I have a dilemna.....To sell or not to sell?

Question

Hello BP Family,

I currently own 2 SFR. One I own free and clear (House #1) and I owe about $28K on the other (House #2). The rent on the free and clear is $500 and the other is $675, so I am positive cashflowing on both. The $675 tenant is moving out at the end of the month, which has me thinking. I have been watching the market and I may be able to sell the house and make about $17-20K, however if I keep it a couple more years I may be able to sell for more or, quite naturally, I could keep for the next 25 yrs and make significantly more over the life of the property. The other issue is I want to buy another property and I am currently a little short on cash. So here are the options I am considering:

1. Sell house #2, and take that money to put a down payment on income producing property  and keep a little money in pocket.

Pro: I will still own the other property free and clear and possible increase my number of units if I can find deal on multi-family.

Con: Selling off a good cash-flowing property in a good neighborhood that rents easily.

2. Do a cash-out refi on house #1, keep both houses and have less cashflow, but have the cash to purchase another property.

Pro: Increasing number of units and maintaining established property

Con: Leveraging a paid for property and reducing cashflow.

What would you do? All suggestions will be appreciated.

Dave Foster · Answer

Hi @Terrence  Smith

You've started a most interesting philosophical string discussion.   I think maybe your original priorities are getting lost in the shuffle.  Here's what I'm hearing you say are your two biggest priorities and neither one is really about wanting to sell.  Selling is simply one of your options to get what you really want which is -

1. You'd like more properties

2. You need cash

Can you do both?  That all depends on the numbers doesn't it.  And of course there's the very thoroughly discussed question of the cost of doing that.  Does the money you get now cost you more in the long run?  Does the cost of saving taxes now in real dollars, time and opportunity cost out weigh the benefits of using a tax deferred strategy?

We see clients all the time having the same dilemma of wanting to continue to use 1031 tax-deferred dollars to grow their portfolio but need cash for immediate use.  Well you may be able to do it all if you can make your numbers work and find the right properties.  The structure would look something like -

1. Sell Building number 2 and do a 1031 exchange.  The mortgage is paid off and you use your cash proceeds as down payments on 2 properties.  Either pay cash for one and take a larger loan on one (preferred to lower cost of borrowing) or take loans on both.  You just kept all of your money tax deferred and increased your number of units.  Goal number one complete.

2. Immediately after the purchase (not before! There is precedent for the IRS to disallow an exchange that was refinanced immediately before a sale in order to pull cash out) do a refinance, or take out a new first or a heloc.  Again you kept all of your profit tax deferred and now goal number2 is complete.

Again, only you will know whether your credit and the equity in the properties and the state of the market will handle it but it may be possible to have your cake and eat it too!

Dave

Rod Smith · Answer

Account Closed

Thank you all for your thought provoking responses! This discussion has made me stick to my intial goals of building a large rental property portfolio. Guess I was just getting a little impatient, which is never good. Thanks for being a sounding board.

Account Closed · Answer

Everyone eventually gets to spot where they have no more money to buy with.  This is where your investment philosophy comes in.  Yes, you can sell a house.  Unless you do a 1031 exchange, you're going to have taxes to pay.  And, you're going to have transaction costs, which will be higher if you do the 1031.  And with the 1031, if you do the delayed exchange you'll put yourself under time pressure to both identify your next property (upleg) and then to buy it.

You can also refi.  In this case it sounds like you could refi either house.  You going to create those transaction costs again, points, closing costs, etc.

You could take some of that cash flow and do another deal.  How about partners, private lenders, owner finance, etc.  Alot of ways to do transactions where you might not have to sell or refi.

I remember one time listening to Harry Helmsley (the richest real estate investor at one time, owned the Empire State building among other things) being interviewed.  He bragged about the fact that he had never sold a single property.  Interesting eh?  And from my own vantage point I must say that if you're able to hold the properties I think it's more profitable than flipping in the end.

So really, you have to set your own objectives and goals.  But that house you're thinking about selling, sounds like a good house, and you said it was easy to rent.  I'd say you need to think about that too.

Gilbert Dominguez · Answer

I would not sell. Uncle Sam is all too ready to take your money. I would refi on both your existing properties and use the proceeds to buy more units but make sure they will also cash flow beyond whatever your total and ongoing expenses will be. Playing with Uncle Sam and putting the ball in his court is a losing game. You may drop your overall cash flow per unit but over all your cash flow should be higher in comparison to your out of pocket expenses.

Mike Hurney · Answer

@Rod Smith my inclination would be to refi cashout as much as possible, AFTER I maxed out the rental value (i.e. find the amenities your competitors have: DW, GD, cleanup the entrance) then get something else.

However with a sale and 1031, the Multis will give you the economy of scale that'll really let you get ahead.

Mark Del Grosso · Answer

My vote is for a refi with the stipulation that the new (third ) property MUST positive cash flow equal to or more that the new refi loan payment. So your income is the same and you add another property.

I agree with Harry Helmsley.

Elizabeth Colegrove · Answer

I just completed a 1031 exchange for my parents. It made sense because it allowed them to sell and old depreciating asset and buy 3 newer appreciating assets. Areas and markets change, so it is important to keep us what is happening in the area.

Rod Smith · Answer

Thanks @Terrence  Smith

& @Bill Exeter

@Mark Whittlesey

I said that eventhough I would still only have 2 units, I would not have to leverage house #1 to do it and I will have a little more cash anyway. Also, I ideally would like to find a multi-family which will increase my unit #.

Bill Exeter · Answer

There are many reasons that you might sell one property and acquire another property through a 1031 Exchange.  The most important part of the transaction, in my opinion, is that the 1031 Exchange must put the investor into a better position (how ever they define that) than they were before.  If the 1031 Exchange does not put the investor into a better position, how ever that is defined, the investor should probably not be doing the transaction.

Mark Whittlesey · Answer

What is the benefit of selling a house to buy another house? There ARE reasons to do it. But I am not sure I have heard them here.

Typical reasons would involve moving up (or possibly down but typically up) in density, neighborhood changes, your lifestyle changes.

I guess what is your motivation.. if you sell one to buy another, you will still only have 2 right? And there will be costs on both transactions.

I have a dilemna.....To sell or not to sell?

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