When to Sell a Successful Project and Trade Up via 1031-exchange in Today's Market

Question

Hi All,

I bought a SFR in the KCMO area back in January 2021. It has strong cash-flow but has also appreciated quite well. I am struggling to understand how to pencil out at what point the correct decision is to "trade-up" from this successful property through 1031-exchange so that I am making the best use of this investment capital. With the low 30yr fixed interest rate I have locked in, and the solid cash flow from this stabilized property - I am finding it difficult to make the decision to 1031 into a bigger property given current mortgage rates in the 7's-8's. But at some point, I am just not making best use of the ~100k equity sitting in this property - So, at what point does RoE drop far enough that the only logical financial decision is to 1031-exchange and trade-up?

Thanks in advance for your advice/opinions.

Purchase: $136,000 - Jan 2021

Current Loan Balance: $126,585

30-yr fixed Mortgage (3.875%): $979 PITI

LTR Monthly Rent: $1595/mo

Cash-Flow: $1595 (rent) - $979 (PITI) - $200/mo (CapEx/PM/Repair/Vacancy/Contingency) = $335/mo

This leaves me with an approximate RoI: 9% and RoE: 4%

Estimated Current Market Price  (Dec 2023): $230-240,000

Estimated Post-Sale Equity: $ 90,000 - 100,000

Key assumptions:

- The area the current property is in is not suitable for transition to MTR/STR strategy to boost current cash-flow.

- I do not live in the KCMO area and do not have the option to house hack/owner occupy any new purchase.

- With current investment property HELOC rates in the 10-15% range, I do not see this as a viable option currently to access my equity position.

- My 15 year goal (currently in year 3) is to replace my current income with stable passive real estate cash-flow and retire.

Alex Olson · Answer

I think so many investors at this point get holed up on finding as good of a deal or better than "the last one." Where as that is not what you are needing to do with a 1031 exchange. The goal is to look at how much you like the property you have (tenants, location, structure, style, payments etc...) vs what you could get with the equity you have. It improves your life, I would do it. So many investor get held up on current rates - it is not about the rate, it is about the asset. This is always true. We have helped investors with this same conundrum in KC for quite some time.

Jacob St. Martin · Answer

Hello Jon,

You are definitely thinking through this in the right way. Your return on equity is pretty low so I agree that it is time to utilize that equity somehow. As you mentioned your two options are take out a heloc or sell. Here are the things that I am thinking:

1. How strong is the market that you first rental is in? It seems like you property has nearly doubled in a two year period which is pretty crazy. Do you think there is enough demand that you will continue to see prices rise at that pace? I'd be hesitant to sell in a market with that much appreciation.

2. What is your strategy for redeploying whatever capital you get out? With rates as high as they are it really only makes sense to use the heloc if you are doing something that has a relatively short time horizon like a flip or BRRRR.

3. How confident are you in your ability to find a good deal if you sell? The worst thing you can do is sell out of an appreciating asset, not be able to find a good place to park your capital, and end up paying capital gains tax AND not having an asset, or being forced into a bad asset before the 1031 window runs out.

From what I know it sounds to me like the best option is to get a heloc and to start looking for a flip or BRRRR. The heloc won't accrue any interest until you pull from it, so you are not time pressured, it should allow you to force equity on whatever property you get into which is great, and you still have your assets in what seems like a highly appreciating market.

i hope this helpful! Feel free to reach out if you have any more questions!

Dave Foster · Answer

@Jon Edmondson, good words by @Alex Olson and @Jacob St. Martin.  Folks get frustrated with 1031s because they can't find "better" deals.  But when you think that you sold your property at the top of the market to start your 1031. It's probably unreasonable to think you'll be able to buy at the bottom of the market to complete your 1031.  So price and equity alone aren't the reason to sell and 1031.  But what is

1. Move from high potential capx to low.

2. Go from one to several purchase

3. Go from several purchase to one.

4. Change class of real estate

5. Improve cash flow (or potential cash flow)

And it is this last one that is intriguing right now because it illustrates Warren Buffet's feelings about buying in a market.  He's said several times that he wonders why people buy stocks that are climbing and sell during down turns.  When he does exactly the opposit.

The thing that has softened the market right now (although it's not all that soft) is the interest rate. But that's the one thing you can change whenever you want without creating a taxable event.  Maybe you can sell and 1031 into a couple of properties that don't give you any better cash flow yet. But are simply waiting for rates to drop a little and they become cash cows.

Lot's of people say marry the property and date the rate - there's truth in that.  Or have another "why" to sell that property.

When to Sell a Successful Project and Trade Up via 1031-exchange in Today's Market

Most Popular Reply