Should I stay or Should I go?

[Maya German]

Hello everyone,

First of all, I am new to BP and I enjoy reading people's posts. So here is my dilemma.  I am selling a couple of my rental properties in San Diego, CA and would like to do a 1031 exchange on a multi-family unit. I am not sure if I want to buy a multi-family unit in San Diego because of the high costs. I would like to know what would you do? Would you invest in other state like TX or AZ or stay here in San Diego. Any feedback is appreciated. 

[Dan H.]

I will start by stating that I believe the RE market is an efficient market.  Prices depict a range of variables that basically boil down to risk and return.  For the return, there is both short-term and long term return.  Risk is made up of many items including eviction rates, tenant quality (very much a function of vacancy rates), vacancy rates, etc.

What this really means it that different markets have different strengths and weaknesses.  I recommend all newbies start local.  There are a plethora of reasons for this that I have posted elsewhere.  The OP is not a newbie.

So here is what I believe about the San Diego market:

• Historically it has produced outstanding long-term returns.  This is a function of both the property and rent appreciation.
• The rent appreciation has made San diego, contrary to popular belief, and outstanding market for long-term cash flow.  It is simple math that the market with the higher rent appreciation rate will always eventually produce better cash flow than the market with a lower rent appreciation rate.
• The eviction and missed payment rate in San Diego is one of the lowest in the nation.  It is my belief that this is more a function of the low vacancy rate than the cumbersome eviction process.
• Prop 13 is unbelievable benefit for long-term investors.  The state average property tax paid has been estimated at 0.77%.  The high appreciation cities pull this down.  What this implies for San Diego is that our average property tax rate is likely below 0.77%.  I know our (H3 Properties) property tax rate is way below 0.77%  We have multiple properties (close to half) that have rates near or below 0.5% of the value.  We have one that I suspect is below 0.25% of value.

As indicated, the market reflects multiple variables so here is the bad.  The bad is mostly short-term negatives:

• High price of entry. Especially for the investor with no value add using traditional financing that is getting 80% LTV. This is less an issue if house hacking (95% LTV), doing a value add with a refi (extract out of investment), or using creative financing (obtaining higher than 80% LTV). It is why for a long time all or our acquisitions had a value add.
• Poor initial cash flow.
• Tenant friendly regulations.  I have found with the low vacancy rate, the tenant friendly regulations are of virtually zero impact but they are real.

I believe strongly that San Diego will continue to be an outstanding long-term market.  I also believe that many markets can produce better return in the short-term.

We are at about the maximum number of units we can handle without changes. If that were not the case, I would more actively be acquiring more properties (we closed on a quad New Years Eve, but our acquisition rate has slowed) like the ones we have (mostly duplex to quad). Because I am considering commercial MF (5+ units) and sustainability requirements on commercial financing, we may in the near future look non-local. It will not be because I do not have huge confidence in the San Diego market. It would be due to the sustainability requirements and my aversion to have to have LTV typically lower than 70% and often lower than 60% on San Diego commercial MF.

Good luck