1031 Strategy: Sell first or find replacement property first?

Question

I'm ready for my first "Big" 1031 exchange. I've done several 1 for 1 exchanges, trading a SFR for a triplex or a duplex for a fourplex. But now I'm wanting to up my game, upgrade my clientele and get a 30-50 unit complex. This is uncharted territory for me so I would love some advice from people who have done this.

Here's what I'm selling - I have a portfolio of duplexes triplexes and fourplexes - 7 of them that I'm ready to sell. They are all value-add plays that I've improved, and increased income. They are mostly in the Everett area of Washington with one in Marysville one in Seattle. I've had two different residential multifam realtors give me CMAs for each property and the portfolio is worth about $6.3mil, of which I should net about $2.6Mil for my down payment.

So far, I've had a couple commercial brokers out scouting around looking for a deal for me in the 30-50 unit range in South Snohomish County in the $5mil - $10mil range. So far they haven't found one and I'm getting conflicting advice from the brokers about how to go about this.

One says I should wait until I have my replacement property identified - since that could take a while - and then list the small properties once i'm under contract, making the deal contingent on the sale of those properties. I'm pretty comfortable with this tactic. as I'm nervous about running up against my 45 day identification deadline.

One says I should list my 7 properties as a package deal, I might net a little less (5-10%) but the benefit of closing everything at once and being able to snag a deal on an upleg is worth it. Furthermore he says I should market and sell my properties first without having any replacement identified because no seller is going to take me serious, or want to tie up their property with a buyer's selling contingency.

When I did a 1 for 1 exchange it has always been kindof easy, I was usually able to find a buyer and a replacement property at the same time it seemed. But this twist of trying to sell 7 properties is tricky and stressing me out!

What have you done? Have you sold multiple properties to exchange into a larger one? If so, did you list and sell your properties first or wait until you identified a replacement? Did you sell your portfolio as a package? Or am I better off listing them individually?

Thanks! Todd

Alex Olson · Answer

@Todd Young With that kind of portfolio and that kind of value I would look at exchanging it out of state to somewhere in the midwest that has good growth to it. Of course I am partial to KC but on the forums people talk about OKC, STL, parts of Texas, Indianapoplis, cleveland, etc...Just a thought.

Dave Foster · Answer

@Todd Young, It's a very delicate gas pedal/brake pedal exercise and much really depend on your lendability and pace at which those current units will sell not to mention the availability for a building that you're looking for.

From the sounds of it, Locating the building will be the toughest part.  So that is probably the best place to start.  Job  1 - find the new property.  At the price point you're looking at the purchase schedule becomes more prolonged naturally with acceptance of the LOI, and then the back and forths of inspection finance and other contingencies.  You could have several months from contract to close.  And from the sound of things that would be a lot of time to sell your current properties - even as individuals.  And consolidate those 1031s into the one purchase.  Of course it's always easier to explain than to perform :)

A couple ways to mitigate other than what youve already described (the portfolio sale etc) would be

1. Find a mezzanine financing entity that will provide the interim financing.  Not that you would use this for purchase because because you have to close your sales before you close your purchase.  But a lender of this type might be persuaded to take a security interest in your current properties in exchange for providing a very healthy earnest money payment and letter indicating your lendability for the rest.  I  think a seller might look at that favorably.

2. A reverse exchange is another twist on the above.  If it comes down to having to commit to the new property first, then locate mezzanine or straight up private financing for the purchase.  You can cross collateralize with both the new property and your old properties.  The EAT of the QI takes title to the new property.  And you have 180 days to sell as many properties as you can to 1031 into that property.  We can also shape that reverse exchange to accommodate a value add component to the new property using 1031 proceeds which is a huge bonus.

And during that 180 day period your are generating the income from both the new property and the old properties that haven't sold.

It's not the easiest transition.  But the runway you can create toward a $10 mil purchase might surprise you.

Dave Foster · Answer

@Alyssa Dyer, Thanks for the kind words.  My website on my profile has links to about 34 youtube videos I've produced on various 1031 topics.  If you reach out via dm I can put some paper in your hand as well.

Dave Foster · Answer

@Alyssa Dyer, It all depends on how much gain is going to be deferred, and how tight the market is. Not so much how expensive the property is If you absolutely can't find good properties to purchase then it makes sense to use a reverse to buy and control one of those unicorns when you find it and then sell the old property.  Or if you're wanting to add a lot of value in improvements to a property you're going to purchase, the reverse improvement exchange can be perfect for that.

Reverse exchange are not cheap.  They're generally not quite as bad as @Khang Tran said.  But they are expensive.  So a general rule of thumb would be that if you're deferring more than $40K - $50K of gain then the reverse produces a net financial positive to you.  And actually if you calculate being able to double dip income while both properties are in your control a reverse exchange is usually net neutral to you.

Like Khang said, in the right circumstances these can be great.

Peter MacKercher · Answer

Wait till you have a property under contract large Multi take a while to close anyway. Small 2-4 multi's are easy to move and you should have no problem selling them.

Khang Tran · Answer

A reverse exchange is quite complicated to pull off  and usually costs about $10,0000 additional in fees and costs.  So its  not quite as easy as the above would suggest.   And  the mezzanine financing can also be quite  expensive in terms of loan costs and interest rate.

So a reverse exchange can be a good idea if you  find the perfect replacement property and have not had time to sell your  relinquished property yet.  But that is the only time I would recommend  doing a reverse given the complexity and costs.   Hope this helps.

Alyssa Dyer · Answer

This is great! Does this much work make sense for smaller deals (< $1mil) or just the bigger ones? We run into this type of thing all the time and I've not heard a 1031 agent/attorney/advisor ever break this down as an option. Super interesting.

Alyssa Dyer · Answer

Thanks for breaking that down. It's super interesting and helpful! I'm not sure if you have content or anything but if you know of a good YouTube video that goes into the details of it I'd love the link so I can learn a little more!

Jason Hunt · Answer

Everett is pretty hot right now. Multi family properties don’t seem to last long. You could probably sell these all off market pretty quickly without even listing. I bought a fourplex in Everett off market recently. EVERY multi family listed recently is snapped up quickly. I know a couple people who have been looking for a fourplex and they are gone as soon as they hit the market. If you connect with the right people you could probably sell them all in one shot. I would love to talk and hear more about what you have.

1031 Strategy: Sell first or find replacement property first?

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