Exit Strategies For The Real Estate Investor

	By David Zaslow Partner Real Estate Group dzaslow@rbz.com
Publication Date: Fall 2005
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Investing in real estate has always been challenging. The monitoring of a specific real estate investment is much more difficult than monitoring a diversified portfolio of stocks and bonds. The average investor feels much more comfortable with stocks and bonds because they provide a daily valuation, regulated markets with the liquidity and ease of buying and selling. On the other hand, real estate is not liquid, has to be properly managed and requires a series of rental reports, which include statements of profit and loss, rent rolls, budgets, collections reports, etc. Since real estate is a more difficult investment to own, it requires much more long-term planning with an “Exit Strategy.”

What is my Exit Strategy? That is the very first question to ask before purchasing real estate. Value can be added at the time of purchase and/or during the holding period. However, it is imperative to have an exit plan in order to maximize the value added. Investing in real estate can be financially rewarding as well as personally rewarding if decisions are planned properly. Every investor of real estate knows the value of land because “they are not manufacturing any more.” With the increase in population, environmental concerns, construction costs, building requirements, inflation and low interest rates, real estate will most likely continue to increase in value.

The big questions become: which property to buy, how long to hold and what is the exit? In order to answer those questions, it is important to have a planned Exit Strategy. The phrase “Exit Strategy” sounds final. However, it is the process of achieving where you want to be in three years, five years or twenty years, etc. Once your goals have been determined with your target in mind, the real estate investor can focus on maximizing profits and building for the future.

The following are Exit Strategy alternatives that could be considered:

1. Family succession
2. Sale to unrelated existing co-owners, partners or employee group
3. Sale to an outside third party (all cash or with a note receivable)
4. Tax-free exchange into a TIC (tenant-in-common) interest of an REIT
5. Contribution to charitable organization(s)

Family Succession

The basic American dream is to leave your real estate to family members. That is sometimes easier said than done. There are many issues and considerations that must be addressed, such as:

1. Who will take over management responsibilities?
2. Who will make controlling decisions?
3. Is the voting determined by ownership or by formula?
4. Does new management have the authority to sell the real estate?

Usually the parents who have managed the real estate investments want to reduce their participation and a family member is brought into the business. With planning, the above issues can be addressed. It is sometimes difficult for parents to relinquish control of the companies they built and a family member is not always available to take over the responsibilities for the succession transfer. However, some parents prefer to relinquish control during their lifetime in order to determine if the succession plan is working.

Sale to Unrelated Existing Co-Owners, Partners or Existing Employee Group

Selling to co-owners, existing partners or an employee group can help to make the succession plan “seamless” to outsiders. It will also reward those who have helped build the real estate organization and act as an incentive for those individuals to continue to maximize the future potential. Selling to those individuals, integrated with estate planning, can maximize the benefit to the sellers. For example, if planned properly, income taxes due to the potential sale of these properties could possibly be deferred and/or avoided.

Sale to Outside Third Parties

The sale to outside third parties would be applicable when no family members, existing co-owners or partners are available to step in as purchaser. There are a new set of issues to be addressed if the properties are sold to third parties, such as:

1. The amount of income tax to be paid by the seller due to the gain on sale (which would include applicable gain due to depreciation recapture).
2. Prepayment loan penalties.
3. How to invest sale proceeds (net of income tax) after the sale.
4. In reference to estate planning, do you want to leave liquid assets to your beneficiaries?
5. This exit strategy is final. Are you ready to make this decision?
6. Installment sale vs. cash sale.

Tax-Free Exchange into a TIC (Tenant-in-Common) Interest of an REIT

This area can have some very favorable results if the existing owners want to turn over management to an institutional type of process and do not need immediate liquidity. It is also possible to avoid owing income taxes on any gain or depreciation recapture. This could also be an advantage to families who do not have the ability to have a succession plan. If these properties are of institutional quality, they can be contributed to an REIT in exchange for units of the REIT. If the properties are not of institutional quality, they can be sold and then exchanged for REIT properties as tenants-in-common. If structured properly, these contributions to an REIT might not result in a taxable event until such time as the units are sold. This method can accomplish many goals to obtain the proper exit strategy. However, the quality of the REIT and its management must be thoroughly investigated before proceeding in this manner.

Charitable Organizations

Charitable giving is always an option. There are many methods of making the contribution, depending on the year or years the deduction is taken, control and use of the property during the contributor’s lifetime and coordinating with an estate plan. No matter which option is used, they all result in giving up control of and the property itself at a certain point in time.

In conclusion, many issues must be addressed before the Exit Strategy alternatives can be pursued. Many real estate owners have spent their lives acquiring, managing and adding value to their real estate investments and very little time spent in “Planning an Exit Strategy.” Your Exit Strategy will help you make better decisions for the future. The Exit Strategy must be compatible with your personal goals for income, flexibility, family, retirement, lifestyle, and so on. Exit planning involves complex issues, such as wealth preservation, contingency planning and income tax, estate and gifting regulations. There is no “one-size-fits-all” answer. You have spent your life making sound real estate decisions; you now owe it to yourself to spend the time to make the most important decisions for the future. These decisions for the future could also affect the charitable organizations of your choice and the ones you love the most.