Four Options: What would you do?

Question

Hi all, I'm looking for some different perspectives on what I 'should' do in my situation, which is as follows:

I own a SFR in San Francisco. Valued at about 1.2MM, with 300K left on the mortgage. Right now, I only make about $900/MO cash flow (not including repairs, which are minimal. But still not included in that number.) It's a terrible cap rate / cash on cash return, but a good problem to have.

My tenant is moving out next month, and I feel like it's time to get out and 1031 it into something bigger and in my own market (I don't live in SF anymore...Denver now.)

After educating myself the past couple years, and talking to friends in real estate, here are the options I'm considering.

1) Keep the condo, do a cash out refi. I can get about $300K out of it and still cash flow about 1K a month with the refi (not including maintenance.) So I'd have a 600K loan and still be at 50% equity.) So I could take that 300K and invest in other properties, the stock market, a ski house rental, etc.)

2) 1031 into a smaller multi family for equal price as my sale (say, 1.1MM after commissions and closing). In that instance, I'd have 800K into a 1.1MM 4 plex, let's say. Then do a cash out refi on that building, to invest in other things as noted above.

3) Use my equity to lever up to something bigger, say a 10 - 15 unit building. Understanding the loans are different and will need management, etc. In this case, I'm hopefully cash flowing much more than my 1K a month on my condo in SF. Even at a 5% cap on, say a 2.5 MM building, that's 125,000/year NOI.

4) Do a cash out refi on my current property, take out 300K (as noted in #1), and then do an exchange in a year or so. In this case I can get some money out now, then still do an exchange into a 1.2MM property with 50% equity (give or take).

Actually, there is a 5th option, which is to do a TIC into a friend's large multi-family business as a passive investor. I realize there are rules around this re: a 1031 but I understand it can be done if done right.

Good problems to have, but is one of these options clearly better than another?

@Dave Foster you've had great insights on my questions in the past. Would love your thoughts here a well.

Thanks everyone in advance!

Aaron S. · Answer

Thanks @Dave Foster, that's helpful. Yes, I'm definitely considering doing the cash out refi. My issue with that is two fold. One, it's a pain for me to rent it and manage it remotely. I had one tenant for 11 years, who was a dream. Then one tenant for one year who was calling me every couple weeks. Since I live out of state and don't have management, it's definitely a little more challenging. And as I charge more in rent (currently $4800/month!) I feel I need to respond quickly to any problems.

My other issue is the pressure to make more in the investment of the cash out money than the interest I'm paying. Let's say I get 4.75%, I need to find something that is going to at least make it worth it. Then I have a 600K loan on my rental to get 300K in cash...I don't know. If you look at economies of scale, putting 800K down on a 2 MM property will still cashflow way better than my SFR plus the 300K invested, I'd think.

@Matt M., I work in advertising / marketing, mostly from home.  So while this isn't going to be my day job, I've been interested in getting my feet wet in MF for a while. That said, maybe I'm underestimating how much time I'm going to need to put into it. My hope Is that I can still make a deal work financially with management.  As I said, even at say a solid 5% cap rate, I'm still making a lot more in cash flow that I am currently on my SFR. Yes, my CoC return won't be as high since I'll probably have more equity than necessary, but for my first deal I don't mind the cushion.

Any of your thoughts are always helpful. Thanks again!

Aaron S. · Answer

Thanks @Amit M.,

I've always assumed my HELOC limit would be lower than a cash out refi. Also, I believe it's harder to get a HELOC on a rental property, but I could be wrong. I hear you though, I'm torn. My guess is as good as anyone's what the market will do. I bought in 2003 for 560K, it went up to about 800 in 2006, then back down to about purchase price for a few years, then a straight shot up to where it is now. It just makes me nervous to have all that equity exposed to price fluctuations right now.

I agree, I'll always be able to rent it out. But as I mentioned earlier, needing to make a 4.75-5% interest rate on 300K pay off in another investment –– while not too ambitious–– is still a factor. This is vs. putting the equity in to a 15 or so unit bldg even at a lower cap is still cash flowing way more.

Am I being shortsighted?

Amit M. · Answer

A variant on options 1 & 4 is to take out a heloc instead. that way you have dry powder ready to use for another RE acquisition, and you’re not paying interest until you buy. Given its top of market, and who knows what will happen with the economy in the next 1-2 years, flexibility is a big advantage.

I’d be reluctant to part with a cash flowing blue chip asset in San Francisco. You’ve locked in a low property tax base (prop 13, yay!), and it will always be easy to rent that property out. Plus being a condo, and this is a huge plus, no rent control! (Caveat, that may get overturned by politics this year or next, hard to tell for certain.)

Bottom line: I’d angle to keep that condo, but leverage it opportunistically for a future acquisition. I don’t know too many people in San Francisco that didn’t regret selling a property 5-10 years later. Perhaps modest cash flow now, but don’t be short sighted on the larger (appreciation) picture! This chart says a lot:

my2c

Dennis M. · Answer

Option 3 . No brainer ...Get into apartments

Matt M. · Answer

What's your day job? If you don't want to be full-time RE, then put your gains into option 5. Not as sexy, but hands-free assuming your guy knows what he is doing.

Dave Foster · Answer

@Aaron S., Thanks.   Man this is a tough one.  If your condo was anywhere but where it is I tell you to tear your arm off signing the listing agreement.  A bad rental never becomes a good rental when you add debt to it.  But, the bay is the bay.  And there's a bunch of folk who will tell you horror stories of selling while watching appreciation continue.  I sold a Million dollar portfolio in Denver around 2000 that I wouldn't  mind having now.  But you never know what you don't know.  So your analysis of that has to be a key.  What's appreciation going to do???

It sounds like a refi to grab $300K wouldn't affect your NOI much.  So why not do that while you're analyzing the market for where appreciation is going to end up.  Then use that refi money to move into the best cash producer you can find. - If you like your friends MF business why not use the refi to go into that.  That way you don't impact your 1031 at all and make it easy.  Then once you figure out your exit point for the condo you sell and can still 1031 the remaining equity into another better cash flow investment.

So I guess I'd think about taking it in stages.  The nuggets are harder to find now so there's nothing wrong with staging it forward.  A refi to go into a good cash flow instrument.  Then a 1031 into another one that will carry the debt and improve the NOI at the same time.

Oleg Shalumov · Answer

@Aaron S. I would go with #1 or #3

Michael Ealy · Answer

Aaron,

My specialty is 50+ unit apartment buildings and hotels so I am biased. I have acquired over 1,000 apartment units so my choice if I am in your situation is # 3.

Cashflow with apartments is so much bigger than houses, provided of course you know what you're doing.

Four Options: What would you do?

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