Have you diversified away from real estate?

Question

It's gotten to the point that I'm 1031 exchanging some of my rental properties for additional rentals. Started out turning primary residences into rentals but held them long enough in most cases that I now have to 1031. But I'm also at the point where I'm considering holding onto proceeds from some sales. I don't see huge upsides as there is only a few years left in the up swing and after transaction costs, it's not that fruitful to buy now and hold for another 5 years or so.

Also, I'm in earthquake country and insurance is a gamble at best as they may deny a claim. To top it off I am way of having all of my money in one asset: real estate. As such I'm considering putting more money into index funds instead of real estate to balance the portfolio out.

Dave Foster · Answer

@Jack B. It's a counter intuitive thought but sometimes avoiding the corrections in a real estate cycle is not the best thing to do. You've started a path of tax deferral and it's worked for you. Now you're thinking to exit real estate to avoid the next crash. If you cash out now your equity and the money you are earning income from drops dramatically and immediately. Sort of exactly like would happen to your equity in a market correction but with one big difference every investor has learned over time. Selling and paying the tax is the same as selling a property at the bottom of a market and you don't get the opportunity to recoup because that asset (meaning the deferred tax) is gone. Investors that had to sell due to credit/leverage issues got hammered. Same as you if you sell and pay the tax. But what has happened to every investor who did not sell during the last crash (think@Pat L.) - nothing! Their rents continued and improved. Their equity has recovered and improved. So who got hurt in the market crash? - People who were over leveraged or in the wrong markets and the wrong sectors - Folks who bought negative or near negative cash flow and then got caught short and had to sell.Real estate investors in it for the long haul sit tight while the ship is sinking so they can be the first salvage crew on site. You have the opportunity to use your 1031 and keep that profit inside your control but still shape your portfolio to be more recession resistant.1. Change locations - Get away from Earthquake central. Come to Hurricane Central or Avalanche central or drought central.2 Change philosophies - Go from high appreciation to high cash flow regions.3. Change sectors - Go from residential to commercial or agricultural or industrial or or or...4. Change Your operating model - Go from active to passive - NNN or TICs or DSTs many tenants to one tenant.5. Switch from offense to Defense - Use the 1031 to concentrate debt in a few properties and keep more free and clear. At the worst by ratholing those you significantly mitigate risk and you give yourself something to leverage when the next buying opportunity comes around.6. Use cash flow to change your overall portfolio rather than asset sales. Sure diversification into things other than real estate might be a good thing. So do it. But use cash throwing off rather than taking the tax hit. It's slower but it saves you a bunch off the top in taxes.I'm first in line for an autographed copy of @Steve Vaughan's new book "The Lazyboy Landlord".

Steve Vaughan · Answer

Yes, I'm 'diversifying' out a bit as well. Mostly selling smalls as they become vacant. 2 last year and 1 so far this year. Taxes not too bad when I sell piecemeal. Will have to exchange soon though if I continue to liquidate. I'm doing a little stock trading and smelling the roses between naps. Been a long haul. Doing a little small business lending, getting a car that doesn't squeak or overheat. Matter a fact, it's too small to haul tools and too fast to give a rip.Anyway, it's not a market timing thing for me (although it's been great on the sell side) as much as a career path cycle maturing. Maybe you're ready for something new, too, Jack? I'll always love RE and have my eye on 28 or so specific units, but sometimes 'diversifying' into an easy chair is ok for a while, too.

Jordan Moorhead · Answer

@Steve Vaughan one of these days I'm going to get a car that doesn't squeak or overheat :)I don't have a ton of real estate but I am selling my duplex that's seen great appreciation to 1031 into more cashflow.

Pat L. · Answer

we have concentrated exclusively in REI since '74 (rentals, commercial, flips, notes) & the only regrets were having to sell any of it!!!

Mike Dymski · Answer

Moving into an inflated stock market is not a flight to safety. You may want to exchange value plays for cash flow plays if you are concerned about the future IRR of your value plays. Congratulations...achieving the property strategy is success and a good problem to have.

Jay Hinrichs · Answer

Short term mezz notes middle term notes .. new construction.. paring way back on flips high end flips find new construction easier at least for us.

Jeffrey Holst · Answer

I hold a small amount in the stock market and another small chunk in cash accounts but I am not going to try to time the real estate market. I have no clue what's coming next but I don't see significant drops in rent in most areas so as long as I have a solid cashflow I'm cool with riding out whatever may come.

Sam Shueh · Answer

Do not count you have 5 years left in upside potential on RE. 30% fixed mortgage is now 4.53%, all lenders are working on 4 more raises in 2018 and perhaps 3 more hikes in 2019. Once it reaches 5-5.5% interest rate it will stall the affordability freak out home buyers. If you purchase now 5 years down the road I suspect the value may be lower. In Silicon Valley, I see people use 12-15% ROI as threshold to determine where they want to invest as equity seems to be a better choice. It is liquid by click SELL button you take profit or have paper loss. Warren Buffet as rich as he is he has problem to unload his beach front home months after months. He can afford vacancy most investors can not.Suggest you talk to your CPA and a financial planner for alternatives.

Anthony Gayden · Answer

Jack B. No, I am not diversifying away from real estate. I do not feel that the stock market is a good place to hold money. The difference though may be that I don't invest in an expensive market.

Brandon M. · Answer

What about just diversifying the location of your investments and/or the class of real estate? Could be commercial, could be retail, self storage, whatever you feel is a more stable/safer asset class. You could either go into one of those asset classes on your own and self-manage or find property manage, or if you prefer you could find a DST of one of those asset classes that would be completely 100% hands off. For instance, the most recent one we are selling (not a sales pitch, just a disclosure that I am also Series 7 licensed which you do have to be in order to speak with clients about DSTs) is purchasing a large multi-family complex in NC, one in MN, and one in CT. Those are 3 different areas completely, so aren't tied to just one market in case of recession, etc. Something like that provides investors a 5% return with a 5-7 year anticipated hold, and does qualify to be purchased through a 1031 exchange ($100k minimum). I can get into more of the DST details if you so desire, I won't take over this post with all of those details. If you are interested in seeing the pitch book on the deal please send me a PM.