Should I sell my Bay Area property to buy a house with cash in Phoenix?

Question

I'm a late newbie RE investor and only own a primary residence with a family of two kids. We have about 600k equity in our Bay Area,CA house with another 650K left to pay on our 2.5% refinanced mortgage. I also have enough cash on hand for 20% down for a potential property and have been waiting for housing prices to go down in AZ. I was thinking of renting out our CA house once we found an AZ home but have noticed long rental vacancies in my CA neighborhood. With my 2.5% rate, I could still probably rent for under market rate including cap expenditure to keep the property at break even and allow me to keep the home for potential price or rental appreciation while i pull a new conventional loan in AZ. I suppose this decision puts me in the long term mortgage game, but allows me to "use other people's money" -RDPD

OR

I let go of this fantastic mortgage rate, and use the equity of our house by selling the CA house to purchase the AZ house with all cash. No mortgage ever. This would allow us to rapidly invest more from our W2 income for either retirement or hopefully a second chance at having that second rental property to hopefully attain FIRE retirement as the ultimate goal.

What would the Biggerpocket community suggest given my circumstance and runway? I've also been digging around trying to find househacking opportunities in big duplex/multifamilies but those only exist in TX as far as i've noticed, and i'm not savvy enough (yet) to be a wholesale/flipper. I wouldn't mind learning but I also don't have much runway being 44 yrs young.

Thanks for any suggestion, excited to be here!

Becca F. · Answer

For right now she said she recommended that I don't sell it since this area (San Francisco) is not getting high demand or it's more difficult to find renters now - people are leaving the city as a product of the pandemic, remote work and other reasons. Depending on what part of the Bay Area you are in your market may be seeing different activity. Her recommendation was to look at doing a 1031 exchange in the future. I gave her all my numbers, mortgage payments (PITI) on all rentals and primary residence and rental income. We didn't get into a deeper analysis with property taxes for California and other states, which have no Proposition 13. The property tax on my Indiana SFH rental (that I bought 10 years ago) has gone up another $500 a year (no renovations done). At this rate the property tax will be the same as my California property taxes if it keeps increasing in the 10% to 25% range. My property tax rate there for that county is 2.771%. Indiana is a landlord friendly state and the home prices are much lower than the Bay Area. It seems like property taxes in the Bay Area are in the 1% range. I'm seeing around 0.62% average property tax in Arizona unless you have a different number. If you look strictly at purchase prices and rent to price ratios on the surface it looks like it's better to buy OOS. I'll agree on the California not being landlord friendly which is big factor with investing here. Factor in Proposition 13 and how long you've owned your home, your property tax can be relatively low to super high. Her recommendation was to sell the S.F. house in the near future (not this year or next year) and 1031 exchange and buy a multi-unit, an apartment building out of state to get a higher return but I would need to talk more to her about this. I also don't know much about commercial loans. I recently purchased another SFH rental (move in ready, not a rehab) in the Indianapolis area, Class C but moving up a Class B and it was just listed for rent by the property management company so I'll see if that turns out to be a smart purchase. I worked with a realtor that works with many out of state investors and also got feedback from other local investors before I had put the offer in. I also used to live in Indiana so I know most of the areas, not down to the street but which are Class A, B and C areas and good/bad school districts. If I continue to buy anymore this year, it won't be from selling the S.F house and doing a 1031. I'll use my own money which will be a financial sting (or find a private lender and do a BRRRR) if buying in Arizona, Nevada, Florida or Nashville Tennessee which are appreciation markets vs. Midwest which is more cash flow with low price points.

John T. · Answer

@Herman Fox Option 2 (or some variant of Option 2) looks good to me.

Becca F. · Answer

Herman, has this home been your primary residence for at least 2 years? If yes, you qualify for the Section 121 exclusion by the IRS. You don't pay capital gains tax on up to $250,000 for single filers and $500,000 married filing jointly. You can own a house for 5 years but if you lived in it at least 2 out of the 5 years (e.g. if you live in it for 2 years, rent it out for 2 years then sell it) and qualify for Section 121. https://www.irs.gov/taxtopics/...I would lean towards Option 1. I favor keeping a Bay Area SFH and trying to pull equity out of it. Once you sell that house, if you ever want to move back or want the house back for some reason it's gone and it'll be difficult to re-enter the California market especially with a 2.5% interest rate. I have a SFH rental here with tons of equity and I'm leaning 95 to 98% chance of keeping it. I'm considering selling and doing a 1031 exchange for out-of-state rentals (prices are up everywhere and interest rates are higher so that factors in my decision) and other states don't have a Proposition 13 which limits property tax increases to 2% a year. I'm getting on a call next with a realtor to discuss all my options.

Herman Fox · Answer

Oh! i didn't realize doing a cash-out-refi doesn't incurr capital gains or is a taxable event. I will definately consider that as an option and dig into that more especially if that allows me to keep property and access more cash to use in AZ, this is perfect! Thank you!

George Mevawala · Answer

@Herman Fox Option 2 allows you to put your money more to work. I would use the equity from the sale of your primary residence in CA to purchase 2 properties in AZ.. One as a primary residence ( still mostly buyers market currently & could find you a property with a motivated enough seller to get you some seller concessions towards closing costs and contribute to the rate buy down as well), and then purchase an investment property and turn it into a short term rental shortly after... You could still see some nice returns self managing it since you will be local, as we have lenient short term rental laws. Then you will be able to see the appreciation from both properties, cash flow from the STR, and tax benefits of owning the short term rental as well. Just my two cents for whatever it's worth. Feel free to reach out if you have any questions or would like to chat more. Best of luck!

Dylan Vargas · Answer

@Herman Fox Welcome! Interesting situation. The long California play is a great call if you want to stay in California until history proves otherwise. With regard to Arizona if you are in the Phoenix metro and suburbs your equity will buy a decent primary home say for 450k but not leave you with much cash to buy a second home (unless financed of course). You may have enough to swing 1 entry level 300k house in say Casa Grande, maybe. I dig on the no mortgage and sounds like your jobs and income will be able to move to Arizona. This will allow you to pile cash away. High interest rates, high prices which mean higher rents make it tough to play the rental game as you may not get that required rental amount to make profit on rentals. Have you thought of out of state rentals? Might be an option if you sell California home, move to Arizona and have more purchasing power out of state. Maybe cheaper areas of Arizona or bordering California/Nevada towns to make your rental property purchase go further. At any rate....just some thought to get your mind going. Good luck and keep us posted.

Herb Lau · Answer

If it were me, i'd be a) renting out the Bay area houseb) borrowing up to $400k in 2nd mortgage/home equity loan on it (up to 80% ltv) c) using that for AZ home purchase. If enough for duplex, awesome! If not still ok. Ideally the rent covers both loan payments and the $200k can be invested in HYS account while you scout AZ market more. Eventually, you find a good deal, and that 200k is even more and you still have W2 income saved during that time to add to it.

Melanie Johnston · Answer

@Herman FoxIf your decision is to find a great property in Arizona, I would be happy to help. I've helped about 20 BiggerPockets investors from around the country buy their own homes here, as well as both long-term and short-term rentals here.I help clients buy throughout Metro Phoenix, including Scottsdale and all the surrounding cities. I know the best neighborhoods well, having been in this market for decades.Please check out the reviews left by BP members on my profile. I would love to discuss opportunities in our market and help you and your family achieve your RE goals here.Melanie

Herman Fox · Answer

Thanks for your reply Theresa! I've considered CA, but house prices have mostly gone up even in this downturn and any numbers i run have shown 10+ years out of negative cash flow for the loan i would need at these CA prices. At least in AZ, i could accept negative cashflow for 5 yrs or hopefully less even at these rates. Great story, i certainly don't want to feel paralized waiting for a dip that never happens. I do plan in retiring in AZ and holding, maybe start doing investments locally in AZ would be easier to manage.I will certainly consider your suggestion of buying multiple rentals, and it sounds like you would opt to Sell the CA one if you were me - and i'm considering even trying to do repeated 1031 exchange since we want to move there first for better schools for the kids, so it would be a primary home, and maybe we live in it for a couple of years and improve it slowly while we're there and 1031 to another home later on down the road until forever.

Theresa Harris · Answer

Do you want to be a landlord in CA with all of the restrictions they have in place?If you want to buy more investments, why not sell it and use the money to buy a few other rentals elsewhere? You say you plan on moving to AZ. Buy a rental with a mortgage (use other people's money to help you buy it). If you have enough to buy two rentals, then do that.A story about waiting for prices to go down. I bought a place about 6 years ago and planned to hold it for a year or two, then sell it and buy a better home. House prices went up (almost doubled in that time) and I couldn't do that. I'm happy I bought when I did because I plan to retire in that area and had I not bought, it would be almost impossible for me to move there (my local market is very different). So don't wait for prices to go down. Find a place where the numbers work and buy it.