Sell SF for South LA?

Question

I've been going back and forth on selling my SF 1 bedroom condo in a 1031 exchange for a duplex-like property in South LA.  I'd really love some thoughts from the BP community on this.  Let me give more details to give some rationale behind my thoughts:

My SF condo is breaking-even and although it is technically not under rent-control, my current tenant has a LIFETIME lease.  To keep this explanation brief, in exchange for converting our TIC to condo in SF, I had to offer my tenant a lifetime lease.  Once she leaves, no rent-control. My tenant has lived there for 3 years now.  She's young, late-20's or early-30's.  Not married.  No kids - yet.  I could wait, but I've owned this property for 11 years and only last year, I finally broke even.  (Now mind you, I lived there and did not originally buy it for investment purposes).    I'd really like to buy something that cash-flows.  Here comes my idea to buy in South LA.

I work in South LA so earlier in the summer, I was flirting with the idea of buying 2 detached homes on a lot (Idk if that's the definition of a duplex), each home with 2-3 bedrooms.  Looked into the prices (mid-$400s to $500) which is what I would 1031 exchange my SF for, and it would cash flow - very conservatively speaking - at least $1000.

Does this seem like a no-brainer thing to do?

Steve Kiser · Answer

@Mabel Lung, I don't respond to post too often (but I am endeavoring to do so more in 2017).  Here are my thoughts staring with the cond on SF.

First looking at the motivations for your tenant, this is a hard deal for her to turn away from.  A lifetime agreement with, based on what you mentioned, modest rent increases.  What motivation does she have to leave?  Until she is married with kids, I would assume very little.  So given that it is break even, selling this might be difficult.  Also, depending on how the lease was written, I would ask another question which is, does she have the ability to sublet.  If so, then this property is never going out of her hands.  Make sure you have these issues identified before you start to market and move the property.  I am certain that you can sell the property but you would need to do so the the right person.

In regards to So Cal, my first question is why there?  Lots of places have housing shortages.  What draws you to So LA?  What kind of tenant are you looking to serve?  For my multi-family we aave only purchased B/C complexes.  For houses however, we focus more on the A/B market.  The expectations are different and the returns are different.  I would suggest that you have a good idea of who you are looking to serve before looking for the property.  After the 'who' question, the ask the where question.  Where do the numbers make sense given the client that you are looking to attract.  Do you have a team or the ability  to assemble the team to support you.

Lastly, while appreciation in SF or even in LA my be attractive, I would caution you to not count on that as, unless you are finding a way to manufacture the appreciation, don't count on it.  By manufacture, I mean add a room, convert a 1/2 bath to a 3/4 or full bath, add a laundry room, etc.  Those items change the utility of the building.  I typically do not assume that market appreciation will exist.  If I can't control it, I don't want to count on it.

I do not know if I am answering you question with a no/no-go but I wanted to give you some factors to consider in your equation.  I hope this helps.

Matt W. · Answer

If it were me, and I could trade a possible long term rent controlled unit that isn't cash flowing to two non-controlled units, closer to my home base, that start producing cash flow, I would do it immediately.

I help operate a 3 pack of live/work units near Western/Manchester. It is not my typical area of operation, but the rents vs cost per unit is astounding.

Daniel Y. · Answer

Okay, so I don't have too much experience of that area personally. However, I see the area is close to USC, and with all the friends I had that went to USC, they all had the same opinion. The USC campus is great, but once you go off campus it is a different environment. I know there a decent amount of agents on here in that area, hopefully one can help you give you more insight. If not, I am in the process of getting my real estate license and once I get it, I can tap into the network of offices in that area and help you find an agent more knowledgeable of that area and investor-minded. Feel free to contact me any time and I'll see what I can do for you. Good luck with everything.

Mabel L. · Answer

@Manolo D. And I'm also obviously a very inexperienced landlord in the sense of landlording in C/D neighborhoods.  Between a few properties I've owned, I've only had to use one tenant's security deposit and it was about $800.  This is exactly the type of things I need to think about that I wasn't aware of.  I don't think about vacancy or excessive damage because that hasn't been my experience with tenants in A/B class...so thank you for putting that into my analysis.    @Daniel Y., I was looking at zip 90011 or 90037.

Manolo D. · Answer

@Mabel Lung 1000 will not be enough if you have an unstable tenant, the cost to evict, number of months lost rent, rehab for the next renter, etc. It's piles up easy. Maybe I expect too much of that cost because my clientele is higher in the food chain, that might be something i need to consider if I were to be a landlord, maybe 20 years from now. :) Maybe @Fay Chen can help on the analysis, she might have the same brain wavelength as what you are trying to do, I however still have a lot to learn on residential.

Daniel Y. · Answer

Hi @Mabel Lung, where in South LA are you looking specifically? So it sounds like you are putting a bit more emphasis on cash flow over appreciation, which is great because I lean more towards that strategy as well. However, I am sure you not want a low C or D class neighbor that would produce high turnover, headache, and higher overall cost (keep in mind you are in CA, that favors tenants pretty heavily compared to a lot of other states).

Mabel L. · Answer

@Matt W. well those are the questions I wrestle with.  I have seen several properties with my price point over the past few months in South LA that are built after 1987, so no RSO there.  At that same time, I just keep hoping my tenant will leave then boom, re-rent at market price and instant cash flow.  She is a great tenant and like @Manolo D. mentioned, the tenants in South LA may not be so great due to socio-economic factors so that's another thing that gives me pause.  And believe me, I've tried to buy out my tenant 2 years ago and her lawyer requested $28K.  If I try now, it's closer to $40k!  But it also seems so tempting to buy something that cash-flows immediately.

I cannot imagine $1000 not being enough to offset whatever damage/repairs caused by tenants.  That is crazy.

I have not run through all the numbers, especially the cost to do the 1031 exchange (I've been researching a bit and $1200-$1500 seems to be in the ballpark?  But I don't understand the interest thing yet...), I don't foresee vacancy being much of a problem, being in LA, you know the scarcity for rentals is real!

BUT, let's say my numbers are accurate, the reserves I set aside is sufficient, would you trade 1-bdrm SF for 2 homes on 1 lot, 3-2 bdrms in South LA?

My non-RE friends think it's ludicrous to even entertain such an idea but that's why I'm asking RE/Biggerpockets folks, what they think.

Matt W. · Answer

The only negatives I can think of are missing the greater future price appreciation in SF (although that's speculative I believe it's accurate) and the possibility of trading one rent controlled unit for two rent controlled units. You did not say if you were buying a house effected by LA City RSO but at that price point I'd imagine they would be. Possible immediate cash flow is a huge positive though.

Have you run through all the costs you might generate from the sale, escrow, 1031 exchange, and purchase, immediate repair, possible vacancy of your new purchase?