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!

[Taz Zettergren]

@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! 

[Becca F.]

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.

[Zachary Jensen]

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

[Benjamin Aaker]

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.

[Alex Olson]

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. 

[Bradley Buxton]

@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. 

[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.

[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?

[Bill B.]

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]

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!

[Lee Ripma]

@David Matthew

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! 

[David Matthew]

@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!

[Tyler M.]

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. 

[Kristen Haynes]

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

[Tyler M.]

Of course. I messaged you.