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Thoughts on my 1031 re-invest strategy?
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!
@David Matthew I hate the thought of giving up the sub 3.5% loans but if you're ROE is sub 4% then I believe you're having the right thought process if a cash out refi or heloc isn't feasible right now. I work with dozens of investors who have done 1031's into the souther/middle part of the country where the price points are much easier and the laws are more friendly. Feel free to reach out if I can be of any assistance. Best of luck!
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Real Estate Agent
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.
Quote from @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!
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
- Rental Property Investor
- Brandon, SD
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It would be nice to know if the high maintenance is referring to the cost driving down the cash flow, or is it just the headache of managing the maintenance, but they still cash flow. For the latter, it's a full service property manager. For the former, then selling is the way to go.
Otherwise, sounds like you are already knowledgeable about out of state investing. The Midwest can be a great place to get good cash flow, but make sure you have quality management.
Your ROE is low. I would try selling one, 1031 exchange into the Midwest with a newer build property. Of course I am partial to KC. If you like that, you could do it again until you are satisfied.
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.
#1 1031 Exchanges Contributor
- Qualified Intermediary for 1031 Exchanges
- St. Petersburg, FL
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#1 1031 Exchanges Contributor
- Qualified Intermediary for 1031 Exchanges
- St. Petersburg, FL
@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.
Thank you for the replies and different opinions! It's nice to consider different viewpoints. Excellent point on the IRR, I haven't built my spreadsheet out to accurately calculate that yet but I know it's pretty high for the SoCal properties. The appreciation has been no joke!
I’ll add some details to the mountain houses which will shed some light.
The houses are aging and I’m doing a lot of wood, siding and deck component repairs plus they need staining quite often. There is a lack of good management options up there so I manage myself. There is a lack of handymen as well so I do a good amount of the work myself or using helpers. The biggest issue is that eventually those decks will need replacement (I’m keeping them alive as long as I can). Replacement costs are 35-45,000+ EACH! Ridiculous. The other issue is forest fire risk plus insurers are dropping policies and most insurers won’t write policies there anymore. These factors cause a bit of anxiety and have led to this whole re-evaluation. On a second look, one of the houses I could probably get up to 5% ROE, the other 4% max, not sure it’s worth it though.
The other rental down the hill is a different story. Stucco, no decks, I’m renting individual rooms, 10min away from my house, easy maintenance. If I’m being honest with myself, I just haven’t been keeping the rooms up at market rate. I used to live there myself and know them somewhat personally (one pretty well) so I’ve been soft on price increases (when someone rarely moves out that room goes to market rate though). If I put on my business hat I realize I could really increase cash flow from ~900 to 1400-1700. That could get that house to ROE 6% plus the benefit enhanced appreciation. I just need to give them the tough news about how much I need to increase prices and deal with potentially some leaving. So the performance here is really on me.
Based on the opinions and realization I’m now leaning towards a middle of the road approach - keeping the SoCal room rental house, get that to market rates (~6% ROE) and 1031 the mountain houses. Thoughts?
#3 1031 Exchanges Contributor
- Investor
- Las Vegas, NV
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.
Appreciate the info, I now see I was misunderstanding the 1031 NSP purchase requirement. So I'll make a new spreadsheet and re-run my numbers to see what I can pull off. In the meantime I will optimize my SoCal properties. Thanks everybody!
Great thread you have going here!
I'll jump in with my two cents. I had a place in Mammoth Lakes, CA. I am guessing your rentals are probably in Big Bear. I sold out of Mammoth because I had already captured a lot of appreciation (equity) and I saw the writing on the wall with the fires an insurance premium increases. After I sold the insurance premium went up 5x. I did a 1031 exchange and purchased a 19 unit in Overland Park, KS.
It sounds like you really want to sell the mountain houses and with each of them you could easily pickup a 4-8 unit in the KC metro. I would personally do that because I actually did do that. Maybe sell the mountain houses and keep the other two that way you are keeping your foot in the door with appreciation but getting rid of the hassle of the mountain houses.
Regardless of what you do you're in a great position with equity. I am fond of saying when you have equity you have options. You have options!
@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!
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.
- Real Estate Broker
- Greater Charlotte NC and Charleston, SC areas
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Tyler, I would like more info on the passive 1031 fund...
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Broker North Carolina (#173307) and South Carolina (#13212)
Of course. I messaged you.
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!
Quote from @David Matthew:
Thank you for the replies and different opinions! It's nice to consider different viewpoints. Excellent point on the IRR, I haven't built my spreadsheet out to accurately calculate that yet but I know it's pretty high for the SoCal properties. The appreciation has been no joke!
I’ll add some details to the mountain houses which will shed some light.
The houses are aging and I’m doing a lot of wood, siding and deck component repairs plus they need staining quite often. There is a lack of good management options up there so I manage myself. There is a lack of handymen as well so I do a good amount of the work myself or using helpers. The biggest issue is that eventually those decks will need replacement (I’m keeping them alive as long as I can). Replacement costs are 35-45,000+ EACH! Ridiculous. The other issue is forest fire risk plus insurers are dropping policies and most insurers won’t write policies there anymore. These factors cause a bit of anxiety and have led to this whole re-evaluation. On a second look, one of the houses I could probably get up to 5% ROE, the other 4% max, not sure it’s worth it though.
The other rental down the hill is a different story. Stucco, no decks, I’m renting individual rooms, 10min away from my house, easy maintenance. If I’m being honest with myself, I just haven’t been keeping the rooms up at market rate. I used to live there myself and know them somewhat personally (one pretty well) so I’ve been soft on price increases (when someone rarely moves out that room goes to market rate though). If I put on my business hat I realize I could really increase cash flow from ~900 to 1400-1700. That could get that house to ROE 6% plus the benefit enhanced appreciation. I just need to give them the tough news about how much I need to increase prices and deal with potentially some leaving. So the performance here is really on me.
Based on the opinions and realization I’m now leaning towards a middle of the road approach - keeping the SoCal room rental house, get that to market rates (~6% ROE) and 1031 the mountain houses. Thoughts?
Also, now you have a good chunk of change in equity that could give you a huge boost in wealth if you now use the money actively. I’ve had investors that initially bought SFRs in CA and accumulated about $400k - then sold the properties and now are actively buying fixers, small homes and value add properties where they use the $300k to purchase and improve and make between $200k to $300k per year in gross profits when selling a renovated or improved property. You may choose to keep a really good property you fixed where the equity grew by 30% to 40% in year 1.
The great thing about CA is that the price per sq ft is very high. So many people are buying for $700k improving with $300k and now that property is worth about $1.5
You could also buy a duplex and turn it into a 4 Plex with ADUs : increase value/ equity and also cash flow.
I would guess that your current rents and net profit from rents are no where near $150k to $200k per year?
But the main question would be for you to ask yourself:
Are you growing and building ? Or are you maintaining and cruising ? if you are growing and building wealth, then the strategies described above could work. Reach out if you need resources out here? Deal finding, contractors, architects etc
good luck
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.
Quote from @David Matthew:
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.
You should come to some of our meetups and ‘home crawls' where we walk some of our current projects with clients in LA. That will give you an idea of what we can help with and what other investors in similar situations are doing. Keep in mind that you don't have to do everything at once. Look 1 property (probably one that is not performing as well as the others), and see: #1 how can you infuse value into it (ADU, More sq ft, higher rents etc)- take it to its best and highest use for more value and then see what you could buy instead. If what you buy next gives you either: more cash flow or more equity or both, then it's a no brainer (even with higher interest rates). Example: we had a condo rental in Azusa, CA : bought it for $290k worth $450k in 2018. We had a 2.8% interest rate. And we were getting a net $300 per month cash flow- pretty passively. We had $180k sitting in the property. Most friends in the industry were telling me to keep it bc of the interest rate… so I sold it. We took the same amount of money and transferred it to a different investment. Now, instead of $300 per month, we are making : $2k from an ADU rental and $2,500 per month from another investment (with $150k invested ).
Next year: we are likely buying another single fam. Home on a corner lot. Making the front of the property : Main home + ADU and taking the back of the lot and will put 1 or 2 units (top and bottom) : depending on how much capital i have to work with. So we will go from 1 unit to 4 units, with a combination of personal funds and construction loans. My cost to build is pretty low, so it makes sense. Full construction costs will be around $300k with $50k for purchase and closing costs. On a $700k purchase. Just including the numbers on here to give you an idea.