LA Property with lots of Equity

Member since 2024 · 2 posts · 3 votes

I purchased my Los Angeles (Compton) 4-bedroom home in 2013 for 240K; according to Redfin, it is now worth 686K. 2 years ago the entire house was completely renovated (Insurance claim) due to a burst pipe that caused extensive damage while vacant. I'm not sure what I want to do or what my options are. I've been thinking I would like to fix the outside landscaping/fence/Kitchen cabinetry and roof so I that I can get the max rent or just sell and buy in the midwest, 1031 exchange (not sure if I qualify). I mainly would like to expand my portfolio using the equity but am hesitant to refi because my current rate is 3.3%. Even Airbnb would be an option but I'm starting to feel like I need a partner who knows what they are doing to guide me. HELP!!

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Travis Biziorek

Investor · Arroyo Grande, CA · Member since 2014 · 1k+ posts · 1k+ votes

Quote from @Mike D.:

Interesting. I'd probably take out a HELOC and use it to invest in rentals out of state. $400k could be the down payment on eight small houses in the Midwest. This is your best cashflow option since nothing other than the situation you've lucked into is going to cashflow in California. This also allows you to keep the incredibly low-interest loan you currently have, and to only use the funds as you need them to acquire each new property.

This probably isn't a great idea.

Yes, she could put 25% down on a handful of midwest properties that might cash flow but then what? They aren't going to be cash flowing enough to cover the HELOC payments. And she'll be borrowing money at a higher rate of return than he'll earn from the properties he'll buy.

Using a HELOC is only smart if you have a plan to pay it back. That often means flips or BRRRR's where you're going to leave a fair bit less than 25% of the ARV in the deal.

Anna, a 1031 isn't an option since this is your primary residence. I'm sure if you moved out and bought something else, turning this home into a rental, there's probably an ability to do that down the road. But if you're married you'd get $500k tax free upon the sale of this home anyway. If you're single, that number is $250k.

Another option would be to pull a HELOC and use that to put as little money as possible down on a duplex that you could house hack. Then move into that and use the rental income from this home and the second duplex unit to aggressively pay down the HELOC.

I'm all for out-of-state investing in the Midwest (I own 12-doors in Detroit from California) but you have to be really smart about how you approach it. And if you have the option to stay local you likely should.

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Travis Biziorek
Investor · Arroyo Grande, CA · Member since 2014 · 1k+ posts · 1k+ votes
2y
Quote from @Mike D.:

Quote from @Dan H.:

Quote from @Mike D.:

Quote from @Dan H.:

Quote from @Mike D.:

@Dan H. @Travis Biziorek

Dan and Travis, I'd love to hear you guys hash out appropriate vacancy and maintenance numbers on low-cost rentals in the Midwest.
Travis owns rentals in the Midwest and uses 15%, Dan thinks it should be 45%+.

I do not know how to say this clearer: maintenance/cap ex should not be based on a percentage of rent. I showed examples of why this is bad even if many rental calculators have it as a percentage.
The issue is a 3/2, 1000' unit that rents for $4k in San diego has very similar maintenance/cap ex as 3/2, 1000' in Peoria that may not rent for $1k. On this property in my market, I would have ~$450 allocated for maintenance/cap ex (varies depending on landscape, hardscape, flooring, fencing, HVAC vs furnace, roof type, and many other items). This is not a guess. I used to maintain a spreadsheet that calculated this based on lifetime and cost for each of my units. As my unit counts increased, I stopped the exercise but I know maintenance/cap ex is costly.. Here is an example that is more expensive in my market (so this one does not transfer well). A 40 gal water heater changed by licensed plumber in my market costs $1600. Unlike most parts, our water heater is more expensive because it is a different part than would be required in Midwest. $1600 / 12 years / 12 months is $11.11/month. A duplex has 2 kitchen (refrigerator, range, etc), water heaters, HVAC or furnace, 2x the bathrooms, etc. so a duplex has maintenance/cap ex much higher than a SFH. mintnnr/cap ex just on replacement is $22/month for a duplex. In reality there is likely to be a need to light the pilot a few times over 12 years. Occasionally an igniter goes, the TPR fails, the drain valve goes, or the thermal coupler. I had $18/month maintenance/cap ex for a water heater ($36 for 2 water heaters of a duplex).

Note using a percentage of rent would have the maintenance on a $1600 SFH the same as a duplex where each unit rents for $800 even though SFH has one kitchen, water heater, HVAC, etc but the duplex has 2 of each of those items.

Mike thinks 15% of rent would cover vacancy, maintenance/cap ex, misc (missed payments, asset protection (actually I am not surehebelieves in asset protection), utilities from property failure such as slab leak). So Mike has $120/month allocated. At 45%, the allocation would be $360/month (which I think is too low). Peoria Illinois vacancy rate is over 10% (10.4%) so $83 in this case. Mike would $37 for maintenance/cap ex etc. I would have $277 which is not enough in small unit count. So you would have an allocation in excess of 45% for this particular property (but maintenance/cap ex should not be based on a percentage of rent).
I am unsure how Mike has derived his maintenance/cap ex estimate, but I am curious. I know I have derived mine with a process that can be described and justified.
Peoria vacancy 10.4%:
   https://www.rate.com/research/peoria-il#:~:text=Among%20Peor... recognize my underwriting many would consider conservative. I have yet to encounter an investor who has put forth the effort to determine a maintenance/cap ex that I have that thought my numbers are extremely conservative. In addition, I desire my underwriting to be a little on the conservative side and suggest this for all investors. It should take rare events such as Great Recession or Covid to under perform an underwriting.
Good luck

Hey Dan I want to clarify that I don't absolutely 100% disagree with the general *concept* of what you're doing here, although the end result is too conservative and will prevent you from making profitable investments, at least if it's the kind of stuff I invest in.

To be really honest, I didn't know this discussion was going to get so involved and I was not thinking deeply about my initial 15% figure. I was discussing this with Travis and he used it for his own rentals so I just did the same and spat out an example. In retrospect, it's low. I don't have my actual maintenance and vacancy numbers in front of me right now. I have been running probably 90-95% occupancy for the past couple years on my rentals in the Midwest, off the top of my head. Maintenance is NOT 35% no matter what your model may say. I'd need to really dig down to get you the appropriate number for my own rentals, but I can tell you right now that 25% for maintenance and vacancy combined is not too far off. Fannie Mae uses it and I've always found it appropriate for back of the envelope stuff. I have not taken this to the granular level that you are doing here. I understand your attempt to predict costs more accurately, but in the end, there may be a reason Fannie Mae does it the way they do it. You are overestimating these numbers.

Speculations as to why: tenants in these particular rentals may be tolerating a lower standard of maintenance than you think and thus everything wears longer than you think it will, I may have a different relationship with my maintenance people than you do (actually I don't let my management company do anything and I'm very involved in maintenance, I know how to do practically every necessary task, I manage people directly and sometimes I'll do a few things), there may be an error in your calculations such as you're assuming two units in a duplex don't share as much as they really do (they still share roofs, yards, and many other things), or something else entirely.

Either way, your numbers are way too high and I will not be able to answer why in more detail or provide you with my exact numbers without spending a significant amount of time on this. 25% ain't too far off. No way do rentals such as these have close to 45% vacancy and maintenance unless very badly managed.

Now, I'd love to hear how @Travis Biziorek got his 15%.
> I can tell you right now that 25% for maintenance and vacancy combined is not too far off. Fannie Mae uses it and I've always found it appropriate for back of the envelope stuff.

It is important to understand how the 25% is used. f/f provides 25% of rent to go to income and typically loans at 30% which equates to 7.5% on the loan. So from the lenders perspective, they are covered if expenses are less than 92.5% but this includes more than vacancy, maintenance/cap ex. It has to include all expenses.

So the 25% does not mean what you seem to be implying and it certainly is not meant as an estimate of vacancy and maintenance/cap ex.

>Maintenance is NOT 35% no matter what your model may say. I'd need to really dig down to get you the appropriate number for my own rentals, but I can tell you right now that 25% for maintenance and vacancy combined is not too far off.

in the one statement you indicate my number (which really was 45%, but I am assuming a typo) is wrong and my model is wrong. Then you admit to not knowing the number and needing to “dig down to get the appropriate number”.    You certainly do not justify any number here but your comment below does provide some explanation.
> I may have a different relationship with my maintenance people than you do (actually I don't let my management company do anything and I'm very involved in maintenance, I know how to do practically every necessary task, I manage people directly and sometimes I'll do a few things), there may be an error in your calculations such as you're assuming two units in a duplex don't share as much as they really do (they still share roofs, yards, and many other things), or something else entirely.

Active participation will reduce the costs. Depending on the level of participation, the costs can be reduced significantly. I can believe with an active role you may be able to get maintenance/cap ex to 25% (but not including vacancy where the rental vacancy is above 10% - no way maintenance/cap ex is $120/unit)  at that rent meaning $200/unit per month for maintenance/cap ex. depends on how active you are but remember you likely strive to make more than the trades (even though plumbers are expensive, my time is worth much more). When you do trade work, you are in effect earning trade wages.
My numbers were explicitly for the condition of the OP. OP is OOS investor. They would be very challenged to have active role in maintenance/cap ex even if they had the desire.
For the case of the typical OOS RE investor who would be hiring out work to contractors or using their PM’s maintenance staff for all repairs, I hold my estimate costs and process that derived it is fairly accurate and easier to justify then pulling numbers out of the air.
I understand some duplexes are attached and share roofs, yards, etc Note some are detached. I own some of both. The items I listed are typically in each unit regardless of attached or detached units
By the way I am way more active with my RE than I desire. We have acted as GC for every rehab (dozens) so far (but maybe will not be going forward). My numbers were not based on me doing the work even though I often do. The numbers were a case like the OP as an OOS purchase.
It does appear you have pondered some of my statements which I am glad. I believe we can all be successful and that there is a lot of opportunity for those who educate, properly access risk/return, and take appropriate actions. I will add work moderately hard at least when starting.
Continued best wishes.

Sure, well, we're at where we're at. I'm glad that we were able to dig into the details of these numbers some more and I could some perspectives based on my experience with this type of rental.

Looks like @Travis Biziorekbowed out. I would have been interested in hearing his viewpoint on these numbers since he seemed to have some pretty strong opinions and was laughing himself silly because my numbers were so ridiculous. But not a peep today. Oh well.

Well, hope everybody makes the best decisions based on the best info they've got.

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Eric FernwoodBusiness Member
Realtor · Las Vegas, NV · Member since 2014 · 997 posts · 1k+ votes
2y
Hello,

Great comments on this thread. However, I believe the focus is almost exclusively on “deals” and properties. I think this is looking through the wrong end of the telescope. Why?

Never, in the history of the world, has a property paid rent. The tenant who occupies the property pays the rent. The purpose of the property is to attract and keep what I call a reliable tenant. A reliable tenant is someone who stays for many years, pays rent on time, and takes good care of the property. My focus when selecting properties is to buy only those that my target tenant segment is willing and able to rent. Results over the last 17+ years:
- Average tenant stays > 5 years.
- Seven evictions in 17+ years out of a tenant population > 1,000.
- During the 2008 financial crash, clients experienced no decrease in rent and no vacancies. It was similar during COVID and the eviction moratorium.
The process I followed is simple and virtually eliminates guessing and luck and has three steps:
1. Identify a tenant segment with a high concentration of reliable people. You can identify this segment by interviewing multiple property managers. If anyone want to know the specifics, let me know.
2. Once you know what and where this segment rents today, buy similar properties. This eliminates the guessing and luck associated with picking a property.
3. Work with a property manager who has a track record of selecting reliable tenants. I know of only two property managers with the skill in Las Vegas. You need this skill because even in a tenant segment with a high concentration of reliable people, not everyone is reliable.
There is another consideration: where to invest. Most cities I have researched have rent growth of 1% to 2% per year. Buying properties in such locations is a fatal mistake. Why? Because the goal of real estate investment is financial freedom. Financial freedom is not just about replacing your current income; it requires an income that increases faster than inflation. No fixed amount of money will enable you to maintain your current lifestyle over time.

For example, suppose you buy a property where rents increase by 2% per year and inflation is 5%. If the rent is $1,000/Mo, what will be the buying power of $1,000 in five, ten, and fifteen years?
- Five years: $1,000 x (1 + 2%)^5 / (1 + 5%) ^5 ≈ $865. So, even though rents increased by 2% per year, inflation was 5%, so your buying power declined. Buying power is not well understood. Suppose you go to the store today and the basket of groceries you need costs $100. If inflation is 5%, how much money will you need in 5 years to buy the same basket of goods because the purchasing power of the dollar declined due to inflation? $100 x (1 + 5%)^5 ≈ $127.63. This is why if rents do not increase faster than inflation, you can never maintain financial freedom because inflation is constantly eroding the buying power of the dollar.
- Ten years: $1,000 x (1 + 2%)^10 / (1 + 5%) ^10 ≈ $748.36
- Fifteen years: $1,000 x (1 + 2%)^15 / (1 + 5%) ^15 ≈ $647.39
What causes rents and prices to rise or fall? Population growth. In cities with declining or static populations, property prices are low because there is little demand so little appreciation. Rents follow prices, so where prices are low, there will be little rent growth. Only in cities with significant and sustained population growth will you find rents outpacing inflation.

Focus on Your Goal

If your goal is financial freedom, focus on the tenant segment you want to occupy your property. Once you identify the segment, buy properties similar to what and where they rent today. Also, only buy in cities where rents and prices have consistently outpaced inflation for many years.

Sell (1031) or Refinance?

The decision to sell or hold depends on how the property has performed in the past. I created the following decision tree to simplify the process.

Ultimately, the decision to use a 1031 exchange or refinance and take out equity depends on your individual circumstances and investment goals.
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Anna Brown
OP
Member since 2024 · 2 posts · 3 votes
2y
Hi all, I have not occupied the home since 2017. The property has been listed on my taxes using a Schedule E for the last two years. After speaking with some people, I do qualify for a 1031 and am being guided to buy 2 properties in the High Desert (Victorville) because it will have the highest ROI. Maybe he's telling me this because he can only sell in CA, but is this the best move?
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Nicholas L.Pro Member
Flipper/Rehabber · Pittsburgh · Member since 2018 · 6k+ posts · 5k+ votes
2y
@Anna Brown
buying "to have the highest ROI" is likely not the best move.
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Ashish AcharyaBusiness Member
CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
2y
You have significant equity in your Los Angeles home, offering multiple options to expand your real estate portfolio. You could consider a cash-out refinance or a HELOC to access funds without losing your low 3.3% mortgage rate, allowing you to make improvements like landscaping, roofing, or kitchen upgrades to increase rental value.

Selling and using a 1031 exchange to reinvest in lower-cost areas like the Midwest could also be a smart move, deferring capital gains taxes and diversifying your investments. However, this needs to be converted to rental property before you can do the 1031 exchange.

You might not even need a 1031 Exchange as you can avoid most of the appreciation on this property under section 121 even if you rent it out for the next three years before selling.

STR can help you get huge tax benefits if done correctly. You don't get the same benefits as newer STR as your purchase date was before 100% bonus depreciation. You need to ask your tax advisor to run the numbers for you so you can make your decisions.
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Mike D.
Investor · Indianapolis, IN · Member since 2014 · 208 posts · 137 votes
2y
Quote from @Anna Brown:

Hi all, I have not occupied the home since 2017. The property has been listed on my taxes using a Schedule E for the last two years. After speaking with some people, I do qualify for a 1031 and am being guided to buy 2 properties in the High Desert (Victorville) because it will have the highest ROI. Maybe he's telling me this because he can only sell in CA, but is this the best move?

Are we talking properties that cost roughly $400k that would rent out for about $2300?
Assuming you're talking about selling the Compton house and putting that equity into the two places in Victorville, I think you're looking at $0 cash flow, best case scenario, and will probably be in the negative. You'd be better off not touching anything and staying with what you've got, unless you want to manage these places as short term rentals or invest out of state.
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Paul Haefele
Lender · Barstow, CA · Member since 2019 · 6 posts · 5 votes
2y
Quote from @Anna Brown:

Hi all, I have not occupied the home since 2017. The property has been listed on my taxes using a Schedule E for the last two years. After speaking with some people, I do qualify for a 1031 and am being guided to buy 2 properties in the High Desert (Victorville) because it will have the highest ROI. Maybe he's telling me this because he can only sell in CA, but is this the best move?
Hi Anna I'm an investor and lender located out here in the High Desert area including Victorville and would be happy to help look over some numbers to make sure that where you are being guided is indeed a good idea. I know the area well being born and raised here and could help you run some numbers to help you make some informed decisions.
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LA Property with lots of Equity

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Focus on Your Goal

Sell (1031) or Refinance?