If you are looking to invest in real estate, be it a multi-bedroom apartment to rent out to students or a space for a growing family, there are many factors you need to consider:
- Price
- Location
- Market forecasts
Aside from these, one of the most important factors is determining what your exit strategy for the property will be.
Your exit strategy is important because it’s how you plan to eventually sell off the property, and will impact your long-term financial plans.
Especially if you hope the property investment will be used as a retirement plan. But your chosen exit strategy will also affect your near-future plans for the property.
Knowing what you want out of the investment and how you plan to handle the property are necessary considerations to think through carefully, before you make a decision on whether or not to invest in real estate.
Exit strategies are generally long-term games (though not always) – and sometimes don’t involve an “exit” from the property at all.
To explain this further, we’ve put together the most common types of exit strategies used for you to consider.
If You Plan To Rent – Not Sell – The Property…
Then this is where is it doesn’t require you to “exit” at all. Many people invest in real estate in hopes of generating a steady stream of passive income from renting it out.
But, depending on what your goals are for the money you earn from the monthly rent, it’ll impact how you approach financials such as the home loan and your current salary:
1) Passive Debt Reduction
Passive debt reduction is when your aim is to rent out the property at a rental rate that allows you to cover the monthly home loan payments.
With this type of strategy, the idea is to earn income from the rent only as the value of the property appreciates over the years, which would allow you to charge more in rent.
By using this type of scheme, it’s likely that you’ll continue working and earning a fixed salary, only earning additional income from the investment property years after the initial investment.
This plan is not particularly risky, as you’re not using the income from the investment property as the basis of your finances.
The one major risk with this type of plan is if the property sits empty for many months or its worth – and thus the rent – goes down in value rather than up.
Knowing what your financial plan would be in a situation where you’re unable to earn the money to meet the home loan payments is important.
The best plan of action in that scenario may be to sell the property for enough money to pay off the home loan so that you’re no longer carrying that debt.
2) Aggressive Debt Reduction
Through an aggressive debt reduction approach, you would use all of the rental income (as well as additional funds) to pay off your home loan faster than the term of the loan.
This would allow you to earn more income from the monthly rent faster, as you wouldn’t need to be paying for the interest rates anymore (of which, the costs add up over time).
It could also possibly provide you with the opportunity to invest in MORE properties, supplement your salary with the rental income, or give you the financial freedom to pursue your dreams.
The risks involved are similar to the passive debt reduction risks, but may not be as impactful if you’re able to successfully pay off the home loan before there’s a downturn in the market.
For both of these plans, your investment has a higher chance to pay off, but it will most likely occur over the course of many years – perhaps even decades.
If you do hold on to the property after the home loan is paid off, you could sell the property when you retire in order to have more liquid cash available to support yourself.
If you do decide to keep it and earn rental income, you can always pass it on to your family.
Now, If You Plan To Sell The Property…
It’s another way to approach property investment, and doesn’t involve generating rental income.
This is where you purchase several properties and then sell them after they’ve appreciated in value, or after you’ve renovated the properties.
No matter your hopes for the property, if you plan to sell it, here are the exit strategies to consider.
1) Paying Off Debt
Selling properties to pay off debt is how many property investors operate, and is a very common scheme.
Here’s how it works: you purchase multiple investment properties over the course of your lifetime, and as the properties appreciate in value, you sell them off one by one.
The proceeds would then be used to pay the debt incurred from purchasing the other properties.
As you pay off the home loans, you can decide if there are properties – perhaps the ones that provide you with the highest rental incomes – that you would like to keep in your real estate portfolio in order to grow your wealth.
Though this sounds like a great scenario, the risk is that because you own multiple properties at the same time, any type of housing bubble or depreciation will directly impact the worth.
Additionally, for any profits made from the sale of properties, you are liable to pay capital gains taxes (also known as RPGT).
In order to ensure you are making as much profit as possible, it may be best to sell the properties slowly, which could mean that it will take several years for you to sell all of the properties and pay down the debts.
2) Living Off Profit
Similar to the paying off debt strategy, this plan involves purchasing several investment properties throughout the course of your lifetime.
But instead of selling off properties to pay debt, you would sell properties to live off the profits of that sale.
When the money from that sale begins to dwindle a few years down the road, you would then sell another property in order to live off of that profit.
The risks here are numerous: it’s always possible the market will change and you’d experience a decrease in rental income or loss upon sale.
However, if that occurs, you could always hold on to the properties and switch to the passive debt reduction strategy so that you’re able to meet the home loan payments and hopefully make a bit of income in the process.
3) Selling All Property
Sometimes referred to as ‘flipping’ property, the selling all property strategy is used when people want to;
- Exercise an exit strategy quickly by buying a property, and
- Then selling it in order to turn a moderate profit on the sale.
This can be an incredibly risky strategy, as it’s possible the improvements required to sell the property will be more than you will ultimately earn on the property.
Sometimes, a piece of real estate does not sell quickly enough and requires you to make the monthly home loan payments when;
- You were not planning to, or
- That you do not earn a profit on a sale.
However, in any of these cases, you do have the option of renting out the properties instead of selling them.
So that you’re at least able to meet the home loan payments and the investment isn’t a complete drain on your finances.
Property is generally considered a very stable investment, and one that will earn you more money over time.
Even in the event of a bubble or a market depreciation, values do usually go back up – it just may take some time.
Keeping all of this in mind and knowing which type of exit strategy will suit you and your financial goals best, will help guide you in determining how to proceed when investing in real estate.
If you want to know more about determining whether that property you’ve set your eyes on would be a worthy decision or not, then it’s best you read up on how to spot a great property investment opportunity.
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Disclaimer: The information is provided for general information only. PropertyGuru International (Malaysia) Sdn Bhd makes no representations or warranties in relation to the information, including but not limited to any representation or warranty as to the fitness for any particular purpose of the information to the fullest extent permitted by law. While every effort has been made to ensure that the information provided in this article is accurate, reliable, and complete as of the time of writing, the information provided in this article should not be relied upon to make any financial, investment, real estate or legal decisions. Additionally, the information should not substitute advice from a trained professional who can take into account your personal facts and circumstances, and we accept no liability if you use the information to form decisions.