Thoughts on my 1031 re-invest strategy?

[David Matthew]

Hey everyone, hoping to get some opinions on my latest strategy thoughts.

At the moment I have four rentals, all SFHs, and bought starting in 2013. Three of the rentals are in Southern California and have appreciated quite a bit and so I’m starting to look at what I could be doing with that equity. Two of the rentals are located in the mountains where it snows and have large decks, they are very high maintenance so I’d like to get out of those if possible.

In the three SoCal houses total I'm now looking at 703k equity (Split among the houses- 162k, 204k and 336k). COCR is good compared to my original investment on all of them and rents have steadily been increased but If I do a ROE calc, it's really only around 3.5-4% on average. All of them were ReFi'd and have 30yr interest rates between 2.5 to 3.5% (VA Home loans).

I've considered lots of options (all real estate based since I can do a 1031 exchange and avoid the capital gains tax). I've thought about selling the properties and getting something in cash here in SoCal to have it local but the COC is not amazing and it lacks diversification. I do have one house in Memphis bought in 2018 so I've dipped into the out of state game already so I'm not scared to go that route again. I've also considered cash out of state multi-family but doing multiple into one 1031 exchange on my first time sounds risky and stressful.

Mostly I like the idea of selling a house here, 1031, then a cash purchase in the midwest/south etc (Then if successful, repeat). If I can even get 7% COCR with my gained equity out of state it would be a substantial increase in cashflow. I feel like the big equity gains are already realized here in SoCal so there isn't much point holding out for more.

I’m curious what y’all think of my general thought process/strategy so far. Anything I’m missing here? Other ideas?

Thanks!

[Dave Foster]

@David Matthew, ROE is important. But the king of metrics is the IRR. This is the total of all sources of income in an investment. And it includes - NOI, Appreciation, Amortization of the loan, and depreciation writeoff.The total of these will paint the picture of how your properties are actually performing.

What is interesting is that each of these components will react differently depending on where and how you place your next investment. CA may be low in cash flow. But the appreciation will certainly be higher. With a cash purchase you reduce some risk and increase cash flow. But the amortization component of the IRR is $0. Whereas now your amortization component is very high because of the favorable financing in place.So you have to consider all of those when looking what and where to invest next.

Another thing to remember is that in order to completely defer tax in a 1031 exchange you must purchase at least as much as your net sale.  And you must use all of your net proceeds in the purchase.  So there is an element where you will either replace a mortgage.  Or you will need to come in with cash of your own if you want to purchase your replacement propety for cash.

Your idea of starting with the 1031 to access 100% of the equity is smart.