Should I sell to scale the value of portfolio

Question

Hi all,

I am considering selling some or one of my multifamily properties to scale up my portfolio in terms of both doors and value. I currently own several properties with approximately $200k in equity. For example, I owe $340k on one property, and it's worth roughly $550k or more. My goal is to expand my portfolio size before starting a family and needing to take on less risk. I would like to sell these properties to acquire a larger building, perhaps a 4-unit or larger (maybe commercial), priced around $1M to $1.2M. The downside is that I currently have low 3% interest rates and the properties are generating good cash flow.

Any advice?

Robert Rixer · Answer

I recently heard a well known real estate mogul say his only regret in his career was not holding on to every property he purchased. He sold most to try and buy more and larger properties - instead he should've figured out a way to fund them all. When you shift in and out of properties you pay fees for commissions, loan origination, transfer taxes, etc. which will silently eat into your gains. Even if you can find an edge in short term maneuvers, you'll almost certainly be better off in the long run if you can figure out a way to keep these current properties (especially at 3%) and fund the bigger, better property either through partnering, syndication, f&f loan, etc.

Evan Polaski · Answer

@Jerry Lakey, you are correct that any leverage = risk due to both less cash flow and possibility of wiping out all equity in the event of any decrease in value. @Ricardo T., I would look long and hard at the actual return potential available in your current portfolio, as is, and what happens if you do sell and buy this 4 family. At the end of the day, investing is not about SCALING but about maximizing the financial return on your money relative to the perceived risk.I don't know your current portfolio or asset, but as others noted, you need to really run the numbers on that sale. A property worth $550k, with a standard 6% commission will incur $33k in commisions alone. So now you have $167K to play with. If there are any buyer credits, that is even less. Tax proration could wipe out several thousand more in sale proceeds. Then you get into a four family, and if you are not going to occupy, your loan will likely be capped at 75% LTV. So let's assume you walk with $160k in net proceeds from sale (and that is before you owe long term capital gains on sale), at 75% LTV, you can basically buy a $640k worth of property. I do not think now is a bad time to sell, but at least in my market, it is a very challenging time to buy. Between high prices (the same thing that are benefiting you on the sale side), high interest rates on new loans, likely slowing rent growth, it makes for a hard time to buy anything. Now if the four family was a big renovation that you bought for say, $1mm but with renovation to all the units, could be worth $1.5mm (assuming you only spent about $200k on renovation), then I would say that would be worth it. But if it is turnkey, I am assuming you will probably not be ahead on cash flow from your current property (and likely less).But I want to reiterate, if you say you are an investor and your focus is scale and number of doors, you are measuring the wrong metric. I would rather have 1 door that yields 50% then 100 doors yielding 3% (assuming total capital invested is equal).

John Clark · Answer

You speak of less risk because you’ll be starting a family, so I assume you’re fairly young. I think the better question would be how much management capacity you’ll have once you start a family—as in how much time you’ll have to devote to your properties. If you will only have time for one property consider a really good management company for your current properties (assuming they’re in one area) so you can concentrate on your family and one new place just to keep your hand in.Pay for the new property by offering second place interests in your current properties in addition to a first on your new property. That way you can tap your equity without losing your current mortgage rates. Coordinate with all your lenders.

John Clark · Answer

Not a heloc, which is a stand alone instrument. You can offer more than one property as security for a mortgage, with the current properties taking on second mortgages. Think of it as a portfolio mortgage and a first mortgage combined in one step to give enough security to have a low/no down payment for the new property.

Jay Thomas · Answer

Selling can unlock equity for a larger building, offering diversification and potential higher returns, especially in the current strong market. However, you may lose favorable financing terms, established cash flow, and incur transaction costs. Alternatively, you could explore options like cash-out refinancing to access equity while keeping low interest rates and established cash flow, or a 1031 exchange to defer capital gains taxes and reinvest proceeds into a similar property. To make the best choice, carefully calculate the financial implications, align with your long-term goals, research the market for larger buildings, and seek advice from a tax professional to navigate potential tax impacts.

Jake Baker · Answer

@Ricardo T.It all depends on your risk tolerance and what gives you peace of mind. I look at my portfolio as a whole. What percentage of leverage do I have? What is my Return on Equity?What is my reserves amount that I need in case of unexpected capital expenditures?

Dave Foster · Answer

@Ricardo T., A possible 1031 strategy for you would be to sell several of those properties and purchase 2 replacement properties using the 1031 exchange.The first property is something larger that you can own in cash. The second property would be something like a zero coupon DST which absorbs your debt with the non-recourse debt of the DST. You don't have to take out a high mortgage. And it eliminates a bunch of risk.

Jerry Lakey · Answer

With a portfolio loan, cashflow will suffer on the existing properties. I guess the bet is the larger property will cashflow better than the old existing properties? If the cash flow on the existing properties goes close to breakeven, seems like you would be increasing your risk of large capital expenditures, like roofs or heat pumps, without cash flow to sustain them. How does this play out, typically?

John Clark · Answer

Check with your bank

Ricardo T. · Answer

Any recommendation on places that do that?