Taking Profits from a Performing Asset to Expand Portfolio

[Elliot Fuller]

Hello BP, it's been a while since I've been on here.

Bottom line up front: How might you proceed if you had a cash-flowing property that had appreciated significantly, and wanted to take the next steps to expand your portfolio?

Longer version:

San Diego SFR Rental - Purchased 2013 for $353,000
Financing: VA loan $0 down at 3.25%
Refinanced: 2.25% in 2020
Remaining: $292,000
Approximate Value: $650,000 (no major improvements, just market appreciation)
Cash Flow: $425 after the refinance and several years of hiking rent.

North Carolina Primary Residence - Purchased 2018 for $192,000
Financing: Conventional 5% down at 4.25% (PMI rolled in)
Refinanced: 2.75% in 2020
Remaining: $182,000
Approximate Value: $240,000-$260,000 (added bedroom & bathroom ~ $50,000 reno)

We are considering selling the CA SFR to build additional wealth. Should I even be considering this, if it's cash flowing $425 a month, and giving us about $9,200 annually in principle pay down, with an "almost free" interest rate? The build-up in equity is making me salivate.

1.) Thought about 1031'ing it into a small apartment complex, but I am unfamiliar with financing options for that, and since we are, at this point, accidental amateur RE investors, I'm thinking a jump straight into multifamily apartment complexes probably isn't the right choice.

2.) More beginner-friendly, thought about selling it and using the proceeds for down payments on several duplexes outside of CA. We would eat the capital gains tax losses and fees from the sale, but we could hopefully match or beat the cash flow from CA property, diversify into several units, and have more room for appreciation.

3.) Selling it and paying off our primary residence would be an emotional win, allow us to pocket more of our income ("virtual cash flow"), leave us a little extra cash to purchase another SFR or duplex investment property, and allow flexibility for potential job transitions in the future.  Selling would also renew our VA benefit eligibility, and we could buy a new primary residence with zero down, opening up our current home to tenants.

4.) Instead of a sale, do a cash-out refi?  What would happen if we took enough equity out to invest in several other properties, and then the market corrected?  Wouldn't we be at risk of being underwater on the home if the market swiftly corrected?  On that same note, a cash-out refi would raise our mortgage payments on the home and eat into our cash flow, is that correct?  Maybe I'm not looking at this aspect of it correctly.

Although I understand the basics of these options, there are a lot of scenarios for me to wrap my head around from a wealth management standpoint, and I'm struggling to find the one that makes the most sense.  Dave Ramsey says to pay off your mortgage... Brandon Turner says to use leverage to build wealth.

From Brandon Turner's book, there are 3 ways to accumulate wealth with RE: Appreciation, cash flow, and loan paydown. Right now I feel like the CA SFR has run up so much with appreciation, that it would be wrong to not at least consider taking profits and finding a new opportunity(ies) that can capitalize on all 3 methods of wealth accumulation.

How might you proceed here?

[Dave Foster]

@Elliot Fullerl, Do not refinance. It's not worth your while. If you even take $150K out of that you'll put that house under water from an NOI perspective. You'll have a %600K asset that is making you nothing and making the bank rich.

I like your cautious approach to going too big too fast as someone relatively inexperienced.  That leaves option 2 - But with a twist - Use the 1031 exchange to sell that SD property and purchase several smaller properties.

I also appreciate @Jason Shackletons nod to Dave Ramsey.  Here's a way to do option #2 the Ramsey way (sort of).

1. Sell your SD property and put the $300K ish of cash in the 1031.

2. Purchae a duplex free and clear for cash - $200K

4. use the remaining $100K to purchase $400K of duplexes or SF rentals using the $100K as down payments.

A couple of things happen in this scenario

1. You actually start making money on your rentals.

2. Although your primary still has a loan on it you do own a property free and clear which is now recission proof and could be moved into by you if things really hit the fan.

3. You still get the arbitrage of leverage but now your leverage is less so cash flow is better

4. You can move those units closer to you so you can learn the joys of self management :)

The only argument against this is the long long term appreciation play that is CA.  It booms and stagnates and booms and stagnates.  You've got to decide if that is better than cash flow for your goals.