Sell Central Valley Rental and move equity to San Diego rental?

Question

Hi, would love some input/advice on this scenario:  I currently live in the Bay Area, and have a single family rental in Merced, CA that I believe has a slow appreciation: bought for $170k in 2005 & its now worth about $400k. Rents have increased slowly (not a ton of growth there), but we do have cash flow of about $1000/month & its locked into a 3% fixed rate. I've depreciated it over the years so it's been a good investment for tax purposes and we've also leveraged it previously to purchase another rental before we refinanced it in 2021 at 3%.

But I'm now considering selling that Merced rental and using the equity to buy a San Diego house that I would use as a 2nd home/vacation home & rental.
I would rent out a portion of the house & save a space for myself when I visit. I love it in San Diego, have family there and plan to move there at some point in next 10 years or so either way. I currently visit SD about 4-5 times a year.

Due to high costs in San Diego, I would likely have about $2500-$3k month negative cash flow even with renting out the rooms/house. But we can afford that (our current bay area home is paid off) and we have a regular income & no other debts.  When we finally move to SD permanently  I plan to refinance, pay it down and reduce the loan.

Does this seem like a reasonable plan or should I allow the 3% rate to lock me into that rental even though I want to use that equity to buy in SD rather than wait several more years, till I save up more for a down payment to buy in SD?

I would love to hear some input about this.

Thank you.

Melanie P. · Answer

That money is not down the toilet. Part of it is paying down principal. The interest portion has been historically wiped out and seriously bested by appreciation:

Dave Foster · Answer

@Anita Zuniga, You're in the middle of a "Purse strings" v "heart strings" moment.  LIke @Steve Meyers mentioned you've actually had some good appreciation (even though it may be slowing now).  Nice positive cash flow, stable rental situation, and incredible interest rate.

San Diego offers a market a the top ish.  negative cash flow, high interest rates.

From a business perspective only the choice would be stay right where you are.

But you are at a time where a vacation rental you can use yourself is attractive.  You like SD.  That complicates the decision.  So change the question and ask if you can afford that negative cash flow indefinitely.  You're certainly in a great position being debt free except for the Merced place to make this move.  And the purchase of a larger property would add to your depreciable basis as well.

Most interestingly - What kind of vacation could you take in SD each year for $42K?  If you took the $12K positive cash flow from Merced and added to that the $30K you are going to be negative in a purchase situation in SD, what kind of vacations would that buy you???

If you hold out a section of the home strictly for personal use that part will not count towards your 1031 reinvestment requirements.  So, like @Steve Meyers said you may want to put it all into service.  And then use it whenever it is not booked.  That way the entire amount would go into the investment bucket.

Dan H. · Answer

>have a single family rental in Merced, CA that I believe has a slow appreciation: bought for $170k in 2005 & its now worth about $400k.

Because that period includes the Great Recession, that is a very good appreciation rate and better than San Diego had over the same period.

3% loan is tough to beat as is a property tax that is ~50% of what it would be if you purchased today.  The prop 13 savings is ~$2k/year. There is little doubt that Merced will have superior cash flow vs San Diego in the near term.  I would be reluctant to sell this property given its current advantages over a new purchase.

This does not mean that I suggest you wait to purchase in San Diego if you are confident you will move here in the future.  Long term it has appreciated noticeably faster than the inflation rate.  I believe this is still likely for the long term.

I suggest you look into extracting equity from your primary rather then sell the Merced property.  You will still end up paying the current rate, but you will maintain your prop 13 discount.

Good luck

Steve Meyers · Answer

@Anita Zuniga if your end goal is to eventually move to San Diego then I think this would be a smart plan.  If I was in your position I would look to air bnb or VRBO the property you purchase in San Diego this way you will have less negative cash flow than if you were to rent it out to a long term tenant.  You will need to get a STR license but they are not hard to get and over 800 are still available.  The market here in SD continues to appreciate 10-11% year over year and with a shortage of inventory it's not showing signs of letting up so waiting 5-10 years to just sit on a 3% interest rate on your Merced rental when your goal is to move to SD makes sense to do it sooner rather than later.

Anita Z. · Answer

Thank you so much @Dan H. @Dave Foster @Melanie P.  These are all things I hadn't considered. I appreciate all the input! Hadn't thought of Prop 13 and pulling equity from my primary, or the idea of adding up the costs from cash flow and negative cash flow to compare if this is a good move.  Love all the different perspectives on this forum!

Anita Z. · Answer

Thanks  @Steve meyers!

@Twana Rasoul can you clarify what you mean by the limits on the 1031 exchange?

Anita Z. · Answer

Thanks @Melanie P. and @Bruce Woodruff for your input.

I go back and forth on this and trying to see things from various points of view, so I appreciate both comments.   I would likely rent it out whenever possible when I'm not staying there. The goal would be to have this cover or at least minimize the negative cash flow.

Bruce Woodruff · Answer

So if I understand correctly, you are saying that - even when rented, you will have a negative cash flow of $3k a month? That's $36,000 a year x 10 years = $360,000. A third of a million $$ down the toilet.

Look, I lived in SD for 4 decades and yes, it is beautiful. But nowhere is that beautiful.

Twana Rasoul · Answer

If you are doing a 1031 exchange, you are exchanging one investment property for another investment property so you technically would not able to use it whenever you want because it would not be an investment property then and you may get hit with the capital gains.

Melanie P. · Answer

Agree with the advice above. Evaluate your options as a STR. You can lock off a closet or two for your personal things ("owners closet"). Rent out the entire place. You'll probably only go negative in the months you block off time for your own use.

Sell Central Valley Rental and move equity to San Diego rental?

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