Selling multifamily, what to do next?

Question

I bought my multifamily as a short sale, added value, and can cash out now with some good profit. The property values are topping in the area and starting to see a decline, and I am not seeing rental prices or demand increase over the years. It's also in a flood zone and the insurance keeps shooting higher each year. It's about a 5 cap now. Ideally I want to 1031 exchange it. I own it 100%. Do I go bigger and take on some debt? Find a higher cap rate property? Break it up into 2 or more properties? Move to short term rentals? Move the profits to an OZ fund and then keep the rest of the cash on the side until a good opportunity or pullback comes? Any other suggestions?

Thanks

Michael Ealy · Answer

Cap rate is NOT the same as return on investment.

There are 3 percentages you have to think about when investing in apartment buildings:

1. Cap rate

2. Cash on cash return

3. Internal rate of return

Let's start with #2 - CCR or CoC or cash on cash return. That's the amount of cash one makes on the cash one uses to acquire the property (cash investment = downpayment + reserves + repairs). Typically, investors use leverage or debt. So, even a 5% cap building can produce a 8% or 10% CCR assuming of course the debt's interest rate is lower than 5%.

Cap rate is the CCR if one pays if one uses all cash - no debt.

Internal rate of return factors in not just the cashflow from a building but also the capital gains and loan paydown one gets from the investment.

The IRR on a 5% cap can be a 12-15% or even 20%/yr specially after the sale or property disposition.

So, you can make a good return (double digit IRR) on your money even for a low cap building.

But to answer your question more fully, in general, it's hard to get double digit CCR on an investment without ACTIVE INVESTING specially in the low interest environment we have now. My passive investors typically make 6-8% CCR and 12-18% IRR and it requires that I do value-add not just buy a building for its current cashflow.

Andrea L Eskew · Answer

@Ray S.

See if you can 1031 into a better or more income producing property. Perhaps outside of a flood zone, if you can swing it.

Greg Dickerson · Answer

@Dave Foster I did mention the 10 year hold period for max benefit of profits earned. Max write down of initial gain is 7 years.

Heres the big differentiator now. You can refinance the property or sell and reinvest the gain and profits into another Ozone deal and compound returns but the proceeds need to be deployed back into an Ozone project in under 12 months.

Of course non of the guidance is law and have yet to be ruled on by the Dept of Labor or IRS but this is all in the latest round of guidance.

Greg Dickerson · Answer

@Ray S. Going larger for more cash flow definitely makes the most sense. You could look at commercial and multi family.

1031 versus opportunity zone is an interesting discussion. Ozone will generally be a ground up or heavy renovation and will take a few years to produce cashflow but could have a better upside. This vehicle will not be as flexible as 1031 since you will likely be one of many in a deal vs owning your property and the investment requires a 10 year hold to maximize the benefits. You can recycle the capital if doing your own deal or if allowed by the sponsor/developer.

Unless you are looking for a passive investment approach I think for most individuals a 1031 makes the most sense.

Ray S. · Answer

I want to stay in the game. I have the flexibility to be an active investor, but if I'm putting in time I want to get a better return than 5%. My current place isn't too much work, but it's more than I feel I should be doing for that kind of return. Sure my place could appreciate dramatically in the next few years, but could also plummet or just stay stagnant, so really want to shoot for higher cashflow. So I'm looking for ideas where I could really boost my earnings by being even more hands on and/or taking on more debit, another area, type of property, ect.  Or if there are also good options for better cash flow in a less hands on investment.

What would be some options for better returns that are more passive or more hands on? And if I wanted to be really involved, what would be my best option to get the most gains?

Thanks

Michael Ealy · Answer

Ray, the answer to your question is it depends.

It depends on YOU, your investment goals and your time horizon.

IF you want to continue ACTIVELY investing and you want to increase your cashflow, then do a 1031 exchange with a bigger property with more debt - and more cashflow.

If you want to invest more PASSIVELY and you don't want to pay the taxes on the gain, you can do a 1031 exchange through a DST (Delaware Statutory Trust). I like medical buildings given the ageing population with Fortune 500 tenants.

Jeff Kehl · Answer

@Ray S. I'm selling off some of my properties and doing some combinations of about everything you say. Couple things I would add to the discussion.

First, the OZ rules now are looking like the 180 days to make the investment starts on December 31st of the year you sell. So you can sell now and you have until the end of the year to decided whether to put it into an OZ investment.

Also, I would say a lot depends on whether you're looking for another active investment you would manage or a more passive one. OZ funds would be more passive. But you can also invest in say an apartment syndication and get fairly high losses in the first year from cost seg/bonus depreciation that might offset a lot of your capital gain.

If you want to be more active I would definitely suggest going bigger and looking at other types of commercial real estate since multifamily has gotten so expensive.

Dave Foster · Answer

@Ray S., I'd add one thing to what @Greg Dickerson about flexibility.  The tax on gains past in an OZ fund is only deferred for 10 years.  New gains attributed to your investment are tax free if you stay in the investment for at least 10 years I believe.  But you will still pay tax on gains transferred in (at least that was my last reading).  I prefer the indefinite deferral of the 1031 until I really want to go passive and then I'll continue to defer till I die.

OZ funds are acting a lot like syndications these days.  And that means competition for good product is enormous.  So really dig into the specific property quality of any fund you investigate.

Ray S. · Answer

I would probably use an OZ fund, and not purchase the property myself. The purpose would be to take money out of the market and roll just the profits over tax free. So if it were a 1mil property that had 100k of profits. Take the 100k, put it in an OZ fund and forget about it and then put the 900k on the sidelines until better opportunities come along. Ideally the 100k would start to cashflow in 1.5-2 years from the fund and then you have that chance of future appreciation as well. V.S. using a 1031 exchange where I would have to spend the full million.

Selling multifamily, what to do next?

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