What would be your exit strategy be on this fourplex?

Question

Hi BP! Newbie here. I am in contract for a fourplex. I am purchasing it for $250,000. It is located in an area where property values have continued to increase annually. I would like to fix up units as they become vacant and increase rents. Potential rent is $3,000/ month ($750/unit). There is currently one vacant unit and one unit being rented below market rent. My plan is to budget $2,000-$3,000 per unit for the rehab. My long term goal is to scale by owning one apartment with many units. I am wondering which exit strategy will work best. Here is my logic on each exit strategy.

Which exit strategy would you choose?

Option 1- BRRR. Pro: I can use cash out money to purchase another property and still benefit from cash flow of this one. Con: Decreases monthly cash flow on property. Short lived until next property starts to cash flow.

Option 2- Value add. Add value by fixing up properties. Get rents to market value. Hold for 2 years while increasing rents each year. Sell and purchase larger property. Pro: No need to fix up properties as nice as if I was relying on a cash out for BRRR. Just nice enough to increase rent. Con: Money tied up in property for 2 years.

Option 3- Combination of option 1 and 2- Fix up property and increase rents. Cash out refinance. Purchase another property with the cash out money. Sell property in 2 years in order to purchase larger MF.

Option 4: Other. Enlighten me.

Lindsey Clark · Answer

Especially in this market. We really don’t know what it will look like in 2 years. I’m flexible either way. If I end up holding the property for longer than I plan and “only” get to cash flow, that doesn’t sound too bad either. @Nick Robinson

Nick Belsky · Answer

@Jon Kelly I am with you about increased rents and value. Especially if you are financing with Debt Service Coverage Ratio (DSCR) loans. Higher cash flows strengthens the deal. Banks will follow the Fair Market Rents determined by an appraiser. The appraiser will use comp, condition, and history to determine.

Lindsey Clark · Answer

@Nick Robinson yes I am ok with that. I am purchasing the property below market value. Comps are selling for $280,000-$290,000. Between buying right and the down payment I am hoping with even a little appreciation there will be enough equity to 1031 into something bigger in 2 years. Cashing out after a rehab to buy more property would be a good idea so I can keep BRRRing until it is the right time to sell all of the properties and buy one large apartment like @Erickson Sainval suggested.

Nick Robinson · Answer

@Lindsey ClarkI have no idea where your 4plex is but raising rents does not increase the value of residential property. That only works for commercial MF (5+units). I think you are underestimating the "rehab" only spending $2,000-$3,000/unit. That basically is just a little over getting the units rent ready. If you want to own apartment buildings my plan would be to get this asset to CF and when it has appreciated enough to buy a MF 1031 into more units. It may take awhile for the principal reduction and appreciation to take effect. I am saying that without knowing the area but if in this market you are buying it for $250k it probably is more a CF market than an appreciating market. Not saying its a bad deal if it is cash flowing well that will help get your next property while you are waiting to move to a bigger deal. @Eric JamesI have to disagree with you about the 1031 exchange. You have plenty of time to trade into a new property if your prepared. I have done multiple 1031 exchanges and have found my down leg/ exchange property while I am in escrow each time. So the time limit is never an issue as long as your prepared. If you aren't prepared you can run into trouble doing 1031 exchanges. Now if Mr. Biden is able to get his limit on 1031 exchanges I agree you do not want to pay capital gains so then I suggest refi' till you die.

Eric James · Answer

A problem with the selling options is selling and finding another property to purchase within the 1031 time limit. You don't want to be paying taxes on your gains every couple years.

Lindsey Clark · Answer

Thank you for your responses everyone! I am seeing the big picture more clearly now.

Evan Polaski · Answer

@Lindsey Clark, as noted all three options entail the same plan. Buy it and start renovating. Typically, you will get a better sale price than appraisal on a cash out refi, but I think the exit will be determined by the next property more than what you want think you should do now. Create the value at hand, then start looking for your next opportunity. If the next property can be executed with a cash out refi, then do that. If you need the additional capital from a sale, go that route.And while it is true that a 4 plex is valued based on comps, what many people seem to forget is that a GRM valuation is a standard valuation technique on a residential appraisal. So more rent should help your appraised value.

Lindsey Clark · Answer

I will keep that in mind @Darius Ogloza. Tenants pay their own utilities except for water. I did include that into my analysis.

Nick Robinson · Answer

@Lindsey Clark @Jon KellyI agree with both of you guys that a building that makes more income is more appealing to a buyer. The way residential properties are valued is based on comps tho so if the appraisal doesn’t come in at the value you want you can not refinance it or sell it for a better price, unless someone is willing to make up the difference between the sale price and the appraised value. That’s why I asked are you comfortable holding the property long term. I was asking because a lot of people on BP make the case that their building is going to appreciate so much in one or two years they will be able to refinance or sell it and make a ton of money. Basing everything on appreciation is speculation ie gambling. The goal in real estate is “Don’t wait to buy real estate. Buy real estate and wait” and cash flow allows you to hold on to the property long term

Darius Ogloza · Answer

Finding a lender willing to do a cash out refi on an investment property can be difficult. If you do, you will almost certainly be paying a higher rate for the loan than your purchase money mortgage. Also, your taxes will be stepped up after closing, especially in an appreciating market (as you describe it). Does the building have split electrical/gas utilities? You almost certainly will be responsible for the water bill. Make sure your cash flow analysis takes these factors into account.