Thursday, March 24, 2011
Real Estate Investing Risk Management
Minimize Risk with Multiple Exit Strategies
In a recent blog, we stressed the importance of taking action as an investor. Taking action means making offers to sellers.
Before you make your first offer to a seller, you will have done your due diligence, inspected the property, estimated repairs and negotiated price and terms. What you negotiate will depend very much on the exit strategies you intend to use. Having multiple exit strategies will minimize the risk you take in making an offer.
Multiple exit strategies? You mean, I need to have more than one?
Yes, indeed! If Plan A fails, what is your Plan B? Better yet, if Plan B fails, what is your Plan C?
If your success is dependent on only one exit strategy, then you are at risk to fail as an investor.
Let’s look at some examples of multiple exit strategies. For example: Let’s say you have no cash, and no credit. So you decide you are going to wholesale property. Wholesaling means you find property at below market value and you sell it below market value. Typically, in order to sell low, you must first secure the property by successfully negotiating a purchase and sale agreement with the seller.
Along with many other savvy investors, I typically wholesale EVERYTHING. I will put an ad up on the internet offering the property for sale which I have just gotten under contract. If I get calls on it, then I know I have a good deal. No calls, well, then maybe it is not such a good deal….
If it is not a good deal, or I may have made a mistake, I’d better have some contingencies in my purchase and sale agreement that allow me to back out without a penalty. Inspection or financing contingencies are often used in this fashion. They allow the buyer to back out, or to renegotiate on price and terms. These are reasonable exit strategies if there are unpleasant surprises early in the contract phase.
But if it looks like a good deal, I have several possible exit strategies: I can go ahead and wholesale it at a price acceptable to me, or I can find the financing to keep it and develop it myself.
If I decide to keep the property, what are my options? Should I fix it up and flip it for quick cash? Or should I hold it and rent it out? I’d better sharpen my pencil, and see which of these options make the most sense, and what I need to do in order to succeed with either option.
If I keep it, I will need financing. Again, I need to have multiple strategies. Can I qualify for low-cost conventional bank loans? If I have no money, and no credit, probably not. Can I partner with another investor, the seller, or another private lender to raise the capital I need? If I decide to borrow hard money, how long can I afford to hold it until I can sell or refinance? What happens if I cannot sell the property within that time frame?
Working through multiple options will minimize the risk of moving forward on any investment. Typically, the best deals afford multiple exit strategies, all profitable to the investor. Remember Andy Heller’s “buy low, rent smart, sell high” approach to investing? If he bought at the right price, it did not matter whether he wholesaled the property, rented it, lease-optioned it, or sold it immediately. He made money either way.
A savvy investor will always ask him/herself, if this exit plan doesn’t work, what else can I do? And there had better be an answer besides “I don’t know!” If you always have a back-up plan, you will never be afraid to make an offer on a really good deal.