1031 Exchange to do or not to do?

Question

I'm readying a house to do a 1031 exchange in Cedar Park TX. Problem is, I'm seeing a lot of listings with price drops all over the area. I wanted buy two houses with the planned $200k plus equity from the sale but I'm getting cold feet.

What's are you guys take on this?

Background.

I was planning to expand my portfolio because the rental had at some point appreciated +- $250k in 4 years, plus the cash flow wasn’t that great. I waited until the lease was up but now, I’m caught up in this upheaval. I’m thinking about pulling out of selling and rent it again. I think I can get an extra $250-$300 on top of the old lease. My cash flow would then be around $400-$450.

The issue is that I don’t think I can get near to what my planning figure was.   And, most likely the house would hit the market in July with another 1% interest hike.  In addition to that I'd be getting into a 7.25% +- investor mortgage rates that would reduce my cash flow to about $100 more than if I kept the house and just rent it again.

I feel I’ll be chasing a falling market.

Your input is greatly appreciated.

Bill B. · Answer

That’s a good time for you to do an exchange. If the market is falling and you’re selling a property that costs X, to buy 2 properties that cost x. That means those 2 properties will fall twice as much as your property. You’ll end up with less out of pocket. Then when it turns around you’ll be gaining twice as much. Win win.

Carlos Ptriawan · Answer

I've been thinking about the same, what really matters in your scenario is actually whether the IRR in the two replacements will perform better or not compare to the original house. If the area is located nearby, then it doesn't really matter as IRR is very close. But if you transfer between a property that has 0 cash flow to high cash flow/high cap rate area, then it could be substantial changes but your main income would be cash flow rather than appreciation. However if in the future economic growth in that area is better than your original investment location, then you'll make more as cash flow increases followed by appreciation. So you need to understand your base number of IRR and cash flow first before making the move. The rests are risk calculations based on high economic growth or a stress recession.

Dave Foster · Answer

@Ron Mayorga, Awesome comment by @Bill Brandt.  Im just now working on an article with that exact theme.  The poison pill with the 1031 is always that the best time to sell and start a 1031 is the worst time to buy your replacement property (a sellers market).  The worst time to sell and start an exchange is also the best time to buy your replacement (a buyers market).

But the absolute best time to do a 1031 exchange is in a transitioning market.  If the market is growing then you feel good that you'll have appreciation equity very quickly.  But if the market is retreating then use the 45 day identification period and catch properties as they are dropping prices.  You bet rising interest rates are a concern you have to think about.  But in the end interest rates come and go.  Your asset is the key.  Since your tenants are paying the interest (they just may not be paying as much principle on the loan).  And that is what @Carlos Ptriawan is talking about as far as the IRR goes.

Just like fishing on the ocean, the greatest opportunities are when the tide is running - in or out!!

Justin Winn · Answer

I really think it depends on if you can cover the mortgage if one or both of your new properties has a vacancy, major repair, etc. If you have the cash reserves for that, with a ~$100/mo retained earnings (what most call cash flow) then I think buying the two is a good idea for the long term.

But if you’re going to lose sleep over it, then I would say you probably need to save a bit more until you have the cash for reserves. I’m OK with being uncomfortable, but not with being scared (aka losing sleep over a deal).

Jonathan R McLaughlin · Answer

So you are saying the sale of the house right now would net you $250K before taxes? Or with the current perceived hit to value maybe $225K?

* your return from equity appreciation and presumably loan paydown has dwarfed your cash flow return

* An exchange puts that essentially free equity to work for you quickly. Who cares about the interest rate in that scenario? Purchase something more valuable where the numbers work. Look to refinance in 5 years if/when rates drop

* unless I'm missing something, you have a success story not a problem

1031 Exchange to do or not to do?

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