To Sell, or Not to Sell, that is the Question (1031 or HODR?)

[Russell Williams]

About my goals:

I'm 35, no kids, own a construction sales business that has variable income (I make commission from selling building products on commercial buildings: windows, skylights, glass, etc.). I live/rent in Santa Monica. My goal is to build wealth by purchasing cash flowing assets in appreciating markets. I'm completely fine with taking a hit on the cash flow in exchange for more upside in appreciating markets. I spent my first 30 years in Denver, so it's an area I'm familiar with and have trustworthy connections in. So I'm biased to invest here but I'm open to other areas.

About the investment property that I'm considering selling:

1500 sqft Single Family Home in Arvada, CO. 3 Bed, 2 bath, 2-car garage. Single level with finished basement, backyard with patio and a beautiful maple tree, in a cul-de-sac. It's a very family friendly home. Neighbors are friendly. I charge $1900 in rent, and make ~$500/mo after all expenses are paid including property manager. I could have justified $1950/mo or so pre-COVID but wanted to keep the same tenants. Small $60 HOA for the subdivision - there's a common space community area and pool for surrounding neighborhood 1.5 blocks away from property. Purchased for $270k + $10k renovation (25% / $67k down) in 2016. This is a really nice, "boring / starter" rental that cashflows about $500/mo and allowed me to get into the game and start learning with hands on experience.

The Situation:

Fast forward 4 years: House is worth $360-380k based on comps (avg appreciation of 7% or so yearly). I owe $180k, so my equity is roughly $180-200k. Tenant lease is up end of March '21. RE agents, friends, and other investment newbs are split on recommending to sell vs telling me to hold on based on the crazy high demand for SFH's in this price range.

I understand my cap rate, cash on cash, and ROE aren't very sexy right now because I have so much equity. I have started to look into selling this property and doing a 1031 into small multi-family or two SFH's. I understand the metrics for small multi are way different, and will present a huge learning opportunity.

What I don't know: Will this property continue to appreciate at this rate? No idea. It could, based on surrounding comps, and with increased demand on SFH's. If I was confident that it would continue to appreciate at 7%, it would probably make sense to just Hold for a couple more years, and maybe do something else in the meantime (like buy another SFH using 25% cash down).

My question:

Should I sell this property so that I can more efficiently use my equity in another investment? I have very little experience in deals (having done ONE), and understand this is a critical pivot point. Perhaps I should hold on for another year or two? Perhaps I'm nervous about the unknown? Perhaps I need to take a risk in order to both continue my RE education and reach for more upside?

I understand that there probably is not 'right answer' to this question but any feedback or guidance on how to analyze or narrow down this decision would be very helpful. 

THANK YOU!

[Chris Freeburg]

@Russell Williams

Congrats on a great investment. Arvada is only becoming more popular. Based on what we're seeing in Denver right now (~3 weeks of inventory, median <6 days on market), I expect 2021 to be another hot year for real estate.

People continue to move to Colorado. US News ranks 4 of the top 5 best places to live in the US in Colorado! And, the Denver Metro Area has appreciated 49 of the past 50 years, with an average around 6% while the national average is 3%. Past performance is no predictor of future results, but historical and present data suggests you can count on future appreciation.

A lot of people are wondering about a looming foreclosure crisis, but the data does not suggest that happening. 

Approximately 8% (90,366) of homes in Colorado are in forbearance. Of those 90,366 homes, only 5% (or 4,518) are delinquent. This means 0.27% of all homes in Colorado are delinquent. Even if all those homes came on the market at the same time, it would only add another 2-3 weeks of inventory.

Based on all this market data, I don't expect a crash and if anything, the future looks stable for real estate. Of course, I don't have a crystal ball.

More importantly, I would consider your present situation, for the good reasons @Greg Scott points out: 1) You want your equity working for you. You have quite a bit of equity sitting idle in your house. 2) Appreciation is speculative and only capitalized when you sell/refinance. You have a great opportunity to do that given the reality of today's financial and real estate markets.

Given the current interest rates and strong market, you have two great options:

1) 1031 (sell and avoid capital gains tax if the $ is reinvested) your property into another investment, possibly with more doors that cash-flows at a higher margin 

2) Refinance and pull out $ through a HELOC for a downpayment on another investment property.

It's worth emphasizing the opportunity of the present moment: Interest rates are at historical lows. Even though prices are higher, what you can actually afford may be greater. Such dramatically low interest rates lead to significantly smaller monthly mortgage payments.