This might sound like a crazy question, but…
When you’re out in public, do you ever think about how you would escape the room you’re in, if the proverbial stuff hit the proverbial fan?
What if there’s a literal fire in the theater, or a knife-wielding crazy man interrupts your dinner? Do you look around your surroundings and think, “if I had to get out of here RIGHT NOW, which way would I go?”
Thankfully, in most public settings, there should be multiple ways to get out. Fire codes tend to mandate multiple egress points. That’s because having multiple exit points significantly reduces risk in the event something in that space goes sideways.
The same is true in real estate investing. A deal that has multiple ways to produce returns is inherently less risky than a deal with only one exit door.
Why Multiple Exit Strategies Matter
Having multiple ways to earn a return (or at least get all of your original investment back) should be a top priority in any real estate deal, regardless of whether you’re an active investor buying property on your own or a passive LP in a syndication.
Multiple exit strategies provide flexibility, which is key in a world full of unknowns.
Common Real Estate Exit Strategies
There are two primary ways to “exit” a real estate deal (meaning, get your original investment back):
- Sell it. You (or the syndication sponsor) sell the property, hopefully for significantly more than you originally invested in it. But with a sale, you introduce a few problems. Assuming the property was performing (generating positive cash flow), your money stops working for you until you can find a new investment. Sales are also taxable events, so your overall returns could be reduced by your tax bill.
- Refinance it. The preferred “exit” for many real estate investors, you (or the sponsor) get a loan on the property, returning some or potentially all of your original investment through the loan proceeds. But you continue to own the property and receive the benefits of ownership, especially the cash flow. And since your original investment has been returned to you, you can redeploy it into another deal to create yet another stream of cash flow. Plus, money returned via a refi typically isn’t taxable (check with your CPA though).
De-Risking With Flexibility
Having a flexible business plan, while not strictly an “exit” strategy, also significantly de-risks deals and increases the likelihood of a future proper exit. Here’s a quick example:
Let’s say you’re evaluating an investment in a syndication for short-term rentals (think Airbnb) because you like the higher cash flow that typically comes with STRs. But STR markets can be tricky - what if demand in that market dries up, or the local municipality decides to ban STRs altogether?
Ideally, the sponsor will consider these possibilities and plan for the contingency. Maybe Plan B is to run the property as a traditional long-term rental. The sponsor ran the numbers and can show that Plan B’s returns may not be as good as Plan A, but even still, the deal isn’t distressed and your original investment is intact.
Avoid Single-Point Failures
The most important takeaway here is: be very, very cautious of deals with a single point of failure.
And especially so if the only exit strategy is heavily reliant on healthy capital markets (in other words, cheap and readily available debt). The unprecedented interest rate hikes of the last couple years caught many investors off guard, and lots of deals that only worked when interest rates were low were suddenly on thin and rapidly melting ice because these investors had no Plan B.
Ask Questions
When you’re evaluating a passive investment opportunity in a syndication, look for the sponsor’s Plan B. And if you don’t see it in their pitch deck or other materials, ask them before investing.
Questions like “what’s breakeven occupancy?” or “what if the rehab goes way over budget?” or “what if we can’t get permits from the city?” You want to hear clear answers that show they’ve thought through potential risks and have built contingencies into the business plan.
To sum it up, having multiple exit strategies in real estate investing is like having multiple exits in a building – it increases safety and reduces risk. Planning for the unknown helps ensure that your investment doesn’t get stuck in what should have been an avoidable situation.