The Art of Timing: Exiting a Multifamily Investment

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Investing in multifamily real estate can be a lucrative venture, but you’ll want to begin considering your possible exit strategy right away. To be clear, an exit strategy isn’t a way to bail on your investment. It is actually a plan to eventually sell a property so you can make the most of current market conditions and help maximize returns on your multifamily investments.. We’ll delve a little deeper into the concept of an exit strategy to help you learn more about the concept, how it works, and what the different options are for exiting your real estate investment.

Reasons to Exit

Exiting a multifamily investment is essential for realizing a full return on the investment. The sale of the property brings liquidity to your investment, so you can recover the physical cash for your initial investment as well as any profits realized from the sale. In some cases, investors may decide to exit an investment if it’s not performing as expected. Investors serving as both the sole owner of a property and a full-time landlord for its tenants might consider exiting due to the workload that comes with single ownership of a multifamily asset.

Multifamily Exit Strategies

There are several different exit strategies available for investors, but we will be covering the main four here. Each of these exit options has different pros and cons, so you’ll want to consider each one carefully as you craft your plan.

Buy and Hold

The concept of buy and hold means simply that once you’ve made your investment, you hold on to the asset and give it time to build equity. Some investors plan on keeping a property in their portfolios for 5-10 years. This provides plenty of time to improve the property, increase cash flow, and potentially increase the value of the asset  before the eventual sale. 

One potential downside for buy and hold is the lack of liquidity. While you can see monthly income in the form of rents (if you are a direct owner) or dividends (if you are part of an investor group), your core investment remains inaccessible until the sale of the property is complete. 

Refinance to Leverage Current Market Conditions

Refinancing is an option that lets you keep your multifamily property while taking advantage of current market conditions. A refinance when interest rates are lower can be used to pay off the initial investment, and it can also give you access to extra cash you can use to improve the property. It’s a good idea to keep an eye on interest rates throughout the length of your investment so you can make the decision to refinance when conditions are at their most favorable. 

Choosing to refinance only works if you’re willing to keep your investment longer. If you feel you’ve already maximized the return on your multifamily asset, selling might be a better option.

The 1031 Exchange

If you’re ready to sell your existing property but have your eye on a new asset to replace it with, the 1031 Exchange can be an advantageous exit strategy option. This concept lets you essentially “swap” on property for another, deferring any capital gains taxes in the process. You can use the 1031 exchange as many times as you like, provided you follow all the rules and regulations of the tax law. Remember that selling a property outright without a replacement investment makes the sale subject to capital gains taxes. The 1031 exchange basically lets you continue to defer until you sell without a replacement investment. 

There are a couple of downsides to this exit strategy. The rules can be difficult to follow if you don’t have a tax professional helping you, and the process means your investment continues to be illiquid. 

Open Up to Additional Investors

If you are a sole investor in a property, opening it up to additional investors can provide you with some additional financial freedom. You don’t have to carry the burden of managing the asset on your own, and you can share risk with the other investors. For an asset you already own, this process gives you access to extra cash for capital or value-add improvements. You can also use this concept before you purchase a property. Pooling money together with other investors makes it easier to invest in larger or more expensive properties without having to put up all of the cash. 

Sharing an asset with other investors isn’t for everyone. You’ll need to give up some power and control, as each investor has a say in how the property is handled and when it’s ready for sale. You’ll want to make sure you thoroughly vet any potential investor so you have a good idea of who you are sharing your investment with.

Timing Your Exit

The timing of any exit strategy is crucial, so it’s important to keep a close watch on current market conditions, interest rates, and inflation throughout the length of your investment. Multifamily investment wealth preservation, or the art of keeping and maintaining the wealth gained through your real estate investment, relies on leveraging current conditions to make the most informed decisions about your property. Some things to consider when timing your exit are:

• Tax implications: How will the sale impact your tax situation? There are ways to offset or defer tax liability, such as a 1031 exchange, to help you maximize returns on multifamily investments. 
• Interest Rates: Can lower interest rates make refinancing a better option than selling? Refinancing means spending less to own the property you’ve purchased, and it can also help you build equity while deploying a buy and hold strategy. 
• Market Volatility: During times of market volatility, owning real estate can provide a hedge against inflation and unpredictable markets. If you believe the value of your property can continue to increase in the future, does it make more sense to hold on to the property as a buffer against a volatile market?
• Investment Capital Preservation: Real estate can be used in an investment capital preservation strategy, making it a unique addition to an investment portfolio. The multifamily asset you invest in can help you preserve capital and avoid loss, so holding on to these types of investments for the long-term may make more sense than selling. 

Looking at comps for other properties in the area can help you decide when it’s time to employ a hard exit strategy. If you’re hoping to take advantage of the 1031 exchange and will be financing the new purchase, it’s also a good idea to monitor interest rates. A financial expert can also help you determine the right timing for any of the exit strategies we’ve discussed above, even when to consider adding an outside investor. 

Investing in real estate is about more than just buying properties. It truly is like the old song goes… you do have to know when to hold them. As always, you’ll want to consult with your financial expert before making any money moves, including your exit strategy.

Source: DiversyFund