Acquiring great apartment deals is one of the most rewarding – and fun – things any investor can do.
You’ve got so much going for you – control, tax benefits, steady income, income increases, return of capital and even a growing basis.
However, have you ever thought about your exit strategy?
No matter what you invest in, there should always be a plan to get out.
Now, this doesn’t necessarily mean “selling” the apartment complex. Your exit strategy could simply be to get your initial money back so that you can do another deal.
However, there is still a question as to how long you should actually own the complex.
On the surface of it, you might say forever, right? I mean – this is a great investment, why would you ever get rid of it?
Good point, and you may not. To help shed some light on this question, let’s take a look at a couple of common exit strategies first.
One of the best ways to get your initial money back is to simply put a new first mortgage on the property that covers your existing mortgage and also the initial equity you put in with your down payment.
For example: Take our old friend the 200 unit, $5.5 million apartment complex. Let’s say that you bought it with 25%, or about $1.4 million down.
So, you want to get a new $5.5 million mortgage on the property. Of course, you can’t do this right away.
Remember that the bank wants something like a 1.25% debt coverage ratio – in other words, the net operating income should be 1.25 times the size of the loan.
The bank can limit how much of refi you can do, but for this purpose, a $5.5 million loan would represent an annual payment of about $450K. Well, that means that our net operating income must be at least $565,000 at a cap rate of 10.
In other words, the property is worth $5.65 million.
Not a big deal, you could raise rents and probably get there after a year or so.
What’s nice is that you get your entire $1.4 million back, and you’re still left with an annual cash flow of $115,000 – basically free money.
How’s that for an exit?
You could simply sell the apartment outright. After a few years of raising rents, you’d not only get your deposit back, but a little extra too.
There’s a catch to this one, however.
If you’ve read our I.D.E.A.L. series, you know a little about depreciation. Well, there’s a dark side to depreciation if you simply sell outright.
Basically, the government says, “Okay, you’ve enjoyed that nice tax break – but now we want some of it back.”
Oh yes, and while you’re at it, pay us a little capital gains tax, too.
Ouch! Its okay after a few years, but you’ll definitely have some of those gains eaten away. This really isn’t the best exit.
I’m not going to talk about this too much in detail here. The next article will explain this in more detail.
However, in short, exchanging means that you can sell your apartment and buy another property within certain guidelines and a certain time frame and you won’t pay any taxes on the sale.
So, you move your equity from a 200 unit property into a 350 unit complex, maybe.
You can actually do this all the way to the grave.
Pretty cool, huh?
We like options 1 and 3 for exit strategies, Refinancing and Exchanging.
Want to talk through your exit strategy, give us a call as we’re here for you to help.