Option to Buy, prior to 1031?

Question

Hello, this is my first thread and I will soon be attempting my first 1031 property exchange, hopefully in a few months once I line up a sale.

I will have roughly 1M to reinvest and current plan consists of targeting cheaper rental properties that have a potential gross monthly income of $1,000 for each $100,000 invested. I have determined that there are many markets where I can buy a 100K house and expect around $1K a month rent. My idea was to not only acquire houses with this ratio, but to target turn key houses with equity (lower the market value) at the get go. For example buying a $130,000 home in Texas, for $100,000, in an area that has $1,000 a month rent. Upon planning and researching, this idea seems to be a good idea, but I am new to this and I wonder if there are any logical details I am overlooking with this basic approach?

My biggest concern is potentially identifying 20 $100,000 homes in 45 days (based upon the 2X exchange rule). I am wondering from you experienced people, is there a common way to lock the potential "identified homes" into a contract where I can have them committed to selling to me if I wish?I know options contracts are common in many endeavors, but I not sure if they are in this case, if they are legal or if the cost is prohibitive. IF such a thing exists, what are typical terms and the cost of reserving the rights to a 100K home? Can I potentially use boot to secure these option-to-buy contracts once I close on the property I am selling?

Also, I know foreclosures are scary to bet upon, but do any of you know a way to use a 1031 to secure foreclosures with less risk?

Thanks all,

Burke

Zach Quick · Answer

@Burke Ericson I have to ask, why are you going from one property that has made you that much money and I'm assuming wasn't terribly hard to manage to going into 20 different properties that will be difficult to manage. Have you not thought about going into commercial or multifamily? With a million dollar down payment you could find something that won't stress you out as much as 20 SFH's half way across the company....just my two cents.

Dave Foster · Answer

@Burke Ericson, It's a pushme pullyou kind of dilemma for you.  No turn key provider is going to (or should be expected to) lock up properties for you unless there is a certainty of closing.  That will involve skin from you and your confidence in your own sale closing.

You need to start cultivating relationships with those providers now so when you're ready to strike you've already familiarized yourself with who you want to work with, the market you want to be in, and the probable look of the properties you'll be buying.  @Alex Deacon and @Sean Tarpenning are already opening up two markets for your scrutiny.  Each turn key is unique but there's also lots of similarities in type, cost, rehab, and rent nationwide.  So you can get a good flavor before your sale and be ready to strike as soon your sale concludes.

The best way to overcome that 45 day period is to get into contract and even close if possible on all during that 45 day period.  This circumvents any potential issue with the 200% rule as your 45 day list on day 46 is simply the properties you've already closed.  So no matter the size of pool you were looking at, you've closed on more than 95% of the value of the list so the 200% rule is moot.

Another option could be a reverse exchange.  your QI takes title to the new properties and holds them pending your sale at which time you buy them from the holding entity.  They're relatively expensive. You have to fund them so financing could be a bugaboo.  And I'm not convinced that kind of drastic manueuver is needed given the commodity nature of most turn key projects.

Sean Tarpenning · Answer

@Burke Ericson We have current cash flowing inventory in Kansas City, MO. We see high returns, built in equity and a very stable market overall. Let me know if you head out this way or need any questions answered. Best of luck to you!

Alex Deacon · Answer

@Burke Ericson I buy 5-10 homes a month in Pittsburgh. I also have a management company and we mange over 600 units. I can definitely help you find properties for under $80,000 that will rent for $1000 a month. Let me know asap. You dont have much time and thats a challenge on your hands.

I have helped hundreds of investors out of state and out of the country. I have many references I can send to you also. I have a few investors that may consider selling a package of properties. We constantly have our clients trading up or liquidating and going onto some other venture.

Dave Foster · Answer

@Burke Ericson, No matter how you slice it every 1031 has an identification period and list.  At the end of your exchange the property/properties you purchase must be on that list and the list will have been completed prior to day 46.

Your advantage in closing everything by the end of day 45 is that your defacto list becomes the properties you've already purchased. So every property you purchased was on the list and within the 45 day window.  So even if you were looking at many properties (more than 3) and their aggregate value was more than 200% of what you sold,  your 1031 is still valid because you closed on at least 95% of the value of the list (you actually closed on 100%).

The other advantage is that the sooner you close on your replacement properties the sooner cash flow and roi return.  If you close at day 45 rather than day 180 you generate almost 5 months of return more.  So shopping now and getting properties under contract so they can close as soon as you sell can be a very good thing - tempered of course by the need to make sure that they're the right properties and not just being purchased to meet a time frame.

Zach Quick · Answer

@Burke Ericson You are thinking about it correctly, but from an ease of management I think you should think long and hard about going from one building into 20 different buildings in different areas.

I think you should sell and exchange into something different, but I would suggest doing that into a larger multifamily property in a market that you are comfortable with and not anything where you are taking a giant step down in property class wise. I imagine even in California you could find a 10+ unit in a nice area within two hours driving distance, but you could still feel comfortable giving to a property management company. I guess at the end of the day, it depends on your goals and need for immediate income.

Option to Buy, prior to 1031?

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