Exchange from High value to Lower value RE

6 Replies

My wife and I have been following Bigger Pockets for the last couple of years including a few podcasts. I’m writing because I need a sounding board. 

I'd been involved in REI a number of years ago and in the 2008/2009 downturn took hits along with everyone else. I came out of the mess holding two prior homes that became rental properties due to being upside down. Cap rates and rental values aren't good on either of these.

Regardless, since starting to follow Bigger Pockets, over the past twelve months, we’ve closed on two more income properties and are starting to rebuild our portfolio.

However, my current opportunity has me talking myself in circles and not gaining much clarity. I’d greatly appreciate your feedback.

Here’s the situation:

The two investment homes I mentioned above in the north Phoenix area. One was purchased in 2005 for about 317K. Today it is work just about $280K; 8 years after the crash!

The second was purchased for 485K and is just about back up to about that same market value.

Both of these properties were originally my homes and became rentals when I moved and couldn't sell them. Neither one cash flow and I feed them every month. Of course, at tax time, after depreciation and the losses, I do get the benefit from Uncle Sam.

I no longer live in the area and the two properties I purchased this past year are in my new home town…not a booming market, but a growing, rural economy, with housing price escalating quickly with local factories and processing plants expanding; although this might be short-lived as we know rural areas can do..

What I’m considering is selling the two Phoenix properties, either on a 1031 exchange or via a Deferred Sales Trust arrangement and putting the proceeds into a few smaller houses closer to my current area.

So, the facts:

  • -Both homes are still under the value I paid for them
  • -Both homes have negative cash flow, cap rates hovering around 2 – 2.5%
  • -I’ve taken significant heloc or refinance out of each to buy other properties, but have in the ballpark of $120 - 140K equity/profit after selling (both)
  • -I never plan on much appreciation, but the Phoenix housing market should be adding 4% annual today.

I keep telling myself that it makes sense to sell these, get out from under the large debt and negative cash flow and put the funds into multiple smaller places that will cash flow, but may not appreciate as much.

But then I turn the table and say “but what if the Phoenix market does rebound at 4% plus per year”

Talking in circles…any words of advice? Or how could I effectively do a comparison?

I greatly appreciate your time and and words of advise.

Thanks, Dan

Hey @Dan Johns , glad you decided to jump in to Bigger Pockets and start using it to its full potential!

I'm a local agent in Phoenix with my ear to the pulse of the market. I work with traditional residential sellers as well as investors, and I'm a long time local investor myself. 

Here's how I see your situation:

1) Keep the two Phoenix properties (that are negatively cash flowing each month) in hopes that the current market appreciation continues and brings you back into the black in 3-4 years. This is not investing, it's speculating. I like to make “sure” bets, so I’d dump the money losers and find some money makers.

2) Let’s analyze the property you currently value at $280k. Assuming 4% appreciation each year, it will take four years to get above the $317k price you paid for the property (about $327,000). Factor in about 7% in closing costs, so you’ll net around $304k. I sure hope the Phoenix market keeps heading in this direction, but 4 years is a long time and a lot can change. If you needed 1 year of appreciation to get back in the black, I’d say it’s worth the gamble. This math also does not factor in the four years of negative cash flow you’ll have out of pocket.

3) I’m not sure a 1031 Exchange would be the right play either. You’d want your Tax Professional to run the numbers for you based on the cost basis of each property. Keep in mind you have to replace the debt on Replacement property(ies) that you had on the Relinquished Properties.

4) Do you have any large capital gains that you could offset with the losses from selling the properties? Again, speak to your tax professional.

Assuming you sold both now and netted around $140k, how much property could that get you in your part of Idaho? Would it be cash flow positive each month? To me, that would be the ideal investment: 1) something closer to home that I could manage 2) cash flow positive and 3) eliminate two money losing properties in Phoenix. Win - win - win

Hope this info helps to frame and clarify your decision. I’m happy to chat on the phone regarding the Phoenix market at large and more detailed specifics of your situation. 

I don't think 1031 will benefit you much. The profit is quite minimum. Plain sell and buy closer to you, simple and straight forward.

People place more value on things they own than on ones they don't own.  It's called the endowment effect.  It causes us to do thing like hang on to old clothes that we never wear, store stuff that we never use, and to hang onto to former residences.

If you would not buy it at today's prices and have an alternative investment opportunity, sell or exchange it while the market is hot and interest rates are still reasonable.

@Dan Johns , Don't write off the 1031 until you talk to your accountant.  13 years of depreciation recapture isn't going to be small.  And if you've got those leveraged as high as you say it's very possible that you sell and not generate enough cash to pay the tax.  In that instance a 1031 exchange could be strategically used that way.

David, my thought exactly.  I've already had my CPA involved and he's in agreement.  Thanks for responding. Dan


Your thoughts help clear my head.  As Mike D. stated, I may be suffering from endowment., among other things.

No capital gains to offset, but losses I can't take now will rollover, so eventually I'll catch them.  Most important is to get our money working better for us.

Thanks to all for your input. Dan

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