You are in a fantastic position if you are wondering what you are going to potentially do with an investment property before you buy the property—fantastic because that means you are thinking ahead, and when you think ahead, you are more likely to buy into a better investment.
I’m always impressed when I hear someone ask about the potential exit strategies for a turnkey rental property. This means they are thinking, and it is a valid question to not only help determine what property to buy, but in vetting which turnkey provider to work through.
Exit strategy matters.
The good news is that knowing the options for exit strategies on turnkey properties is no different than that of general rental properties.
Turnkey is only a method of buying rental properties, not of owning them!
Once you buy a turnkey rental property, you own a rental property just like anyone else regardless of how they bought theirs. This is all good news because there’s not some separate amount of information you need for turnkeys in addition to that of general rental properties.
In thinking of exit strategies for turnkeys (or any rental property), two different categories come to mind to consider. The first is the logistical options of what you can do with your turnkey property down the road. The second is what factors will make a difference in those options and how will they impact the overall return on your investment.
Related: The Top 3 Mistakes New Turnkey Owners Make Once They Buy
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5 Things You Can Later Do With Your Turnkey Property
The list of options of what you can do with your turnkey property down the road is fairly straight-forward:
- Hold it forever. You never have to do anything with the property if you don’t want to. If you are making great cash flow from the property, especially higher cash flow after the property is paid off, why sell it? You certainly can, but you can also just sit and collect the cash flow (and tax benefits and equity-build) for the rest of your life if you want to.
- Cash-out refinance it. In this case you will continue to own the property and collect cash flow, but if you have gained appreciation/equity on the property, you can refinance the loan on it and use that extra money for whatever you want (hopefully buying another investment property!). Your loan amount will then be higher, and you want to make sure this higher amount will still be covered by the income the property is bringing in. You can also use it to fund a home equity loan or any other creative financing methods you might be interested in.
- Sell it to a primary homebuyer. You can sell it as you would sell any other property. Selling to primary homebuyers is your best chance for getting the most for it. Investors will always want or expect a deal, but primary homebuyers typically offer closer to full value. I have a note about doing this in the next section.
- Sell it back to the turnkey provider. If the turnkey provider that you bought the property from still exists, you can always call them and see if they are interested in buying the property back from you. You aren’t likely to get as much as you would from a primary homebuyer because remember the turnkey provider is most likely going to resell it back off to an investor so they won’t be willing to pay you a ton for it. But especially if you want to offload it quickly for some reason, this may be a viable option.
- Sell it to an investor. You can post the property on the BiggerPockets Marketplace if you want, or if you network with investors in your area, someone may be interested in scooping it up (especially if it’s cash-flowing!).
All of the selling options are technically the same option—sell the property—but I want to make clear the different groups of buyers you can focus on. And with all of the selling options, don’t forget about 1031 Exchanges as a method of minimizing the taxes you will be forced to pay on the sale.
Now on to the more important exit strategy considerations to keep in mind when buying rental properties, including turnkey rental properties.
What You Need to Profit From Each Exit Strategy Option
In all of the options above, certain requirements must be met if you want the option to be a profitable one rather than one that causes you to take a loss.
- Hold it forever. You don’t want to hold onto a losing rental property, so for this option you want your property to be earning Cash flow and equity are the two primary forms of income on a rental property. You need a property that will continue, for as long as you hold it, bringing in one or more of these two income streams.
- Cash-out refinance. You can’t cash-out refinance a property if you don’t have any equity in it; same for an equity line of credit or whatever you are shooting for. If you paid down a lot of the loan on your property or you paid all cash for it in the first place, then you will have equity you can pull. Otherwise, you need to buy a property that will increase in value as you go along. That appreciation will create equity you can pull out of the house.
- Sell it to anyone. As with the cash-out refinance, you want the value of the property at the time you sell it to be more than what you put into it. If it’s not, you’ll lose money. Meaning, the value needs to have increased along the way. Note: If a property hasn’t increased in value but has been positively cash-flowing the whole time you’ve owned it, you could still be in the plus if you have to sell it around the same value that you bought it for.
Notice the commonality with all of these—the property needs to continue bringing in income somehow. How can you ensure a property you buy now will continue to bring in income for the whole time you own it, which will support your exit strategies later? Well, you can’t ensure it completely. But you can certainly increase your chances of it!
If I were to argue that one factor is the single-most critical component of your rental property (or turnkey property), it’s location.
I know—location, location, location! But let’s get past common phrases and actually understand why this is so important.
I could spend a lot of time diving into the depths of every piece of a location—micro-markets, macro-markets, neighborhoods, numbers, and every other detail you can imagine. The list is endless. But for this article, to keep it basic and readable, I am going to focus only on a couple of the more major points and then we can get into details at another time.
Location, Location, Location
Disregarding the numbers for any particular location for now (but not for your real investment!), I’m going to focus on what I deem to be the single-most important factor as to whether your rental/turnkey property is going to continue to positively perform along the way: Location.
The real list of location information that matters for your property includes the micro-market, which means the specific areas within the bigger market (city) you are buying in. This would include the general micro areas as well as each specific neighborhood. As you’ve probably heard, a lot of areas really differ street to street, so specific neighborhoods really do matter. These things matter for the reasons I’m going to mention for the macro-market, but these also matter a lot for tenant quality. Again, I can’t dive into the details of everything here, but if you want to read more on why tenant quality is so important for a rental property investment, check out “The 4 Main Risks of Owning Rental Properties (& How to Mitigate Them!).”
Moving past the details though of the micro-markets, I want to say that I strongly feel that so much of whether or not your rental property is actually going to make it is the macro-market that you buy in.
Remember what you read above. A rental/turnkey property needs to continue producing income in order for your investment to be profitable. The two main ways that can happen is through cash flow and appreciation.
- For cash flow, you need to be able to continue renting out your property to (good) tenants who will consistently pay a rent amount that will cover all of your expenses. When you go shopping for a rental property, you will analyze what those amounts are currently and you will buy if your expenses are being covered by the income. What you need to have happen is for that rental amount to not go down in value to the extent that it will no longer cover your expenses. If it does, you start losing.
- For appreciation, you need the value of your rental/turnkey property to increase in value over time. If it drops a time or two along the way, that’s okay, but it needs to have a longer-term upward trend. If your property has a more general decline in value over time, you will be losing.
For both of these, you need the values of the rent and/or the value of the property (hopefully both!) to at least hold value, but preferably increase in value.
What will make that happen? Demand. As long as there is demand for your property, the values can hold or increase.
What will create demand for your property? I’ll give you a hint—the list is all strongly dependent on the macro-market in which your property is located!
A major market has to offer reasons for people to want to live there. You can tell if people want to live somewhere or if there’s reason to live there by population trends. Focus only on markets with upward trending population statistics. Then, be sure that upward trend is likely to sustain. The number one thing to keep people flooding to a city? Jobs! There must be jobs. What will ensure jobs are available? Multiple industries! If you focus on a city that has only one primary industry (like Vegas with entertainment and Memphis with transportation), what happens if that industry takes a hit? Well, ask a lot of the Michigan cities who used to focus primarily on automobiles.
As long as there is demand for a city—which is created by industry, jobs, universities, and general desire (people like living there)—that is your best chance for securing demand for your property. The city will have enough people to provide a solid tenant pool, there will be plenty of people later who might want to buy your property, and all the while demand goes up, so the value on your property continues to increase.
As I mention all the time, I believe that the top determiner of whether your rental property is a successful investment or not is tenant quality. If that’s true, think about how the quality of the city you buy in will impact the quality of your tenants. If you buy a property in a declining market and rents get lower and people don’t really want to live there, how high of quality do you think your tenant pool is going to be?
For more information on things to look at in a potential rental property market and actual examples of trends in cities that could be determined as good or bad for exit strategy later, check out “How to Know if Any Given Real Estate Market is Wise to Invest In (With Real Life Examples!).”
I know this article is fairly vague, because as I said earlier there are an excessive levels of details involved in each of the components of all of this, but I wanted to get your head thinking in the direction of things to consider first, and then we can dive into the depths later.
Experienced investors—have you had any particularly good or particularly bad experiences with your rental properties in certain cities? Did the city you buy in directly impact the success or failure of your rental property?
Leave your comments below!