Do you have an exit strategy for that real estate deal?
Everyone gets into property investment with a reason. Some investors are searching for monthly cash flow; others are building a retirement home while some are looking to cash in on a seemingly lucrative deal.
Whatever your reason is, it is important to have an exit strategy should your investment fail to bear fruit.
Simply put, real estate exit strategies are a means for investors to profit from property, says Dr Raphael Kieti, a lecturer at Technical University of Kenya, in the department of Real Estate and Property Management.
Mr Johnson Denge, a real estate services manager with Cytonn Investments adds, “It is also a way to earn income by acting middle-man in some real estate deals.”
Deducing from the two realtors’ viewpoints, real estate exit strategies can be viewed as a three-sided coin. On one angle, it can be viewed from the point of an individual who wants to exit from the developer side of real estate to the investor side. In this case, he or she stops building houses and selling them instead, or jumps into buying property and leasing or renting them out.
On the other side, one can look at it from the point of an investor who wants to sell his property, such as a residential or commercial building and venture into something else, for example, manufacturing. Last but not least, it is seen as a way to cash in on a lucrative deal, for instance, buying a house, sprucing it up, then reselling at a profit.
For novice property investors, it might appear too early to start thinking about an exit strategy even before closing the real estate deal, however, real estate insiders concur that the end might come a lot sooner than expected.
Mr Denge gives an example of the impending closure of the Dadaab Refugee camp and the subsequent relocation of refugees to Somalia as one reason you may need to get into real estate with the end in mind.
While the camp had made the real estate and other business ventures around it very lucrative, its closure would mean a fall in land prices, plunging of business activities and a decline in population.
He wonders what will happen to property investors who had set up accommodation spaces to serve the local and international work force here.
CREATING AN EXIT STRATEGY
With such outcomes in mind, Esther Kiarie, a property valuer based in Mombasa, says that being intuitive and looking at the bigger picture will help an investor come up with an exit strategy that not only disposes off a property, but also rakes in some good returns.
“You need to ask yourself questions such as ‘for how long do I intend to hold this investment?’” Holding a property for up to five years can for instance bring more profit on a sale compared to holding it for one or two years and then selling it off. This is because real estate normally appreciates in value year after year.
Consequently, questions regarding the type of buyer who would want the property at hand and how a sale will affect the taxable income should also come up in the course of devising the most appropriate real estate exit strategy.
“If you are building hostels, the neighbouring universities should top your list of prospective clients if you plan to hold on to the property and earn rental income for some time before disposing it. On the other hand, if you plan to complete construction then sell off the property, you need to know that the taxman would like to get his hands on as much of the income (capital gain) that you earn from the property sale as possible. It is therefore wise to consult a tax professional,” says Ms Kiarie.
Dr Kieti and Mr Denge outlined examples of real estate exit strategies that are common in the Kenyan property market for us.
Mr Denge outlines three methods of sale through which an individual can exit the property market. These are fractional sale, timeshare and sale as a going concern.
Under fractional sale, several unrelated parties share in and mitigate the risk of ownership of a high-value tangible asset such as residential units or office spaces.
Timeshare, also known as vacation ownership, refers to an arrangement where unrelated individuals buy a unit of a property, mostly a hotel room, for a certain time. This means the property is put under a single management and each sharer is allocated a specific time of the year to use the property.
With this kind of an arrangement, the property owner receives a stream of income from the property managers for the units which are usually on partial ownership, lease or ‘right to use’ basis.
Sale as a going concern involves selling out an already occupied property such as a residential or commercial building to a buyer who pays the lump sum and takes over any obligations accrued to the property henceforth.
“As property prices go high, buyers become fewer,” says Dr Kieti. Individuals who own big, high-priced properties therefore sometimes find it hard to get a buyer. In such a case, a joint venture arrangement would work best. In a joint venture, the landowner looks for a strategic partner to develop the land by building say, residential or commercial properties. After completing the project, the developer and the land owner then work out a profit sharing formula.
“That could be one perfect way to exit a vacant land and make money while at it,” says the lecturer.
A rehab involves purchasing a house, renovating it and selling it for more than the original investment costs (purchase price and repair costs).
Sprucing up a house for sale through repainting and repairing or replacing faulty appliances will not only make the house more attractive to prospective buyers, but will also scale up its going price. However, before putting his money where his mouth is, an investor should first establish whether the forces of demand and supply are in his favour.
“Are you in a buyer’s or a seller’s market scenario? In a seller’s market, the demand is usually high and the seller determines the prices.
On the flip side, the buyer dictates the prices in a buyer’s market, where, unlike in the seller’s market, the supply is usually high. Essentially, if you inject money into buying and rehabilitating a house for sale in a seller’s market scenario, you are bound to reap in great returns. The vice versa is true for a buyer’s market scenario,” offers Dr Keita.
EXIT THROUGH A DISCOUNTED PRICE
To fully understand this concept, Dr Kieti gives the example of an investor who owns a half-acre piece of land in Kitengela. In an effort to exit the property market, he puts up the land for sale and gets a serious buyer who is willing to part with Sh7 million instead of Sh8 million the land is going for. At this point, he says, the seller has to make a decision whether he wants the offer at hand or he or she is willing to wait for Sh8 million in future.
“Because money has a time value, you would rather take the Sh7 million today, which is below the market value rather than wait for the uncertain Sh8 million in future.” He says a wise bet would be to take the money offered, as long as it is not way below the market price, then put it in another investment vehicle such as the Stock or the foreign exchange market (Forex) to raise the Sh1 million deficit.
Getting a buyer in real estate is no walk in the park though.
“It is not only challenging, but also costly. Advertising the property in the media and on social media is both costly and time consuming. Again, if an agent gets you a buyer, he or she will want a fat commission,” says Dr Kieti.
SALE AND LEASE BACK
To raise cash for its turnaround programme, retail chain, Uchumi Supermarkets, late last year announced that they will be selling Uchumi Ngong Hyper mall, which sits on 2.5 acres, but continue occupying the sizeable area as tenants. Mr Denge says that this is a perfect example of sale and lease back arrangement, where an institution or organisation sells its property then rents it back from the buyer. In that case they move from owners of a property to tenants.
“When you sell your property, you are enhancing your liquidity as an organisation or an individual, which will help you to finance your operations or acquire other properties,” says Mr Denge.
EXIT THROUGH REIT
Real Estate Investment Trust refers to a concept where a real estate company acquires a high yielding property then divides it into shares for listing in the stock market. Instead of people owning titles to the property therefore, they own shares that stream in cash. Unlike in other developing countries such as Singapore and South Africa where REIT has caught on well, the Kenyan market is still struggling to understand the concept. Indeed, Stanlib’s Fahari I-REIT, the first REIT to launch at Nairobi Securities Market (NSE) is trading at Sh11.30 down from Sh20 initially.
Both Dr Keita and Mr Denge are ambivalent about the concept.
Dr Kieti says: “We Africans like owning a title to a property, however, in REIT, you only own shares. The public is yet to understand this concept, but it is a good concept all the same.”
LEASING OR RENTING
According to Mr Denge, different real estate deals need an exit at a certain stage. For instance, a residential house will need to exit into the market once construction is complete. He says that leasing or renting is driven by the need to have an income stream. It is also a good exit strategy for an investor who wants to exit from the developer side and jump into the investor side, however, this comes at a cost.
“The investor will now be required to manage the property personally. In case he decides to put the house under a property manager, he or she will be charged for that service.”
There you have it.
REASONS FOR EXIT
Real estate not a core business, or to exit a non-performing investment, in which case, the purpose of the exit strategy is to limit losses.
An exit strategy may also be executed when an investment or business venture has met its profit objective.
Change in market conditions due to a catastrophic event; legal reasons, such as estate planning, liability lawsuits or a divorce.
The investor is retiring and wants to cash out.