HOW TO PLAN YOUR PROPERTY INVESTMENT EXIT STRATEGY
It would be easy for the people to think that property investors with more than 5 or 10 properties are crazy, but, as any Binvested client would know, there is an end in sight – and it’s the very reason any investor starts on this journey. The end goal. The Holy Grail. The day an investor throws down their punchcard and tells their boss where to go – the start of financial freedom, and an abundant life. Every successful investor has a property investment exit strategy in mind, contingency plans and back-ups to make sure they get there.
It is this end-goal that underpins any well-thought out investment strategy, and it is this end-goal that forces the investor to plan how they will exit the game, well before they have started playing it. Knowing how to plan your property investment exit strategy, however, is a bit like knowing how to plan an outdoor wedding. No matter how carefully you plan all of the finer details, the chance of rain on the big day will always play on your mind – and there’s nothing much you can do about it. The weather is outside of your control. So it is with property investing. No matter how much you calculate, plan and work your arse off to achieve your end-goal, fluctuations of the housing market and the local and international economies; regulatory changes to lending and taxation; social upheaval and natural disasters – all of these things can affect your investments and how soon you can exit the game.
So, how can you plan your property investment exit strategy and make sure you end up in front no matter what happens? The answer lies in careful planning of the basics and a good dose of realistic thinking to help minimise as much risk as you can.
THE IMPORTANCE OF HAVING AN EXIT STRATEGY
Daniel Young, co-founder of Binvested, says an exit strategy provides direction. “what I find is that most people don’t know how much they need in order to retire comfortably,” he says. This ambiguity is compounded by a lack of direction in their investing. Having an exit strategy, he says, forces you to consider how much passive income you will need in order to retire comfortably. This then provides a goal to work towards, which, in turn, forces you to devise a strategy to get there. Daniel says, investors should think of the end-goal first, and work backwards from there.
Once you know what you want to achieve and how you are going to achieve it, the “should I, or shouldn’t I?” of each purchase will become transformed into “is this in line with my strategy, or will it take me further from my end-goal?” Having an exit strategy centred around an end-goal will help to prevent you from buying the wrong types of properties – as long as you consider this at each step of the way.
REMEMBER THE VARIABLES
Daniel says, there are some things you can’t control when planning your property investment exit strategy. Firstly, there is no way of knowing how quickly prices will go up or when the next real estate cycle will be. If you are waiting for your properties to double in value so that you can use the equity to buy more, or sell half of them to pay the remainder off, then there is no reliable way to know when this will happen. Looking at growth trends across Australia will only give you a limited idea of what the future holds, as each geographical market is affected by a unique set of economic and social factors that can vary tremendously over the course of time.
Fluctuations of the market, over and under supply, interest rate movements and lending regulations can all affect the price of real estate. The same goes for social disturbances in the form of unemployment and consumer confidence – even periods of natural disaster such as flooding and bushfires can have an impact over the rate of growth. All of this uncertainty makes putting an exit deadline in place next to impossible. As an investor, it is necessary to be flexible over how long it will take in order to reach financial freedom.
Secondly, unexpected changes may occur within your personal life that affect your ability to carry out your investment strategy as you had planned it. A change in career, divorce, a new baby or an injury that affects your ability to work may have significant consequences on your financial situation. When planning an investment strategy, it is essential to have a buffer in place to cover unexpected costs, and to purchase properties that have positive to neutral / slightly negative cash-flow so that they will look after themselves instead of leaving you out of pocket.
DON’T TRY TO FLUKE IT
Daniel says, a common mistake investors make is to “fluke” their investing. He gives a hypothetical of a family who purchases their home in a suburb that experiences excellent growth within a short period of time. After experiencing such success, they assume it is a good idea to buy an investment in the same suburb. This time round, however, the purchase price is already high (in line with the excellent growth already experienced in the area), and the corresponding rents low (as they don’t catch up that fast to rapid capital growth), resulting in the property having a negative cash flow. The family weather it, assuming that eventually its capital gains will pay off to the same extent as their home. Growth has slowed, however, and the family are out of pocket while having the equity from their home tied up in this new investment. Who knows how long it will take for prices to go up again? Before embarking on property investing, it is essential to know why you are doing it and then figure out the best way of achieving the success you aim for. You should never try to fluke it.
BEGINNING WITH THE BASICS – HOW TO PLAN YOUR EXIT STRATEGY
Daniel says, despite all of the variables that come into play, it is possible to plan a long term exit strategy within a flexible timeline. He offers the following advice, broken down into three questions you should ask yourself.
1) How much passive income will you need to earn in order to retire comfortably?
To figure this out, it is important to look far beyond your current situation. A single person should consider that if they get married and have children further down the track, their expenses will be much greater than what they currently are. Make sure you factor in lifestyle and health costs for both you and your family in order to calculate how much passive income you will need to earn before you retire.
2) How many properties would you need to own in order to generate this much passive income? (We’re talking unencumbered here).
To figure this out, you need to calculate how much rent you would earn from one property in a year, then see how many of these sorts of properties you would need to own in order to reach the required amount. It is also important to factor in holding costs as well. So, ten properties rented out at $350 a week would bring in $182,000 each year, minus holding costs such as strata levies and council rates, etc.
You should also consider how much tax you would need to pay on this amount, as well as how much of a buffer you would need to reserve in order to cover unexpected costs.
It is important to be realistic about how much rent you could make against the purchase price of the properties you can afford. It is also important to have a realistic idea of the holding costs of each property.
3) How will you achieve this?
In order to own 10 properties unencumbered, you may need to purchase 10. When the properties have doubled in value, then you will be able to sell half of them in order to pay off the remaining ten. There’s your ten properties you needed. For this to work you would need to factor in exit costs such as capital gains tax and agent commisions. You would also need to be flexible in terms of how long it would take – it may be 20 years before your properties have doubled in value. For this reason, says Daniel, it is important to have neutral to positive cash-flow from day one so that your investments are taking care of themselves each week. You don’t want to be out of pocket for 20 properties over 20 years until you can consolidate them! Again, being realistic with the numbers is vital. If you underestimate the costs of holding and selling, you could be selling yourself short of retirement.
And, if you can’t get financing for this number of properties, at least you will have a clear goal to work towards. Engaging a trusted financial planner will help you to identify ways to better your financial position so you can boost your borrowing power and set aside more money for investing.
Keep in mind, that once you are in a position such as this, you may not want to sell in order to consolidate. Depending on your situation and needs, you may wish to increase the passive income you receive by renovating or subdividing. Once you have a strong foundation portfolio under the belt, you may be interested in higher risk investments that hold greater potential for higher yields, such as apartment blocks. Depending on how soon your foundation portfolio increases in value, you may want to reassess your exit strategy in order to generate more passive income to support your needs and ambitions.
THE LONG AND SHORT OF IT
In addition to having a long term exit strategy, Daniel says it is important to also have a short term exit strategy in order to mitigate the risks associated with leveraging. Imagine, for instance, you had just purchased another investment property, only to be afflicted with a major illness or injury that meant you could no longer work. You already had existing debt, and could have easily serviced another loan at the time of purchase. Now, however, you just cannot manage the risk that another $300,000 debt (plus interest) will incur on your family’s livelihood.
Daniel says, “If shit hit the fan and you had to sell your property one week after settlement, how much could you sell it for?” If you have to sell your property ASAP, then it is likely you will be getting less than market value for it. What about agents’ fees? What about legal costs? Will you be out of pocket after this sale? Or, will you still make something from the transaction? When buying an investment property, it is important to buy it under market value and have an understanding of how much it will cost in order to sell it quickly, before it has grown in value. Having a short term exit strategy will prevent you from losing your shirt if shit hits the fan.
EASY AS ABC AND D
Investors should always have a Plan B. They should also have a Plan C and a plan D. If your properties are neutral cash-flow, you may be covered enough to weather a change of employment. If Strata suddenly hits you with an additional levy for extensive repairs, then what’s your next contingency plan? Having a back-up for your back-up (and a back-up for that too) means you are three times more protected from losing money due to the unforeseen.
When planning your property investment exit strategy, it is essential to cover your back against as many eventualities as possible. If you find all of this too much to get your head around, then it is advisable to talk to the experts about your goals and situation. The Binvested team can help you to identify your end-goal and figure out the most realistic exit strategy to get you there.