There is a common saying, “By failing to prepare, you are preparing to fail.” Savvy investors know this is particularly true in commercial real estate investing. The importance of having a NNN investment exit strategy is this: to not only get the money you put into your income property out of it but also make a profit.
The path to an exit strategy that best suits your goals starts with answering a few questions such as why you are buying the property, how long you plan to keep the property, what your tax objectives are, and whether you want to upgrade and sell or buy and hold.
Let’s explore these questions in greater depth and talk about the types of exit strategies that may best suit your financial and lifestyle goals.
Why Am I Buying the Property?
The first and most important consideration is why you are buying the property.
- Are you looking to buy a property for the extra monthly income?
- Do you plan on passing this property to your children or grandchildren?
- Perhaps the NOI on this property will support you during retirement?
- Do you need this property as a 1031 exchange or tax shelter?
- All of the above?
There is no right answer, but whatever you decide will help set the tone for choosing the right exit strategy.
How Long Do I Plan to Keep This Property?
How long will I keep this property? The answer may determine your financing choices and whether it is best to take on debt or pay cash.
The type of loan you choose to finance your investment property and the interest rate can be affected by whether you keep it for the short-term or hold on to it for 10 to 20 years.
You may also plan to use all cash for your investment. Some investors use cash-on-hand and flip the property when the market is just right to get a fast return on investment. This is all dependent on certain market factors such as cap rates, supply and demand, etc. Other investors may pay all cash and keep properties for the long-haul, using depreciation and other tax benefits for increased returns.
Be sure to talk with your CPA and learn which financial options are best for your situation, then you can answer this question with a bit more confidence.
How will Selling the Property Affect My Taxable Income?
How will selling affect my taxable income? This is a critical question and one that greatly affects the success of your investment. Planning for taxes is essential, lest you get hit with easily avoidable penalties, or worse, eat up most of your profits paying capital gains tax.
The most common way to defer the tax on profit from the sale is by using a 1031 exchange to purchase another like-kind property. Due to the short 45-day timeline to officially identify the property you plan to buy in the exchange, it’s best to start the process of talking to a buyer’s advisor before you sell the property.
Another possible tax consequence is depreciation recapture, which will vary greatly based on how long you own the property and what type of depreciation you utilize. If you’re unsure, consult a tax professional before you purchase the property so you can reduce your tax burden right from the start.
Want to Upgrade and Sell?
Do you prefer to find investment properties that can be upgraded and sold within a few years? Typically, if you buy an absolute NNN lease property with a long-term, corporate-guaranteed lease, the tenant will make all the upgrades to the property to fit brand uniformity. In some cases, investors may buy at a higher than average cap rate and can sell at a profit if cap rates decline.
Thinking of Buying and Holding?
Interested in holding a property for the long-term and enjoying the monthly income? A triple-net lease property would be a great fit. Most NNN lease tenants operate under 10- to 20-year leases with extension options. These leases provide a steady income for the length of the lease with few or no landlord expenses or worries.
When you hold the property for many years, there are different tax opportunities that can increase your overall internal rate of return (IRR) and decrease your tax liability.
Other NNN Exit Strategy Factors
When you choose to invest in a NNN lease property, many of other factors also play a role in your exit strategy:
- Market conditions
- Location of the property
- Purchase price
- Property value
- Type the property
- Type of asset class
- Lease type
- Financing options
- Profit potential
“Investors are often unsure of the proper exit strategy. Westwood can offer a detailed analysis year after year to determine a tailored approach to our clients’ needs.” – Chris Schellin, President, Westwood Net Lease Advisors
Types of Investment Property Exit Strategies
Now that you have established your rationale for buying an investment property and your future financial objectives, here is a shortlist of possible exit strategies.
- Keep the property long term and reap the benefits of income, tax advantages, and financial leverage.
- Buy and sell the property as soon as it makes sense for your goals, reinvest, or cash out.
- Sell the property after two or three years, then trade-up in a 1031 exchange.
- Gift the property to heirs (be sure to look into the 1031 exchange for this transaction).
- Effectuate a cash-out refinance loan; additional money can be used to buy a new property.
Over time, you may have more than one exit strategy. Chances are, you will likely have one type of exit strategy before you purchase the property, another one after you’ve owned it for a while and have a better handle on things, and a third strategy composed right before you plan on exiting or selling.
Simply start with a solid plan that gives you the most direct route to your destination and follow the path it takes throughout the course of ownership, always with a documented exit strategy.
To Wrap it Up – Have an Exit Strategy as You Plan Your NNN Investment
As you can see, an exit strategy from the very start of your NNN investment journey helps define the entire process. Though that plan may change over time, knowing why you’re buying and what your long-term goals are will ensure you buy the right property for your objectives.
If you have questions about commercial real estate exit planning or would like to learn more about NNN lease property investing, Westwood Net Lease Advisors educates, advocates, and represents our buyers from the planning stage all the way through closing, at no charge. Contact us today for your free, no-obligation consultation. 314-997-5227