Flip, Rent or 1031 exchange on property in LA

[Jennifer Pithie]

I own a SFR in a popular area of Los Angeles where rents are high and in demand. The property was my primary residence for 7 years until we purchased a larger house in 2012. We kept the property as we were under water on our mortgage at the time and felt it was better to rent and ride it out then sell for a loss. We were right on that bet and now have more than $400K equity in the property. The rent covered the mortgage and expenses but we make no cash flow on the property. Now our tenant is moving out and we have a few decisions to make. I have run the numbers for multiple scenarios and just can't make a decision on what is our best move. The issue with the home as is, is that it is old. The renovations we did 10 years ago need to be updated and we need to put some $$ into the home to rent it for a higher rent. The property is also small, two bedroom/one bath. Although rents are high for the neighborhood, you can only go so high on a two bedroom.

1. With the new laws in California, we can build a converted garage unit and rent that out as well.  Renting both units would bring in @ $6500/mth and costs would be around $3200. We could maybe add another bathroom or bedroom to the original house as well?? 

CONS:  We have to borrow $150K to make this scenario work and we have to build the additional unit as well as update the home leaving us out of pocket for expenses for @4-6 months.  

PROS: Super hot neighborhood near downtown so property will be always easy to rent and in demand. The additional unit should increase the value of the property. So we should be able to refinance after all the construction and pull the HELOC into that mortgage.

2. We sell the property as is and make a nice profit, 1031 that into a four plex and put out little no money on the exchange unless we have to fix up the four plex. If we do this right, we can have a positive cash flow with little to no money out of pocket.  That property will gain in value and try to get more properties in the next few years.  

CONS:  Easier said than done in LA, pretty hard to find a good four plex in the $1Mill price range and to actually get it over other investors. No guarantee it will be positive cash flow.  

Our tax accountant advised the 1031 exchange feeling our property might be at the peak of the market and if we buy a four plex in an emerging neighborhood we could then get the gains on that property.  It just seems really risky, so sort of scared to sell and then what if we don't find a new property.  We would love to keep the one and add another, but not sure where we can get all the $$ to do this.  We also want to grow our portfolio. I do design and have done three house flips prior to purchasing these homes. 

Any tips!!!!