Sell California Condo or Sell and 1031 into OOS Multifamily?

19 Replies

Edit: The title should have been "Lease California Condo or Sell and 1031 into OOS Multifamily?"

I have a condominium I bought about 5 years ago for $60,000 that I can sell today and walk away with about $100,000 after selling expenses. It rents for $975 per month ($11,700 per year) and after expenses I clear about $6,500 of NOI. It's owned free and clear which means, based on my total cash invested, it has a COC return of 10.8%.

However, when calculating my Return on Equity, I'm only getting about 6.5%.  My question is, if you were in my situation, would you continue renting this property out or would you sell the condo and look into investing out-of-state in a market where you could take that $100,000 and buy 5 houses or a small apartment building?  I think I could get closer to a return of 10 to 12 percent on my $100,000 rather than a 10.8% return on $60,000.

Also, another option is that I rent the condo out and get a line a credit on it. I have a bank that is willing to loan $60,000 at 5% interest against this property, so I could pull some equity out and deploy it elsewhere for a higher return.

I am interested in Cincinnati as a market but I am hesitant to jump into an out-of-state property because of the difficulty in managing a property that's not within a few hours drive of where I am.  Also, my condo is currently vacant and I want to either rent or sell it ASAP which means I don't have a lot of time to fly out to other markets and make connections with property managers, etc.  Additionally, I work full time and wouldn't be able to get time off until around Thanksgiving.

I'm interested to hear your thoughts and suggestions on my situation. 

@Kyle Steiner : Hey, fellow Californian!

I can't tell you what to do, but I can tell you what I did, as I'm in a very similar situation as you, but just scaled up slightly.

I began acquiring SFR in various CA markets around 2009, and like you, I ran up the score on appreciation.

We've had a pretty awesome run here in CA, but for my own reasons, I wanted to diversify out of NorCal. Within the last year, I sold 2 CA SFH in CA and traded them for 2 SFH's in Austin, and a 4-plex in OH. Since these are fairly recent trades, time will tell if they work out or not.

what I will say is that acquisitions OOS is not at all "passive", especially in this hot market. It's not just about writing checks and entertaining the notary at closing. You will mostly likely need to get on a plane, probably twice.

Even if you buy "turnkey," you're essentially trusting a random stranger that you probably met on the Internet to manage your 100K. That can go wrong on a lot of different levels from outright fraud to just run-of-the-mill incompetence. How do you know they aren't selling you a flaming pile of crap in the middle of a war-zone? You should be doing a bunch of background checks on the provider AND you should be getting on a plane to see what you're buying.

I should also mention that a 1031 puts you on a very tight timeline. If you aren't already familiar with them, then research that first.

Finally: I really wouldn't recommend trying to self-manage a property OOS. It can be done, and there are proponents of such tactics, but it is fraught with pitfalls and demogorgons. However, using a PM gives you a roughly 10% haircut. You should factor that into your ROI. If you still prefer DUI management, and you do go into Cincy, give Misty a call at CincyRents, and tell her I sent you. They have tiered services which may match your style.

Hope that's some valuable food for thought. Let me know if I can help otherwise.

James

1031 has a tight schedule. If you sell your condo you have 45 days to get into another contract. When you try out of the area investment properties I doubt people will take your offer serious with a contingency condition.  Like your condo leaving it vacant is costly. You may want to unload pay some tax and decide what your next move is.  REITs are good alternative. 1031 also has a stipulation that you still have to pay capital gain and recapture depreciation unless the like property will be greater than previous cost basis. 

There are some 1031 properties like shopping center that you have no votes and they will accept your money to park your sold investment property. You can leave the funds there for a few years and withdraw.  Some are reputable others can be risky.  RE is always speculative. You want risk the upward potential is greater. You don't want risk 1.3% interest on money market gives you almost no risk.

Because you have a full time job in CA, I would say any OOS endeavor should be through something extremely passive. Otherwise, you are placing yourself at a much greater risk. CA as a whole doesn't provide very much opportunity for cash flow but it's out there. I would recommend getting your condo rented out and pursue refinancing on it. You said a bank is willing to extend $60,000 credit line but that is only 60% LTV based on your $100,000 equity. Try to find a bank that will give you 80% LTV and find a comfortable path for you to deploy that $80,000 from the bank.

My company is putting together a large multifamily acquisition in Pittsburgh catered to wealthy CA residents. There are plenty of opportunities for you to seek out in which you can invest with a syndicate. We offer 8% preferred return but some other general partner investors may offer more or less return depending on your risk appetite. 

Hi Kyle,

Checkout the recent BP podcast with Swanny, he goes over this in detail. It’s always hard to tell someone else to do so I’ll tell you what I would do. My background: I live in CA and rent and invest in MF in Kansas City, MO. I’m also waiting for a delayed flight from Sweden back to LA so I have ample time to consider this question! If I were in your position I would think about if I have any interest in the condo in question in the future. Do I want to own it for some reason? If so, I would rent it, and pull the 60-80k out of it once I have found a suitable use of the money. In my definition a suitable use would include anything that would give me higher than an annual cash on cash return of 10%. I don’t know what your definition of suitable is. Some ideas for me would be using the money as a down payment on a OOS MF with a commercial loan. They will usually lend 80% of acquisition plus rehab. So you would be able to pick up something in the 300-400k range. In my market that’s a 4-9 plex. I would look for something that I could buy for 200k and put 100-150k in to get a valuation around 400-500k. Another use would be lending that money to someone wanting to do renovations to increase the value on a commercial property. You’d be a second loan for a return of 10-12%. Also, you could just sell, then you’re looking at a 1031 into a higher purchase price on a MF or more than one MF. That’s what I would do, keep keep us posted on what you do!

You might want to consider a 721 exchange (aka up-REIT)

You could get some tenants in there for a year or two while deciding on what to do? I read your stated goals in your profile, so, the question is which decision will allow you to pick up those two homes for the year as fast as possible in accordance with your other objectives? I'm in Michigan, even around where I live (which sucks), you couldn't get 5 houses for $100k that were move in ready, unless you're looking to do D Class 'renovations' for D Class neighborhoods and tenants? 

@Kyle Steiner , I actually like your current property.  Visions of 10% and 20% and higher and higher are the things of early markets and they ride on the backs of unicorns.  6.8% ROE at this point in the cycle without factoring in depreciation and appreciation is actually pretty good. Maybe a careful refi can boost that significantly while not hurting coc too much or putting you at risk.

Nobody ever talks about the COF index that is the truest measure of the success of your investment. It is way more important than ROE.

But that being said a 1031 might be right for you.  I'm not as pessimistic as @Sam Shueh is for a couple of reasons:

1. You don't have to have a property under contract in the first 45 days.  You simply have to identify a list of potential replacements.  

2. Nationwide, other than the SF Bay area, avg DOM is well above the 45 day window.  In Kansas City and Cincinnati for instance the avg DOM is well over 100 days.  This means that almost every property you'll have time to identify as a potential and then negotiate several even after the 45 days.

3.  Turn Key properties have in essence become a commodity.  The addresses may be different but the returns condition, and costs are remarkably consistent within classes.  I'd certainly be worried about doing anything (1031 or not) outside your known area - that's a recipe for disaster!  But if you're working with reputable agents and turn key providers you will almost always find the exact same properties available at any given point in time within ranges.  The addresses may be different but the nature will be the same.  The difference simply happens to be which pork bellies are on sale at that moment and really, the service level of your provider.

@Kyle Steiner I would say it depends on where in CA the condo is located. I'm often an advocate for OOS investing for Californian's because it's so difficult to get anything to cash flow, however, in your case, you already have positive cash flow and being in CA, you have strong appreciation potential. I agree that you can get at least 10-12% COC returns in other markets, especially the midwest, but you really need to factor in long term appreciation. Personally, I would I would pull equity out and hold on to the condo.

@Kyle Steiner looks like you’re right down the street from me. I’m in Irvine.

My 2 cents would be to hold your condo in California. It’s near impossible in today’s market to find an investment to give you that kind of return in our local markets. Especially being free and clear. I’d suggest getting that line of credit and investing OOS. This way you’ll diversify and still have one here in California that will still appreciate in the long run (10-20+ years) and can have one OOS that cash flows. I have a few rentals here in Cali along with some OOS, so speaking from experience.

Good luck and feel free to message if you have any questions

Originally posted by @Dave Foster :

@Kyle Steiner , I actually like your current property.  Visions of 10% and 20% and higher and higher are the things of early markets and they ride on the backs of unicorns.  6.8% ROE at this point in the cycle without factoring in depreciation and appreciation is actually pretty good. Maybe a careful refi can boost that significantly while not hurting coc too much or putting you at risk.

2. Nationwide, other than the SF Bay area, avg DOM is well above the 45 day window.  In Kansas City and Cincinnati for instance the avg DOM is well over 100 days.  This means that almost every property you'll have time to identify as a potential and then negotiate several even after the 45 days.

Dave, that's only true of new homes in Kansas City. The average DOM for existing homes is only 43 days.

@Mike D'Arrigo , Wet noodle for me!! I grabbed an older report. But Nar shows current national avg to be 69 dom. Heartland MLS is showing a September decrease from 58 - 51 year over year in Sept from 16 - 17. I pay attention primarily to new homes because I'm selling out a 200 new home subdivision just west of there.
 So I'm sure this is a blended rate and your dom for older might lower.  And a scan of investment only might yield an entirely different number.

And of course we both recognize how highly regionalized and seasonalized things can be.  But even if dom is less than 45 days that means that an investor with a 1031 in process can identify a new listing on day 40 and still have on average another month and a half to get it under contract or choose between a couple.

My point was only that that the 45 day period in most cases is more psychological than a real barrier with the right team in place.

I would hold on to the condo and pull out equity. way better chance of more appreciation in CA. plus w/ the strong rental market, your coc will continue to grow as the rents do.

Thanks for all the feedback everyone. I think I'm going to go the route of pulling out the equity via a line of credit since that gives me more flexibility in terms of identifying another property to purchase. Also, like some of you have mentioned, it will allow me to benefit from some potential future appreciation.

As a side note, these condos peaked at about $135k back in 2006-2007 so I feel like we're close to the top of the market. However, even if there is a pullback in the market, I should still be able to cash flow even after adding the line of credit.

To the person who suggested I listen to podcast with Swanny, that podcast is what prompted me to post this in the first place. It sounds like he was able to do pretty much exactly what I would like to do. I just need to spend some time laying the groundwork to get a team on the ground in an out of state market.

If anyone on here sees this and has some reliable brokers, property managers, etc in their networks, please let me know as I would like to start making connections prior to investing in another market.

@Dave Foster There is definitely a difference between existing and new homes. Existing home inventory is down 22.3% YOY and days on market down 15.7%. Inventory is very tight and there is no guarantee that he can find  5 properties that meet his criteria in the 45 day identification period. It's going to be important for him to start identifying as early as possible.

@Kyle Steiner ,

Did I talk to you yet on the phone.  Go to my profile and give me a call.  That invitation is open to anyone that wants to talk specifics and follow a similar path I am traveling on now.  I only take financial advice from people that have already gone down the same path I wish to go.  You need practical experience, successes, and failures to refer back to as you start your journey to where I started and have progressed to after almost 7 years of investing in my first little San Diego rental Condo in May of 2011.

Swanny

@Kyle Steiner I am almost in the same situation as you. I am barely breaking even on my condo rental. If  I sell it, I could make around $100k too and was thinking of doing a 1031 OOS. I spoke to Swanny over the phone he gave some very good advice.

@Ruel K. I spoke to Swanny today.  I agree, he has good advice and we share a lot of the same views on how to grow our real estate holdings and cash flow.

I was trading emails with Swanny as well and he makes a lot of sense, however, the Cleveland area scares me: A continuous migration out of the Cleveland area, continuous depreciation, and with both of those factors, rents may follow, killing your ROI. I see amazing Cap rates in almost every market but mainly "C" class properties with NO hope of appreciation. I too own a condo in So. Orange County that is depreciated out and hasn't appreciated in years. Sure it cash flows but I could triple my cash flow in NE Ohio or Texas. Anyone have any thoughts?

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