase its value, I would also look at selling. If the price of a property does not go and rent remains constant, why would I want to sell it? You are buying for cash flow, if that does not change why would you want to sell it? If more profitable properties come along and you want to move your money then sure, but all things being equal why sale if it is doing what you bought it for? I have made exceptions where my equity was so great I could turn it into more properties or bigger properties.

    2Reply
  • Elizabeth Colegrove
    Hanford, CA · Member since 2013 · 5k+ posts · 1k+ votes
    10y

    We honestly plan on keep rolling the houses through 1031 till we die and the basis is wiped clean. This will our children to wipe the basis of our appreciation. We can grow it into an empire buy selling and leveraging for more eventually retiring off the cash flow.

    0Reply
  • Justin R.
    Developer · San Diego, CA · Member since 2015 · 1k+ posts · 1k+ votes
    10y
    Charles Marshall You can also think of "exit strategy" as "a way to get my money out." In addition to selling, that could be refinancing at some point in the future. Depending on the property, that could also be splitting a lot and selling off one, re-zoning to get higher use, developing to add additional units, purchasing adjacent properties, or other options. For vanilla buy-and-hold properties, though, these really aren't applicable.
    1Reply
  • David Faulkner
    Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes
    10y
    Originally posted by @Bill Exeter:
    Originally posted by @Jeff Rabinowitz:

    1031s come with a big gotcha at the end if you want to cash out. Using them can lock you into a strategy that may not be as attractive down the road as it can seem up front. The Government usually offers strategies that look like they help the taxpayer but often cost them more in the end. 

    Hi Jeff,

    This is not necessarily true.  If the investor holds until death, their heirs get a step-up in cost basis and pay no capital gain taxes or depreciation recapture taxes.  If the investor continues to 1031 Exchange but pulls some cash out or trades down in value each time (taking some of their chips off the table so to speak), they do not get the big gotcha.  If they combine the final sale with a seller carry back note, they can spread the tax over a period of time.  The big benefit is that you continue to build wealth faster because you have more net cash to invest as opposed to paying it to the government.  The investors net worth at the end of the day will be much greater than if they paid taxes as they went.  In short, the big gotcha is not always a big gotcha, is a good problem to have and can be planned for and managed. 

    While it is true that the step-up basis would eliminate cap gain taxes, I think what Jeff was saying is that 1031 can pretty well lock you into this strategy ... if you later change your mind and wish to sell, then it is painful and those chickens come home to roost big time.

    0Reply
  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    10y

    Here are some of the more common exit strategies:

    • Continue to hold (if its not broke, don't fix it)
    • Sell and pay the taxes (cash out)
    • Sell with seller carry back financing (defer capital gain taxes over the term of the note)
    • 1031 Exchange into properties that have less property (labor) management issues and/or less capital intensive issues
    • 1031 Exchange into smaller assets (trading down in value) over the years so that you slowly cash out and don't get hit with all of the taxes in the same year.
    • 1031 Exchange into more passive investments such as Net Lease Properties (NNN), Delaware Statutory Trusts (DSTs), Tenant-In-Common Investment Properties (TICs)
    • 1031 Exchange into gas, oil, air, water or other mineral rights that require no management
    • Contribute into and sell through a Charitable Trust
    • Consider charitable donations of property

    These are just a few that came to mind quickly.  Other folks can probably add to this list.

    Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
    WebsiteView Page
    6Reply
  • Jeff Rabinowitz
    Investor/Landlord · Farmington Hills, MI · Member since 2011 · 1k+ posts · 1k+ votes
    10y

    @Bill Exeter, of course you are an advocate of the 1031 exchange since you are an intermediary. I agree that for some people who have planned well (or especially those who wish to gift the properties to their heirs) these can be great plans. For those who do not wish to gift the properties to their heirs (maybe the heirs want nothing to do with the property or the owner would rather enjoy the proceeds themselves or has expenses they must meet) and have not planned well, the 1031 can be a problem. What does the owner who has exchanged into a $2 million shopping center that is no longer performing well exchange to? How long will it take them to find the property or properties that will be needed? Will there be anything appropriate when they wish to sell? Won't they be at the mercy of the owner of the property they must exchange into when the owner of that property learns of the other's predicament? What if they don't wish to deal with your list of passive investments? The tax bill on the sale of that shopping sale may be much larger than the owner had expected. Again, I recognize this can be a great vehicle for some. For me, I prefer to preserve my options and pay the gains tax when it comes due. Of course, I mobilize deferred losses when possible (if I have them) and often choose to sell when I have offsetting losses to use against the gain. 

    0Reply
  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    10y

    Hi @Jeff Rabinowitz,

    Yes, I am an advocate of 1031 Exchange as a Qualified Intermediary, but we are trust advisors that also advise against 1031 Exchanges when they are not suitable or appropriate for the client, and there are many cases where they are not appropriate.

    However, the math is very clear for buy and hold investors.  Those who defer their taxes over time build substantially more wealth (net worth) than those who pay taxes as they go.  Could it create a problem as you describe, yes.  But, I would argue that building more net worth (wealth) over time than what you would have otherwise if you paid the taxes as you go is a good thing.

    The investor does have to manage their portfolio like with any kind of investment portfolio such as a stock/bond portfolio in an IRA. You have to make sure that you plan for liquidity for market down turns and as you approach your later years for example. This is true of any investment strategy. You have to understand how it works, what the pros and cons are, when to use it and when not to, etc.

    Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
    WebsiteView Page
    0Reply
  • Mike H.
    Rental Property Investor · Manteno, IL · Member since 2009 · 2k+ posts · 2k+ votes
    10y

    Couple of things i'd add.

    1) @Justin R. has a great point about refinancing. Sometimes, the only reason you need to sell a house is that you're short on cash.. Well a refi accomplishes the same thing - gets you cash. And you pay no taxes on it when you pull it out.

    2) In terms of buy and hold exit, I keep seeing the notion that you'd take a loss if you were to sell it. How can that be? You shouldn't buy anything unless you're getting it at a decent discount. 30% is typically the target but at least 25% is what you should be looking for.

    As a buy and hold investor, we can afford to pay a little more than flippers. But usually the cash flow numbers don't work very well when you start hitting that 15% to 20% discount.

    Just to clarify, the discount is based on the estimated appraisal value when you're done versus the purchase PLUS rehab costs.

    So if you pay 80k for a house and put in another 25k in rehab, that house should be worth about 150k when its all done. 150k x .7 = 105k all in price.

    Now if you turn around and have to sell that house - and you only owe 105k on it then you should not have to worry about taking a loss there.

    Even if you're all in at 115k on that 150k house, you should still be ok. Quick sale for 135k or 140k and you should at least break even.

    Thats one of the reasons why people always mention you make your money on the purchase in real estate. And that you need to buy it "right". 

    If you're not getting 25 to 30% off the retail price, then you're not going to give yourself the same exit opportunities that an investor typically wants to have. And if you're not getting that kind of discount, I'm not sure you're really investing in real estate as much as you are simply parking your money in it.

    And if thats the case, then there is a little more risk in that type of investing......

    2Reply
  • Jeff B.
    Buy & Hold Owner · Redlands, CA · Member since 2015 · 5k+ posts · 2k+ votes
    10y

    @Bill Exeter  well you see, I have a thing about words - - they mean what they say. So when I read EXIT strategy, I take the O.P. to mean it, they want out, not to trade up.

    The Living Trust is really not an exit as it is a tax strategy to wipe the CG into a step-up in basis for the beneficiary and the property must still be held (and operated, and likely the desire not to  operate any longer is a strong motivator for the question).

    0Reply
  • JT Spangler
    Buy and Hold Investor · Nashville, TN · Member since 2013 · 264 posts · 102 votes
    10y

    Exit strategy is overwhelmingly used by investors to mean exit from a particular deal; not from investing entirely. Exchanging into another property certainly qualifies as an exit strategy, if you're actually reading what is written.

    2Reply
  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    10y
    Originally posted by @Jeff B.:

    @Bill Exeter  well you see, I have a thing about words - - they mean what they say. So when I read EXIT strategy, I take the O.P. to mean it, they want out, not to trade up.

    The Living Trust is really not an exit as it is a tax strategy to wipe the CG into a step-up in basis for the beneficiary and the property must still be held (and operated, and likely the desire not to  operate any longer is a strong motivator for the question).

    The term is most commonly used in the real estate industry as a strategy to exit a particular asset.  I'm not sure where Living Trust came into the picture, perhaps in another post, but I referenced Charitable Trust, which is a completely different entity.

    Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
    WebsiteView Page
    0Reply
  • Franklin Romine
    Visalia-Fresno, CA · Member since 2009 · 1k+ posts · 863 votes
    10y

    My exit strategy is capital allocation.  I refinance property to allocate my capital into new assets.


    Frank

    1Reply
  • Charles Marshall
    OP
    Hingham, MA · Member since 2015 · 78 posts · 21 votes
    10y

    @JT Spangler - thanks.  I am reading everything.  Looks like alot of information so I'm absorbing as the conversation continues.  Appreciate everyone responses.

    0Reply
Join the conversationCreate a free account to reply, vote on answers and follow this thread.
Log InJoin for Free