1031 exchange in Portland OR metro area

[Nick Liu]

Hello,

I am a newbie to biggerpockets and I have a real estate investment strategy dilemma.

I currently own two single family homes in Tigard OR since 1997. There were new construct at the time and has been rented out ever since. We were fortunate to have the same renters since the beginning with stable rent. Both properties are located in the same neighborhood and is probably worth around 400-450k each. With renovation, I could probably sell for 500k each. Both are also paid off resulting in a net operating income of 29k annually combined.

I would like to continue to grow my portfolio and I have several ideas in mind:

Option 1: I could sell both properties if I put some money in to update both homes as they are both stuck in the 1990s. Since we had stable tenants, we really did not have the opportunity to renovate the properties. However selling them would trigger larger capital gains tax and lose the benefits of passive income.

Option 2 is to do 1031 exchange both into Multi-family homes/apartment. I have been following the PDX market for several months now and it seems the cap rate in PDX is on the low side (4-5%). I was looking at several properties in the range of 800k-1million and I just don’t see a great return on these compared to my existing rentals. Anything more than 1 million would require a mortgage which can greatly reduce cash flow.

Option 3 is to take equity out of my current two rentals and buy new properties. I am not sure on how to go about doing that and whether I can take something like a HELOC to buy additional properties.

Any idea on how to move forward is greatly appreciated!

Nick

[Matyas Sustik]

Hi Nick,

I believe my experience in 2019 has some similarity to your situation. I cannot (and do not want to) tell you what to do, because only you know your exact situation, risk tolerance etc. I hope the info below will help you arriving to a decision.

We owned 3 SFH until the end of summer of 2019. We purchased two of them as our homes one as an investment property. We bought the first (A) for 106k in 2000, it was put into service in 2009. We bought the second (B) in 2008 for 413k and it went into service in 2014, we bought the third (C) in 2013 with a tenant in it for 126k. One day, I will summarize the whole cash flow with repairs, mortgage, depreciation etc., and calculate the IRR, but this has to wait until I am done with my 2019 taxes... So here I give just the most relevant info.

We sold house C in Jan 2019 for 210k. We sold B in July 2019 for 675k and finally we sold A (to the tenant in it) for 197k. We employed 1031 exchanges and the proceeds totaled 730k. (Prop. A had no loan anymore, the other two had well below 50% LTV.)

In 2017 when all 3 was still in service the rent was 71k. Actual (real) expenses totaled to 33k and depreciation was 26k. (In 2018 we did a lot of repairs (partly in prep for sale) and had a 3 month vacancy during sale, so 2017 is a better year to look regarding the CF.) (I estimate that equity was between 600k and 650k in that year, with a significant bump in 2018 and first half of 2019.)

We chose multifamily DST-s to invest in with around 53% LTV.We diversified across geography and sponsor. They pay between 4.5% and 6.7% on equity, with an average of 5.4%. That is 39.6k. These are class A apartment complexes. (One of them will reduce distributions starting May to increase reserves in response to COVID-19. Occupancy and rent payment is still in good shape. I expect to get the amount from the reserve later.)

The 38k income in 2017 is not completely representative, because some repairs were delayed (as is often the case with long serving tenants making repaint, kitchen resurface etc. difficult to do). For example, the 2018 NOI was under 30k due to the above mentioned sale vacancy, repairs and selling costs. With this adjustment of delayed costs the DST distributions are not just slightly, but much higher than my prior NOI and the depreciation expense (and saving) will be higher resulting in additional tax savings. Plus, it is completely passive investment. I note here, that I did not employ a property manager. I had good tenants. I had a handy man and I used a real estate agent who listed for rent in MLS for a flat fee ($250). I still had to hustle when a door and a water heater had to be replaced or the plumbing backed up on Christmas day. I am glad I do not have to deal with that anymore or with tenants going through divorce.

The DST-s are for 7-10 years. You can expect capital appreciation, prior sponsor data is encouraging to indicate total IRR over 10% (but no guarantee). Ask me in 8 years how it all went.

I used a fiduciary financial advisor that I never met in person to help me with the DST selections. I also got a healthy reduction of the upfront commission that is otherwise atrocious. He was great. He got paid well, I still feel I got value for my money. And we are staying in touch. However, I am a do it yourselfer and keep learning about investments and moved beyond what he offers.

I am still happy with the investment choices I made. Originally, I considered buying more DST assets using non-1031 money, but then I found other syndicated real estate investments with (much) higher returns (but less tax advantage than DST-s, and riskier). To give you a taste of those, the investors of these opportunities see 10-12% IRR is not really exciting and do not even look unless the distributions are at least 8%. I am also learning about and moving into alternative investments that are supposedly non-correlated with the stock market and real estate market.

A year ago I was enthusiastic and told some close friends about the exciting new opportunities of DST-s. Then as I learned about many other real estate and alternative investments, I realized that I still know so little. So I stopped offering advice. I only tell about my experience and typically only when asked by someone I know. (So the above was an exception. :-)

Good luck.
-Matyas