Hold or Sell - Thoughts?

[George Pauley]

Hi BP'ers!

I am planning on selling my 3 AZ rental properties and wanted to put my thoughts on why and how up for review, critique and alternative thoughts.  :)

All three properties are in the Phoenix AZ area, and were bought between 2009-2011.  I'll tag them by their street names.

Superior:   Purchase:  $142k   Down $40k   Owed $101k   Sell $280k   LifeCoC  $-17k

DragonTree:   Purchase $147k   Down $35k   Owed $103k   Sell $240k   LifeCoC $0

Trellis:   Purchase $155k   Down $35k   Owed $114k   Sell $260k   LifeCoC $-7k

   
My motivations for selling are, first, I've bought other, much better cash flowing properties in the meantime.  (Though I'm not seeing near the appreciation.)  Second, I'm hoping to retire in the next 4-5 years and figure I should get my appreciation cash out while the getting is good.  I think Phoenix is a solid market with plenty of room for more growth, but you think about these things a bit differently as you get close to retirement.  Finally, I would like to get rid of the negative/flat cash flow properties before retirement.

Thoughts, comments?  Are there compelling reasons to hold on to these properties that I haven't considered?  The appreciation on these properties rocks, and maybe that's worth more than the horrid cash flow?

I see the deal as $780k total sales price. Minus 10% commissions/fees. Minus $320k mortgage payoffs. Leaving me about $350k cash afterwards. That's a profit of $240k in 7 years on $110k invested. A bit more than 10% ROI. Any problems with my calculations?

Finally, taxes.  If I take the cash, my accountant is estimating $70k in taxes, leaving me $280k in pocket.  I am vacillating between just taking the $280k, putting it in Patch of Land, or other equivalent vehicle, and getting my 9-10% a year without having to deal with properties, managers and tenants in my retirement.  (At least on these properties)

The other (mathematically better) option is to go through my first (mother of all) 1031 exchange and buy about 10-15 properties in more favorable markets (midwest) each cash flowing about $200/month.

I'm interested in everyone's thoughts on these two options.  Mathematically 1031 is the way to go.  But does impending retirement and the idea of getting my equity safely out of properties that may experience a down turn mitigate the math?

No right or wrong answers here.  Just looking to see what kinds of creative input this group comes up with.  Thanks much!

[Dave Foster]

@George Pauley, Moving these properties out of your portfolio seems like the right move.  Carrying negative cash flow into a mature market or retirement or both is inviting bad things.  Another way of looking at it is that in a mature market you buy cash flow and sell appreciation.

So - 1031 or not.   Compared to the potential tax hit it seems like a no brainer to at least attempt to exchange - especially since there's no penalty for starting but not completing a 1031.  Looks like your potential tax is going to be north of $100K including depreciation recapture so the question to ask would be are you willing to spend a thousand or two on 1031 exchanges for all to get the chance to keep $100K working for you.  

In your estimation you can make 10% on your money so is spending $2K one time worth risking for the chance to get to keep $10K/year/ life???  I know my answer :)

There's several things you can do to mitigate your situation and several options that also may still give you potential leverage and appreciation pop.

@William E.s idea of a portfolio sale is a good one to explore depending on the hair cut you'd have to take to sell all at once.  This would also turn it from 3 exchanges into just one so now you're only risking $750 to keep 10k/year.  

It's still a sellers market so you'll likely have some control on the contract.  When you get a contract on the first try to extend the closing date on it as far as possible or even sell with a contingency to get the others under contract.  

 l like @Ryan Swans hierarchy of difficulty. Selling several and buying several is the deep end of the 1031 pool.  But it doesn't have to be that stressful - especially if your worst case scenario is you shelter what you can and simply pay partial tax on the rest.

There is another blended option that could really benefit you as you near retirement and need to start separating risk and building certainty into your life. Why not sell and 1031 all into one all cash flow producing asset and a few highly leveraged (but passively managed - think good turn key SF or MF) properties. The all cash purchase either a fixed asset or a debt free TIC provides good predictable long term cash flow. And usually are more available because they move more slowly. The remaining cash you use to leverage into fewer good cash flow/appreciation plays. the debt does carry more risk but you've separated it from the cash flow cash so you've isolated the risk to only those leveraged properties. In your case it would look something like do the 1031 and purchase a cash flow instrument with $300K cash yielding you maybe $21/year net of all expenses. Then use the remaining $50K to buy a medium size MF or 2-3 turn keys. All of a sudden you've reduced your work load in the 1031 and still completely deferred all tax, provided long term cash, and still have a leverage and appreciation play but separating the risk.