1031 Exchange or not? Old home for New

[Mike Douglas]

I own a single family home in the Old Town area of Fort Collins, CO that I have a 5.9% Cap Rate on. Currently rented to good tenants. The home was built in 1904. Although the bones are in good condition, there is the potential of expensive cosmetic updates in the future, like concrete work, etc. not to mention more frequent minor repairs than newer homes require and potential of future major expenses like sewer lines, foundation, etc. I also happen to own and rent a SFH in the suburbs with a 7% Cap Rate. Because of the age and upkeep of the older home, I'm considering selling it and 1031 exchanging into a newer suburban home. The thing I can't get past is, the Cap Rate on a newer, less repair-risk suburban home would be around 4%. My question is: Does it make any sense at all to drop 2% cap rate points to swap an older home in need of repairs for a newer home with fewer issues?  Or does it make better sense to stay with a higher Cap Rate property and deal with repairs big or small as they happen? 

[Dave Foster]

@Mike Douglas, I sense some very juicy spread sheet comparisons in your future.  Moving from deferred cap ex/maintenance to new construction without the  looming repairs is a classic strategy for 1031 exchanges.  What you've got to do is isolate and quantify those options to see is the drop in cap is better than the probability of those expenses.

One other thing that could be a factor is to go beyond the cap rate and look at your actual IRR. Cap rate is a great metric to analyze your operating expenses. But Cap rate does not factor in either amortization of a loan, or borrowing expenses. Both of these need to be looked at to get a true comparison like your want. Amortization of the loan can be a huge factor in your actual profitability - especially if you're moving into a more expensive interest rate. And of course increased interest expense can really put a damper in the joy of avoiding cap ex.