Tough decision- To keep my current rental or1031 it into another?

Question

I have a SFH (Single Family Home) in Tucson, AZ and the tenant just moved out.  I've cleaned it up, re-tiled downstairs and its in great shape and in a good school district on the edge of town.  Current mortgage with PITI is just under $1k.  Rent value is just over $2k. HOA is $35 a month.  Once rented I'd be bringing in about $1100 a month after listed costs.  Home value is about $360K.  1031 Exchange proceeds would be roughly $200k after paying agent and old mortgage off.

I'm considering doing a 1031 into a SFH property in the vicinity of Gilbert, AZ (much closer to me).  Purchase price would be in the area of $450 - $500k.  Lets assume $500k.  That would equal a $300k mortgage.  I was quoted a 6.25% interest rate with the $200k down.  I'm calculating a mortgage at this rate would be about $1850 monthly.  HOA would be about $100 a month.  Rent would be around $2200.  Profit before other expenses would be about $350 a month.

So the current situation in Tucson is bringing in a lot more profit from rent.  However, appreciation in Gilbert of a $500k home is likely to be greater than a $360K home in Tucson over the next 10 years.  I'd like to keep the property for 10 years minimum either way before I sell it.

Does anyone have any advice on this decision? Maybe factors I'm missing, or a strategy I haven't thought of yet? what do you think will be the best investment 10 years from now? Thanks in advance!

Michael Emanuel Wojcik · Answer

There are a number of variables that affect markets and some are difficult to foresee.  The Federal Reserve appears poised to raise interest rates by .5 basis points for two consecutive rate hike periods.  The Fed is trying to curb inflation.  High inflation rates can signal an ailing economy.  Increased interest rates can slow the real estate market.  There may be a correction in real estate prices, but the cost of financing a real estate investment will likely rise.  It may be worth observing what affects the next two interest rate hikes have on the economy and then decide your next steps.

Bob E. · Answer

@David Weymouth  If you are close to retirement I would consider holding what you have and seeing how the economy evolves over the next year or so.  Don't do anything that would risk your retirement.

David Weymouth · Answer

Probably the smart approach, hard not to get a little greedy though. But would hate to go backwards, and yes in a year or two hope to be off the payroll. Good advice!

David Weymouth · Answer

Probably no help coming from me but darn near the same issue I am dealing with, but I have couple properties in Gilbert and Mesa. Close to $750K in equity and could pay off the remaining debt in a couple years. So say 1 million in value returning $36K/yr after expenses.Or could 1031 both and purchase 4, with roughly 20% down on each with PCF closer to $28k/ annually. Bottom line I am 60 years old, could just do nothing and take the sure thing or go through a lot of work and hope the real estate market in that area doesn't tank. So not exactly the same circumstances, but in the ball park. Honestly a hobby that I have not worked terribly hard on. Any thoughts?

Chris B. · Answer

Thanks for the additional insight.  I would be going from a 2200 sq ft, 4 bedroom SFH in Tucson to a 1200-1800 sq ft, 3 bedroom SFH in Gilbert.  I'm looking for something smaller.  4 bedroom + extra room homes in Tucson can be tough to rent and when they do, large families tend to produce a lot of wear and tear.  I do expect the maintenance expenses to be a bit lower in a Gilbert property.  I'm pretty handy so I can do a lot of it myself.  Taking most of a day driving to do anything related to the Tucson property gets a bit old not mind current gas prices.  Regarding the additional depreciable basis with a new purchase, I wasn't sure how that works but have done some research and looks helpful.  Last, I feel a 3 bed 2 bath is much more rentable than a 4 bedroom plus loft and extra rooms from my experience.  Thanks!

Chris B. · Answer

I just bought a new to me SFH as my primary residence last year in Chandler.  Inspector did a sub-par job and its been a bit of a money pit getting it in shape so I'm tight on cash and can't afford an additional property without unloading the Tucson property at the moment.  I did keep my last home BTW and am now renting that one out also.

Patrick Allen · Answer

I will borrow from David Greene's logic here and pose 2 questions:1) Is Tucson a market where you want to have continued exposure?

If the answer is "yes" due to the fundamentals of the market, I think that makes a lot of sense.

If the answer is "no" because of the distance to drive down here is inconvenient, or because you think you can get a higher return on "hassle factor" investing in your home market, I think that makes a lot of sense as well.

If you don't like the market: lean towards selling. If you do, towards refinancing

2) Is this still a home you would want to own in 10 years?

If it's in a cool area, has a history of being easy to manage or you simply have an emotional attachment to the property and would hate to give it up: lean towards refinancing. So many podcast guests over the years have said they regret every property they've ever sold...

If the property is kind of annoying to manage, or as you say the primary motivation is the maximum possible market appreciation, then sell it and move your equity elsewhere.

One final thought though: high appreciation markets tend to be more volatile ones. Phoenix probably will appreciate faster than Tucson, and it will probably crash harder and more often for the same reasons.

Dave Foster · Answer

@Chris B., It's an interesting question and comparison.  What I'm hearing from you is that

1. A property closer to you would probably take less in management time by you, gas (not a small number in these times) etc.

2. The higher interest is a bummer.  But the tenant is paying the mortgage so it only affects the amortization of your loan.  And it's an annual write off so will help that way as well.  And you can offset this by dropping additional amounts on the loan periodically.  A heloc like @Michael Emanuel Wojcik said would be perfect for this as it would also adjust the payment.  But even if the payment doesn't adjust with regular financing you'll still be able to accelerate the amortization with periodic paydowns.

3. When you go from a $360K to a $500K property you're buying an additional $140K of depreciable basis.  So that will be a benefit to you over time as well.

Is one of those more rentable?  I don't see vacancy allowances in your numbers.  And of course there needs to be repair allowances as well.  And one of those might be better than the other.

Michael Emanuel Wojcik · Answer

Daniel,

At the end of the 27.5 years, you can no longer take the yearly depreciation value as a tax break.

Best regards,

Mike

Bob E. · Answer

@Chris B.  Any way you could keep the Tuscan property and still buy the Gilbert property?