Free & Clear downtown rental property- How to scale up?

Question

Hey everyone,

I inherited a great home (3/1.5) owned by the family since 1930 in a popular downtown area about 6 years ago. I have ran it as an STR through Evolve (with no great STR knowledge) and didn't clear more than 24k which is quite similar to- if not less than having ran it as an LTR.

Currently: LTR $1650/ month - increasing to $2100/month with no mortgage, HOA, or large monthly payments other than the occasional repairs.

Home is worth 650-700k.  I have twice used HELOCS to purchase my last two primary homes before selling them for large profits in AZ.

I was hoping to get some insights on how some people would proceed with this situation. I plan to retire in 9-10 years with a pension and would like to have a supportive portfolio by that time in lieu of obtaining another W2.

My initial thoughts for options are:

- Sell and 1031 into larger potentially more profitable LTR/STR

- Attempt STR again having completed STS masterclass and further education

- HELOC for smaller LTR's

- Status quo, eventually buy new primary and rent out current primary (870/ month mortgage payment on a 450k home)

Thanks everyone!

- Mike

Michael Harris · Answer

Thanks Dave, greatly appreciate it.

Christian Ehlers · Answer

I haven't worked with Evolve personally, but I would imagine if you have a property people want to rent out as a STR and you educate yourself on running one you won't have an issue out-performing a STR management company that isn't as invested in YOUR property/returns as YOU would be. That's where I would start, if it doesn't do great after that, try the LongTerm Rental.

In general STR's make much more cashflow than LTR's so that's what I'd recommend if you are looking for the most cashflow, but if you want less work I would use a HELOC to put down payments on several LTR's.

Hope this helps

Dave Foster · Answer

@Michael Harris, It's as easy as selling the old property.  And then using the proceeds as down payments on multiple replacements.  As long as the aggregate of your purchases is greater than what you sold you'll defer all tax.  A very slick way to scale up quickly.

Dave Foster · Answer

@Michael Harris, On the 1031 side of things, most investors in your situation would choose to do a diversification exchange.  They sell one property and purchase multiple properties using the proceeds as down payments.  This gets you the extra bang from leverage that @Nathan G. was talking about.  The issue with that today is the cost of borrowing.  Not so much the cost of borrowing itself. Historically 6-7% is very much within the norm over decades.   But the cost of borrowing as it relates to rent income.  This is what's giving people fits.  The fed keeps raising interest rates but rents have stagnated a bit in most areas.

So, one way to mitigate this lending dilemma would be to do a diversification exchange and buy one replacement for cash and only take out one loan on the second property.  This protects you from a serious downturn because you have a free and clear property in case everything crashes and burns.  But you also have a leveraged property so you can make your funds go further.

Nathan Gesner · Answer

If the STR is not performing well, crunch the numbers and see if it's worth changing strategy. Make sure you account for all expenses (STR taxes and registration, utilities, landscaping, wifi, furnishings, consumables, marketing, your time, etc.). If the net earnings are not much more than you would get with a long-term rental, then I would switch.

As for scaling, there are quite a few options. You could sell this house, split the money, and invest in multiple properties to accelerate growth. You could keep the house, cash out some equity, and use that money to purchase another rental (or several).

If you are looking to grow faster, you want to have a mortgage. The tax deductions help offset the income and leveraging your money enables you to accelerate growth.

Here's an example. Pay cash for a $400,000 house or split your money and buy four houses at $400,000 with a $100,000 down payment on each one. Each house rents for $1,500 a month or $18,000 a year. The market appreciates 3%.

The first house appreciates 3%, gaining $12,000 in value and earning $18,000 in rent. That's $30,000 total.

The four houses appreciate 3%, gaining $48,000 in value and earning $72,000 in rent. That's $120,000 total.

See the difference? When you pay $400,000 cash, you benefit from $400,000. When you put down $100,000 on four different houses valued at $400,000 then you benefit from $1.6 million. Leveraging your money will dramatically accelerate growth. This is a simplified demonstration because the leveraged homes include mortgages, but do the math and you'll see that leveraging is the way to go. My rentals earned nearly $200,000 last year and I didn't pay a dime in taxes.

Michael Harris · Answer

Thanks Dave! Can you help me understand as to what would that diversification exchange entail? Would utilizing a HELOC on the original paid for property play into that somehow or is it selling the currently paid for property and simply buying a newer one for the same or slightly more expensive price?

Michael Harris · Answer

Thank you so much for the insight sir!

Free & Clear downtown rental property- How to scale up?

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