If you’ve ever attended a real estate investment seminar, you’ve likely heard this mantra repeated time and time again—Buy Low, Sell High. Every book, infomercial, and guru repeats the same concept over and over. As a new investor, you took this information to heart and purchased a low-cost property that had great appreciation potential, and sat back to let your newly acquired asset build a considerable worth.
But nothing is as easy as it sounds. While you may have thought all you had to do was rent out the property and collect your cash. As your real estate experience grew you realized it wouldn’t be that simple. Now what?
Market Appreciation has its Drawbacks
Luckily for you, you managed to secure a property that did indeed have the market appreciation you believed it would and your property has skyrocketed in value. No loss incurred there. However, after years of owning the property, your intended cash machine is no longer producing the same returns it once was.
This is what often referred to as a catch-22. Technically, you do have the wealth you intended to have. Your property has amassed considerable equity and, on paper, your net-worth is substantial. However, you will likely have reached a cap on the rent you are able to charge based on current local market rates. If you’re in an area with recent high appreciation rates, this can be especially damaging to your return on investment rate as rental charges in comparison to property value can be trivial.
In addition to all these factors, your low purchase price has left you limited in the amount of depreciation you can withstand.
Appreciation Investing vs. Cash Flow Investing
Given your new grasp on the real estate investment industry, you realize it’s time to change strategies. Instead of investing for appreciation as you did at first, you want to try investing for cash flow this time.
First, you need to sell.
It’s then that you realize the headache you’ve gotten yourself into. After closing costs, commissions, capital gains taxes, and depreciation recapture, what you walk away with seems hardly worth the trouble.
In all those seminars, books, and workshop, you never heard the Buy Low, Sell High gurus talk about an actual exit strategy. So what do you do?
The Exit Strategy Dilemma
Before you, you see four options to get out from under this less-than-ideal situation.
1. Do nothing. Forget about the hassle of trying to sell the property. Just continue on the same path you’re on. Maybe you can pass it on to your kids as an inheritance.
2. Borrow against the property. If you take a loan out against your property’s exceptional equity, you can invest in a new property. With some strategic planning, you could purchase the new property in an area that is known for high cash flow ratios, thus collecting a return on funds that were once trapped inside the property you currently own.
3. Sell the property utilizing a 1031 exchange, charitable remainder trust, structured sale, installment sale, or a Delaware statutory trust. There is a catch with these methods, though. If you utilize one of these options, you will be severely limited in control and flexibility of how you receive your sale proceeds and how you can use them.
4. Sell the property outright. Pay the taxes and other expenses associated with the sale and then pocket the proceeds. Of course, in this method, you’re walking away leaving close to 40% of your equity on the table.
You’re probably thinking that none of these options seem to financially make sense. No matter what you do, you’re not getting your money’s worth. You’ve put time, money, and energy into owning this property—why should you forego your earnings?
Don’t worry, there is a fifth option. This lesser-known and fairly new option allows you to keep all—or most—of your proceeds for yourself to reinvest in a new asset, allowing you to regain maximum cash-flow on this once locked up profit.
Option five is available to sellers of highly appreciated properties. An IRS-supported tax-planning approach allows sellers to receive a tax-free lump sum nearly equal to their selling price at the close of escrow. This lump sum can be reinvested without time or asset class restriction and even allows you to defer the tax bill.
Working your Investment Dollars Harder!
This relatively new option is a game-changer. A tax-free lump sum allows you to reinvest your equity-suffocating appreciated asset into a cash-flowing asset, thus recouping your hard work and effort. Now you have the ability to carefully select an area that has proven property values in line with current market rental rates. This exit strategy is clearly a win-win on every front!