1031 Exchange Update and Future Plans (July 17, 2014)

As readers may be aware, a few month’s ago, I was seriously entertaining the thought of selling Rental Property #1 so that I could capitalize on the massive appreciation gains (purchase price: $315,000; current market value: ~$470,000). My initial plan was to do a 1031 exchange, and utilize the proceeds to purchase some more out-of-state rentals.

One of the strategies behind the 1031 would have been to trade for some cheap single family homes (SFH), like Rental Property #4 in Indianapolis. The bolder strategy, would have called for a 1031 exchange into a commercial apartment building. Since I have no experience in the commercial space, and am planning to live overseas for awhile when I get to early FI, I ultimately decided that the latter strategy would have been too daring… even for my taste.

Also, initially, I was thinking I might sell Rental Property #1 sometime this summer…

Well, it’s been a few months since I sat down and had a discussion with my real estate agent, and I’ve had a lot to think about… On paper, I must admit, it still looks so appealing to just go ahead and flip Rental Property #1, and acquire 4-5 more SFHs. The short-term cash flow would witness a drastic shot-in-the-arm. On a perfect month right now, the cash flow just surpasses $3,000/month. Adding a few more rentals that could each generate $200/month, or more, would get me pretty close to that coveted $4,000/month mark… Again, if my plans are to live overseas (initially), then that should be more than plenty enough! Even with conservative figures, I should be able to pull in at least $1,000/month net income with the rental properties, which would be my baseline budget overseas… Also, knowing how frugal I am (I love to indulge in cheap fun), I don’t really even picture myself spending that much!

But then I started thinking some more… And I began having discussions with some fellow Bay Area investors… My thoughts kept vacillating back and forth… Long story short, in their minds, they felt that I would be slaughtering a golden goose prematurely by selling Rental Property #1… And I can’t say I disagree in the slightest.

I got into the Bay Area at a perfect time in 2012. Prices were at rock bottom, and everything was being sold for half off retail price. Now that the market has picked up again, you can literally feel the vitality and life back in the air. The Bay Area is bustling, and I honestly feel that the long-term prospects here are spectacular. Everywhere you go, you see new construction and projects. Everyone wants to move into this area, and there’s almost no affordable housing available! Most importantly, the jobs and school districts will keep on magnetizing people to want to live here (let’s also not forget about the perfect weather!).

As an owner of two properties in the Bay Area, I am sitting in a most enviable position. Because I bought in at the right time, the units cash flow adequately, and I get many other benefits: massive appreciation potential (as I’m seeing first-hand in just two years), strong rent appreciation, high quality tenant pool, extremely strong homebuyer demand (easy to sell), etc.

Yes, the Cash-On-Cash returns are not so great at first (especially compared to Midwest properties), but the potential for rent appreciation will help the returns climb over the years…

So, I’ve made up my mind, and that’s to keep my two Bay Area rental properties. I’m no longer looking to sell, and I will not be executing any 1031 exchanges in the future!

I do realize that the cash flow numbers will suffer a bit in the short term… Luckily, I have some very high cash flowing properties in the Midwest (Chicago and Indianapolis) to compensate, so I feel I can still be adequately setup for early FI…

I haven’t done a post covering the never-ending debate raging between “appreciation vs. cash flow” yet, but I do see the importance of both! To be succinct, “cash flow pays the bills and allows you to declare early FI… Appreciation builds massive generational (long-term) wealth.

When I invested in stocks, I was primarily a dividend growth investor. However, I never closed my mind off of investing in hyper-growth stocks… Really, who wants to miss out on investing in the next Apple (AAPL), Google (GOOG), or Tesla Motors (TSLA)?!? When it comes to rental property, my mind is also open to the ideas (and merits) of both camps. Why not do both and realize the benefits of each? 🙂

Ultimately, even without the 1031 exchange, I still feel like I’ll be adequately prepared for early FI next year… I won’t lie and pretend that I have all the answers, I most certainly do not! But I will continue marching on… In the short-term, I’m still going to look into acquiring another rental property later this year (after my August vacation). It’s still premature to say, but right now I’m leaning towards picking up another property in Indianapolis for Rental Property #6.

By spring of 2015, I will have enough seasoning on Rental Property #1 and Rental Property #2 to qualify for a line of credit (HELOC). Most lenders are quoting me at 60 to 65% loan-to-value (LTV)… So, I should have plenty of ammo available, should I decide to make any more investment moves at that time. As of this writing, I can’t say that I have a concrete idea of what I will do with a line of credit… I may elect to do nothing at all. But, we’ll see! 😉

The journey continues…

 

 

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FI FighterJasonNo Nonsense LandlordDave @ The New York BudgetIncome Surfer Recent comment authors
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Retire Before Dad
Guest

FIF,
From everything I hear the bay area is growing very briskly again. No harm in holding on at this point, sounds like the right decision. I put an offer in on a DC area property recently. Not huge cash flows, but very rentable, great location, and high quality tenants, similar to the bay area.
-RBD

Andrew@LivingRichCheaply
Guest

I have no experience with real estate investing but I think I agree with the investors you chatted with…why sell now? The Bay area is a great location and there is likely more appreciation to come, especially if you are thinking of holding on for a while…plus you have positive cashflow. I like the analogy with growth vs dividend stocks. I’m more interested in growth stocks compared to dividend stocks. If I had rental property in NYC that cash flowed and has appreciated considerably…I’d be keeping it, that’s for sure!

Brandon
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Brandon

Not going to lie, was excited to follow the 1031 process!

I agree with you and the others though, you’re situation is going great to just keep on holdin’ on.

North
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North

Just discovered your blog and I love it! Thanks for being so transparent with all this stuff. If I can ask a question – How much time on average do you spend a week handling issues related to your existing rentals?

Income Surfer
Guest

Either could be a good option. If you’re happy with the Cali properties FI, then you may just want to keep them and take some bucks out. I’m more of a cash flow guy, but if you don’t want to own a rental empire for the next 20 years, you may want to reallocate your gains into something else.

I look forward to reading along with your journey.
-Bryan

Dave @ The New York Budget
Guest

So on one hand: “Be fearful when others are greedy and greedy when others are fearful” – the high that people are riding in the Bay area may not last forever. Also, it sounds like a 1031 would get you to your goals and in the end, isn’t that what it’s all about? Why is there a need to take that risk if your cash flow is covered and your needs are met? On the other hand: Of course, if it all came crashing down, all you would have to do is wait for it to bounce back again, which… Read more »

No Nonsense Landlord
Guest

It’s never an easy decision. I am going to do a 1031 when I am ready to get out of the rentals. Maybe buy a ranch or farm and rent the land.

Jason
Guest
Jason

So, I’m in a similar position, with my last 2 Bay Area properties. The renters will be pulling the plug soon.

I’m definitely going to be selling ASAP and moving the money to Texas.

I think that’s the best move because a) you’re releveraging and b) Texas will also have a great future appreciation.

But, I don’t think I’d advise getting more homes in Indy. It seems like that’s a little TOO slanted toward cashflow.

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