When in the market cycle is it best to do a 1031 Exchange?

Question

Hello,

Almost 2 years ago my company purchased a small 2 bed, 1 bath SFR rental in Tampa for $40,000 cash. Title was vested in a land trust with my LLC as the beneficiary.  The property has stabilized and is cash flowing at $325/mo after accounting for all recurring holding costs and maintenance expenses.  The property is located near the boundary of the Tampa InVision Revitalization zone.  Over the past two years the city has been executing this revitalization plan and the neighborhood is improving. Current Fair Market Value is approximately $72,000.  I am thinking about doing a 1031 exchange next spring into a 6-8 unit apartment in Tampa or Jacksonville where I have an established team.

Is this the right time to do the exchange?  Property values are increasing and I can use the appreciated value of my Tampa rental for a larger down payment for a larger multifamily apartment with higher cash flow.  However, in this appreciating market the apartment I want to exchange into will have a higher purchase price.  Should I rather wait to exchange until there is a dip in real estate values?

Thank you,

Shane

Account Closed · Answer

Now, to answer your question about the best time to a 1031.  All things being equal, the best time to do a 1031 is during a recession.

Say you have a property that's worth $100k.  When the market dropped 30%, your property would worth $70k.  However, that $300k property that you want to 1031 into would now worth $210k, all things being equal of course.  When the market doubled again, that $70k property is now worth $140k while your $210k property is now worth $420k.  That's a $210k gains in equity compared to $110k gain had you exchanged into it at $300k.

It sounds counter intuitive, but most people do the opposite. They tend to move up when the market is up.  Could this be the explanation for why 10% of the people control 70%+ of the wealth?  It can be scary going against the herds.  Regardless of which decision you make, I hope it's the right one.

Good luck.

Bill Gulley · Answer

I would not confuse future performance so much with tax deferred proceeds based on a sale at a point in time, other than to look at the MIRR, present value of the tax advantage.

If the market in JAX is a buyer's market, I'm not selling at a premium potential, I'd have less gains to defer.

Can you borrow the equity and use that in a hotter, buyer's market for you next project?

Can you pledge that property to move into the next buy?

With apartments, don't over look the possibility of seller financing. If you need to, pledge the existing property, wait for a better price, then sell.

Get with @Bill Estes, a member here (can't mention him), you may be able to swap as well.

Keep the options open! :)

Shane Clark · Answer

@Robert Curls taking out debt against my Tampa property is definitely an option. The reason I'm leaning away from that option is because it was built in 1986 and I see some major CAPEX if I hold on to it for the next 5-10 yrs. Small 2 bedroom SFRs will just never realize the same level of appreciation as other more desirable properties. When it comes time to make a decision and I have already found a potential replacement property, I'll just have to pencil out the numbers and see which option will yield the best long term return for cash flow and appreciation.

Thanks Robert for the input

Joe Fairless · Answer

@shane

@Shane ClarkI would see if you have any multifamily properties that you can buy at a good price. If you find something then I suspect you can find a buyer for the single family and make the deal happen. That might be easier than determining the exact right moment in a market cycle.

Eric Odum · Answer

If you find a deal that reasonably cash flows, why does it matter?  The better question should be, "what else can I do with the money besides real estate?"  The spread between the 10 year treasury and MultiFamily in Tampa is what 5-6 points?  Three years in a treasury as opposed to a 7.5% CAP multifamily is ostensibly a self inflicted tax....if that spread were considerably less, I might be more inclined to pay the tax and move in to the treasury.  Spreads right now between the two yields are actually pretty reasonable from a historic perspective.  It is tough to find yields right now....doesn't matter what asset class that is out there.

Dave Foster · Answer

@Shane Clark

Timing the market is tough anyway.  To time the market for a 1031 is a double edged sword and you kind of have to pick your druthers.  To sell in a rising market means that replacement properties can be scarcer and more expensive.  But you are positioning your property to weather the next down turn.  Sell in a falling market and you risk chasing it downward to get your sale accomplished. But your chances of getting higher ROI on a cheaper replacement are greater.

The 1031 as a tool can work to your advantage either way. Let the present numbers speak and take the long term positioning as a bonus to your ROI

Jack B. · Answer

This seems like a great explanation actually.

Shane Clark · Answer

I agree with you @Dave Foster. Account Closed's analysis is very insightful in one local market and I will keep that in mind when we see the next recession to step up my investments in each local market I am positioned. What I like most about real estate investing is the fact that it is all local and granular. I'm beginning to realize just how powerful 1031 exchanges can be to jump from one "geographic cone" to the next. I think my future real estate strategy will take a two prong approach. For now I am jumping from market to market because I am still starting out with limited capital and merely shift markets when I get priced out of an appreciating MSA.  Eventually I want to pick one or two locations to vertically integrate and acquire my larger apartment complexes using in house teams and management. However, I don't ever want to get comfortable in one location and lose my remote investing skills because the local nature of this business is one of the greatest advantages real estate has over other asset classes.

Dave Foster · Answer

@Shane Clark

I wanted to respond to Account Closeds comment on cost of an exchange.  The fee quoted there is a very far outrider in my experience.  Most 1031 exchanges in that range would cost much less than $1,000.  So to spend less than a grand to shelter 6 or 7 is something to ponder.

I've been struck by the chronological - market cycle thinking of the group on this question until I re-read your first post and looked at the contributor list to this question.  There are investors from all over the country chiming in on this.  And you yourself talked about the underperformance of Jax compared to the Tampa Bay area relatively speaking.  With that in mind I"d challenge you to consider the best time to 1031 is anytime bull or bear market when you see a geographic disparity in relative appreciation and market returns.  Just like most of the BP contributors.

The power of the 1031 allows you to move from "cone" to "cone" of opportunity geographically as Richard Mayberry said.  I think you're right on in your reasoning to move from one geography to another using the 1031.

Account Closed · Answer

Shane,

I'm a little slow so please take it easy on me. I see a $32k potential gains. After transaction costs and commissions, you're looking at about $25k gains. Your tax liability could be zero to 20% depending on your tax bracket.

I suggest you talk to a 1031 exchange expert on the fees and costs to do a 1031 before moving forward.  The last time I talked to someone at First American Title, he said the fee is about $10k to do a 1031 exchange.  Of course, property prices are much higher in CA.  With that said, paying the taxes might end up being a wash or cheaper after all said and done, and you don't have the constraint to identifying replacement properties in 45 days and closing in 180 days.

Just my 2 pennies.  Have fun researching and investigating.

When in the market cycle is it best to do a 1031 Exchange?

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