How to decide whether to 1031 or just buy more...

Question

Background info: We currently own our house and a triplex in CA and 2 fourplexes in AZ, and we have some money saved up.  We would like to get into the 5+ unit realm of investing, in another state.  We plan to move out of CA in the next 2 to 6 years, and do not plan to keep our house and triplex here after we leave.  We have enough cash saved up to put at least 20% - 30% down on a 5+ unit building, but not enough to pay cash for the whole thing.

Options:

1) Put a down payment on a 5+ unit property and finance the rest with a commercial loan, and worry about selling our CA triplex later (still likely to have pretty good appreciation while we're still here compared to other states, we think...).

2) 1031 our CA triplex, in combination with some of our cash, to buy one (or several) other property(ies) in another state(s).  Possibly lose out on better appreciation while we're still here in CA, but likely get a better ROI as far as cash on cash return.

3) Refi our triplex and/or house to pull some cash out (we bought near the bottom a few years ago, so we have some equity) so we have enough to pay cash for a 5+ unit property.  We can then finance the 5+ unit property later if we decide to do that (for leverage, to invest in other properties, etc.).

4) ...?  Probably other option(s) I haven't thought of.

We have been in the acquisition stage so far, so this is the first time we've had to decide which way to proceed with putting a deal together.  How do others analyze what's the best way to proceed?  How do you compare those kinds of options, considering you can only estimate/guess things like appreciation?  Just looking for some general feedback on how to analyze this.

Thanks!

Will Barnard · Answer

Great follow up questions. The good news is that you have options and options are good. I believe in the power and advantage of leverage when used responsibly. That said, OC is going good and your appreciation should be good for at least the next year, if you are actually cash flowing, hen all the better to keep the rental doors. Use the cash you have and possibly tax free refi funds to put towards a down on a larger multi out of state. When the time comes, sell the a rentals and your personal residence and use the 1031 advantage in buying more doors out of state.

Derek Smith · Answer

@Kimberly T. Thanks for the follow up info. It confirms what I was originally thinking and was touched by both @Will Barnard and J. Martin it does not sound as if any urgency is there to sell your CA properties yet, ESPECIALLY if they are bringing in positive cash flow AND appreciating.

By the sounds of it you have a good idea of which direction you want to go. If anything pans out with that 5+ property on the radar I would be interested in an update as to what plan you decided to execute. Thanks for sharing your experience with us!

Amit M. · Answer

short answer: keep triplex (refi/HELOC if needed) and buy new place.

Think hard before letting to of good CA RE. It may be your best investment of the bunch!

J. Martin · Answer

I'm with @Will Barnard on this one. If you're not in a hurry and can afford to, why not keep what you have for now?

I've heard a lot more people say "I wish I would have held on to that property instead of selling it.." throughout their life, than the other way around.. at least anecdotally.

Make sure you're comfortable with your overall leverage situation, cash flow, and RESERVES, and you should be OK. And due diligence of course on the next area you're buying in.. Good luck!

J. Martin · Answer

@Kimberly T. ,

@Bob Bowling had a great quote about us CA investors complaining every time another $100K equity gain decreased our return on equity b/c rents didn't go up as quickly. lol

I don't have a crystal ball any more than you do. Ultimately you have to decide what's best for you. But if you have all your reserves and overall financial situation well-covered after the transaction, feel comfortable with the leverage relative to your retirement plans (would a reversal put you out of reach of your goals?), and are bullish on RE in general, and especially in CA... Why not?

I figured @Amit M. would be a yes on that one too ;)

Either way, good luck!

Kimberly T. · Answer

@Derek Smith

1. We have one we're considering, but we need to find out more about the area and the property before we consider moving forward with making an offer.

2. Yes, we make around 6% cash on cash return (not including appreciation).

3. Good question, I don't know.  Do you mean if we sell it as part of a 1031, or do you mean that the lender might not like that if we sell the triplex we will no longer own any local rentals?  I don't know what lenders would think about that.

Thanks for your responses, and thanks @Will Barnard and @J Martin as well.  Yes, we could simply finance a 5+ property with only 20% to 30% down and still have some very healthy reserves.  That would leave us leveraged on our triplex and also on the new 5+, but still be able to handle some unexpected issues financially.  Plus, that still leaves us with multiple options for our triplex in the future, rather than selling it now.  That's the direction we were leaning, but I wanted to get some feedback on our options.

Derek Smith · Answer

@Kimberly T.

Couple of follow up questions:

1. Do you already have a 5+ property selected you wish to purchase?

2. Is your triplex bringing home positive cash flow each month?

3. Will the terms of your commercial loan change if you sell (CA properties) prior to securing the loan?

The way I see it, if you're planning on leaving CA but not for a few years and you feel there is still appreciation to be made I would think holding on to it would be ideal. Continue reaping the benefits while it is closer in proximity to your home location. Even if you purchase the 5+ property prior to moving out of CA, I personally would not want to give up my other source of income (the triplex) as a fall back.

Derek Smith · Answer

@Kimberly T.

This is merely me thinking aloud here. If you're planning on selling your triplex regardless, why not proceed with the 1031 exchange? If you purchase your 5+ unit building THEN sell your triplex, will you be using a 1031 for an additional property or bite the bullet and pay capital gains?

I'm not an expert, however, what I do know is I do not want to pay taxes on things when I know they may be deferred. My question would be, if you do plan on selling your triplex AFTER you purchase the 5+ building, are you already forecasting how to use a 1031 to purchase like properties and will you have the means to take out an additional loan?

Kimberly T. · Answer

Good questions.  Yes, if we sell our triplex after buying a 5+, we would either 1031 it into something else or take the tax hit, depending on what we want to do. If we sell it and take the tax hit and the market goes down such that we would have lost more equity than we would have paid in taxes, then we would be better off with the tax hit. We could then use our cash to buy more at the bottom, and come out further ahead than we would have been if we did a 1031. My parents did that strategically during this last downturn: sell at the top, take the tax hit, hold the cash, buy at the bottom.

That is what makes this decision tough, we may not know what the best option is until after we have done it. We just have to make our best guess, so I was hoping I could hear from others who have made this choice in the past.

How to decide whether to 1031 or just buy more...

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