Thoughts on my 1031 re-invest strategy?

Question

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 · Answer

@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.

Becca F. · Answer

Congratulations on the four rentals! Well done on the SoCal properties!

I'm very biased on keeping California properties. You also have great interest rates, 2.5 to 3.5% You mentioned that you started buying them in 2013. Eleven years isn't a super long time. Wealth in real estate appreciation as we've seen with many many long time CA investors.

When you said the two homes in the mountains are high maintenance, are you self managing those? Is the maintenance from the snow issue or something else? If you're wanting to get rid of those, I'd at least keep the other SoCal home.

One thing that OOS people don't understand is that Californians have Proposition 13 and our property taxes to up a maximum of 2% a year (unless someone does a significant renovation causing the property value to be reassessed). I don't know about Memphis but I also invest in Indianapolis and my property taxes went up 17% this year.

Another consideration: Nevada has low property tax rates and is a short flight or long drive away. It's more landlord friendly than CA. That would be my choice if I exited out of Indiana.

I'm not a huge fan of paying cash for properties since you're tying up a large amount on one property. My vote is to keep the SoCal properties and if you can do a HELOC or equity loan to pull some equity out if you want to buy in Memphis or somewhere else.

Bill B. · Answer

You’re trying to get away from maintenance and weather right? So I’d avoid the Midwest where you will get more weather and just as much/more maintenance.

The obvious answers for location, lack of weather is AZ,NV.

As Dave mentioned you’ll have to buy as much as you sell. So…

1)How much will you net after selling costs. That’s how much you have to spend on 1-3 replacement properties (to keep it simple)

2) How much equity do you have in the property? (You’ll have to replace any existing mortgage(s) with a new mortgage or out of pocket cash.) what will the new interest rate to do cash flow/returns (if new mortgage) or returns if you have to add cash. If it’s paid off, ignore this part.

3) I did my first 1031 last year with Dave and I haven’t looked back. (Swapped my oldest property built in the late 90’s for a new build.)

Ps. If you’ve ever though of retiring outside of California that could be the ideal place to buy a “nicer” property that someday may work better as a primary than a rental. Good luck and let us know how it turns out.

David Matthew · Answer

Good stuff to think about, thank you Sebastian.

It's cool to see extra replies from time to time on this post as I continue with the ideas.

It's interesting, I looked into different DSTs and had conversations but just didn't feel comfortable with what I felt was a lack of control or ability to really know the operators and properties.

I also kept running the numbers and just couldn't make 1031s into other properties make sense with the new interest rates compared to what I have now.

Ultimately I just raised rents and got better with outsourcing the maintenance in a cost effective way (wasn't doing that very well before). I keep thinking about this though, revisiting it and thinking if there is a better path forward.

Bradley Buxton · Answer

@David Matthew

I'd second what @Becca F. has said about keeping CA properties. Despite all the downside to CA it's still a great place to invest. If the hassle of the mountain properties is too much I'd sell.  I live in the Tahoe takes regular upkeep from the snow to the intense sun to wildfire risks.  I'm on the Nevada side of the lake and there are some good opportunities for rentals in the lower elevations around Reno. You get the benefits of being close to all the recreation without the heavy snowfall.  Another option for investing out of CA and still close to home.

Account Closed · Answer

Im a fan of more cashflow. Also buying new properties could allow you to create the proper legal structure if you haven't already. You seem like a seasoned investor, but many folks hold the properties all in their own name and while you can do an LLC transfer, being able to "wipe" your portfolio and start a new as a smarter investor then when you started is really nice if you can do it in a tax efficient way

Tanya Maslach · Answer

I really appreciate this thread!!  In the middle of trying to make the same decision (only from CO), and have learned that keeping the property is not financially wise since the ROI is low (<6%).  Even with $700 cash flow, and significant equity, the 1031 gets me into a higher return property (if I can find the right buy) -- andn the one I'm seeking (multiunit, for MTR usage).Love this group!

Kristen Haynes · Answer

Tyler, I would like more info on the passive 1031 fund...

Tyler M. · Answer

Hi @David Matthew - you are getting some good advice here. Definitely talk to a 1031 specialist like @Dave Foster to get the mechanics of the 1031 process.

Sounds like you want to keep your one rental and get rid of the mountain houses. I am in the same boat with low ROE homes and am selling them. Keep in mind that there are options to go passive with your 1031 equity as well. I’m looking at a few - one gives you a 12-15% preferred return and you can exit in a year if you want. (no loan amortization or further depreciation though). DM me if you want to chat.

David Matthew · Answer

@Lee Ripma Thank you for the input! It's good to hear from someone who has been in a very similar situation. These properties are in a smaller town (Crestline) but within an hour of Big Bear in the same mountain range. I agree with that suggestion (if the numbers make sense) as a good middle of the road option to still maintain some SoCal appreciation. Thanks!

Thoughts on my 1031 re-invest strategy?

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