When evaluating a residential property – let’s say it’s a single family home, experienced investors may choose to consider a variety of “exit strategies” when deciding what to do with that property. For purposes of this article, let’s say that an investor is considering the purchase of a 3 bedroom 2 bath residence and wants to determine whether they will to keep it for rental or flip quickly to another buyer for cash.
Each investor will have their own criteria for making a strategy choice. But as I’ve said many times, it’s best to choose a strategy that will be supported by the underlying market fundamentals. The fundamentals are the circumstances that you cannot change about a property. For example – the location of the property is a fundamental issue. You can’t change it. Interest rate activity is also a fundamental that has a widespread impact on the market. If interest rates are rising, it may be more difficult to sell, and when interest rates are low, as they are today, your cash flow from rental could be higher. So a key part of the decision making process is looking at the fundamentals.
Let’s compare a scenario in which we are going to decide whether to keep the subject property and rent it for monthly cash flow, or whether we’ll just sell it outright for a cash profit.
Here is a fundamental question: Where is your financing coming from?
Are you a qualified buyer who can get a long term loan with alow interest rate? Or are you a credit challenged buyer who cannot qualify for a low cost mortgage, but can get a hard money loan for 6 months? One buyer may get cheaper money, with a long time frame for repayment, but another buyer may only qualify for a short term hard money loan at 12% interest, that must be paid back in 6 months or less.
In this case, the fundamental money issue would determine that buyer one, who can qualify for cheap money, might prefer to hold the property for rental because his financing costs are low; he has a long time frame to work with, and his cash flow will be much better with that cheap money. Holding for rental or a lease-option strategy could yield tens of thousands of dollars in net cash flow over time, and eventually, when the property is paid for, the investment becomes a money printing machine.
On the other hand, what if you can’t get that cheaper bank loan, and have to go with a private, hard money loan. This loan is usually via a private, sometimes professional lender, who is willing to loan about 65% of the After Repair Value, to buy and fix the property. But this loan comes with a 12% interest rate, and 5 points at closing. (a point is 1% of the loan amount)
This money is not cheap, and you have to have it all paid back within 6 months. If you can’t get the long term financing, you must sell the property as quickly as possible, in order to pay off the hard money loan. So, the likely choice of exit strategy would be to “flip”, i.e. resell the property, to another buyer as soon as possible. If you negotiated a good price for the property, you should be able to sell it for a quick profit. The amount of cash profit will depend on how good of a job you did figuring out what the property will be worth after the repairs are completed. This is the After Repair Value.(ARV)
Let’s say the ARV of the property is $100,000. A hard money lender will loan you about $65,000 to buy and repair the property. You are a good negotiator, and you buy the property for $45,000, then allow $20,000 for the repairs. (including all holding costs as well). If your total investment is $65,000 and you then sell the property to an owner occupant buyer for $85,000, you’ll pocket a gross profit of $20,000. If you can do that before your loan deadline you’re good to go.
As an alternate, you can get the property under contract for the same price, then find an investor who wants to do the rehab himself. You decide to accept a quick cash profit of $5,000 and sell your $45,000 property to the other investor for $50,000 just two weeks after getting it under contract. That is $5,000 in two weeks, versus $50,000 from cash flow over 10 years.
The choice depends on the fundamentals that control the specific situation. When deciding whether to hold for rental or to flip quickly to another buyer for quick cash, this decision is often determined by your access to financing. Other investors may have access to both cheap money and hard money. In this case they may choose to hold the best properties for rental, while flipping the less desirable properties to another investor.
Creative financing strategies are also very popular these days, because millions of former homeowners now have a bankruptcy or foreclosure on their credit. Many others have a wage garnishment for other debts. Since the recession began, more than 7 million people have fallen victim to unemployment or reduced income. These folks still have options as well for buying a home to live in or a home for investment. It’s all a matter of knowing what strategies are best for you, and that decision is based on what fundamentals are in play. These choices are different for each person, but there are choices and opportunities out there, for anyone who takes the time and makes the effort to discover what they are.
Donna S. Robinson is a real estate investor, author and investing coach located in Atlanta, GA. Follow her on twitter at donnaconsults, Facebook.com/RealtyBizConsulting and watch her videos on youtube. Her latest book, Basics of Real Estate Investing, is now available for Kindle on Amazon.com