Planning an exit strategy: before parting with a property, independent rental owners should consider how to avoid the two most common mistakes.

Because it takes so long to find good real estate deals, many independent rental owners become "buy and hold" investors who don't consider selling their properties. However, there are many circumstances that warrant selling a property, and if owners find themselves in those situations, they need to have an exit plan.

Mistake 1

No 1031 Exchange Plan

The most common mistake real estate investors make when selling their property is not having a solid financial plan--usually a real estate deal--to invest the sales proceeds or profit after the sale.

Investors who are in escrow need to reinvest to defer large tax consequences, a process called a 1031 tax deferred exchange. (See sidebar, page 41.) Because of the short timeframe required for investing the profits, one of the most important tactics in executing a successful 1031 Exchange is to have a solid real estate deal to "roll" in the profits. Smart investors usually have several real estate deals lined up before they put their property into escrow.

Smart investors also have an extensive network of real estate contacts that continue to provide them multiple real estate offerings at any point. These real estate relationships need to be established and nurtured before, during and after a sale.

For example, a California real estate investor recently accepted an unsolicited offer on his property. The price was significantly higher than he had paid just five years ago. Unfortunately, he was looking at the dollars and not at the strategy of what to do with the profit.

This rental owner took his money and invested in a market with which he was unfamiliar. He did not have time to adequately check out a new real estate deal before making a purchase. The time constraints required for the tax-deferred exchange, combined with the lack of planning, led him into a poor real estate purchase.

The money this investor saved by "exchanging" and deferring his taxes was not really a savings for him. Because the newly purchased property was poorly operated when he bought it, the property had negative cash flow and deferred maintenance that required real cash.

The point here is simple. If this investor had been reviewing properties before he sold his property he would have made a much better investment decision.

Mistake 2

A Poorly Positioned Property

The second most common mistake that most investors make is poorly positioning their property for sale. Getting a property ready for sale requires looking at every number very carefully, because the numbers determine the property's value. Ultimately the goal of the seller should be to maximize the cash flow.

There are many ways to maximize cash flow beyond normal operations. One way is to maximize the rental rates when a vacancy is created and before a new renter moves in.

A property that has been 100 percent occupied for several years may be good for cash flow, but it probably means that rents are too low. An independent rental owner should consider increasing rents to the market rate and creating some vacancy. A smart investor will not only see a rental increase opportunity, but also will calculate some vacancy factor in the purchase. An investor's job is to recognize this before listing a property for sale.

Smart investors know that property values are based on income, and smart property owners will attempt to maximize the income before listing a property for sale.

This is part of a collection of articles from owner/author Ken McElroy, who wrote "The ABC's of Real Estate Investing," which was released in September 2004 and became No. 1 on the BusinessWeek best seller list in December 2004. See "Investing in the Right Market" in the May 2005 issue of UNITS, and "Manage and Learn" in the June 2005 issue of UNITS.

Ken McElroy is President of MC Really Advisors in Scottsdale, Ariz., and a NAA Region 7 Vice President. He can be reached at 480/998-5400.