Hold or Sell Multifamily with High Appreciation?

52 Replies

@Jesse Stein

I don’t have an answer to your question because I am a pure buy and hold and pass on to the next gen kind of guy! Yup my kids and likely their kids will be well taken care of. But your case exemplifies the benefits of investing in high appreciation markets while a big chunk of investors are chasing “cash flow” in zero to low appreciation markets. Hopefully people living in high app markets like SF, Seattle etc take notice and look in their own backyard before venturing out into low app OOS simply because barriers to entry are lower.

I had this problem as well. I had three duplexes I bought in 2015 in up and coming neighborhoods and went up in value. I sold them all and bought a bigger place. Also, I hear people talk about the 1031 over and over again, but I wonder how many have actually done it. There is a lot of nuances with it and for me it wasn’t a great fit. Too much to go into now, but sit down for a hour with someone who actually did one a few years ago and if they still like it. A better fit was a cost segregation on my new building that more than wiped out my liability on the old ones.

Final point. Don’t let the tax tail wag the investment body. Lots of other factors to think about except paying for schools and police.

Good luck and it’s a nice problem to have.

Cost seg sounds good but generally its not beneficial for small investors.  Why? Becuase you take a chunk of the purchase price and write it off as an expense - so you need the income to offset and more importantly your depreciation goes way down so you lose that long term benefit. 

Cost seg works for large investments that can use the immediate write offs and who can afford the high cost of getting the report. 

1031s are useful if you have a lot of appreciation in a fully depreciated asset and want the ability to roll the entire sale price over into a new asset...yes there are draw backs and one needs to weigh the pros and cons.  (and I have done several 1031s :)j 

@Johann Jells, I'm not sure it is that, I think it more that many of us don't live in appreciation markets. Mine is very stable, but if I were banking on appreciate I would be in trouble. Therefore, I invest for cashflow and any appreciation is a bonus. I count on building equity, but then will extract it once my return on equity becomes poor, since there isn't much point having hundreds of thousands of dollars tied up in an asset that might increase in value. 

My situation is not necessarily the same as @Jesse Stein , but if I were Jesse, I would have to consider a couple things. 

#1: Do I have the time and energy to build a team and learn a new area to roll the proceeds into a property that cashflows better?

#2: If yes, how long should it take to sell the property after you identify another to 1031 into? 

#3: If no, are there more passive investments that can increase your return on equity?

#4: (Should probably be number 1) What is your risk tolerance? 

#5: Depending on your risk tolerance and future investing plans, you could get creative with your loans and still take money out while keeping the asset and not impacting your mortgage payment with a secured loan of some sort, but I don't have much expertise in that. Don't do a cash out refi because you will torch your cash flow, but you can still do a lot while keeping it as collateral.

@Johann Jells Yes, but is that appreciation likely to continue? Also you cannot live on appreciation. Ideally you have a mixture of both.

When a property appreciates more than the market around it, it's a good time to take advantage and invest in another property that has potential to appreciate in a similar way while paying you more money to hold it.

Originally posted by @Ken Naim :

@Johann Jells Yes, but is that appreciation likely to continue? Also you cannot live on appreciation. Ideally you have a mixture of both.

When a property appreciates more than the market around it, it's a good time to take advantage and invest in another property that has potential to appreciate in a similar way while paying you more money to hold it.

 I have not experienced that situation, what would cause it? My properties appreciated because I chose well in a gentrifying area. I have seen a 60x return on my original capital in 24 years, more if you count the additional properties I bought with equity from the 1st.

The 'living on appreciation' issue I addressed, expecting to live on your investments and quit your day job is one way (among many) to not get rich. By househacking a multifamily we haven't had housing expenses in 24 years, and now have 100k in cashflow. That's not a hundred doors in a low value Great Plains city, that's 13 units including our own. My apartment would rent for at least $3500, so including income taxes that's around $60k of value.  If this is failure I'll take it. Better than the guy I bought my last property from who tried to leverage his inherited 4 family into an empire and lost it all underwater in the subprime crash.

@Jesse Stein

It’s a duplex so If you do a cash out refi the interest will be higher and the mortgage payment will be higher. The only way I would do a cash out refi is if I were to raise the rents to offset the increase of the mortgage payment. If you can do that then you’re fine. Then you can have that extra cash in your pocket in case you need it. Let’s say you want to go bigger and buy a fourplex in your state I’m sure you can do it.

Let’s say that you are more of a go big or go home kinda guy then I would do the 1031 exchange and buy a bunch of 4plexes somewhere where it makes sense to you.

I don't think I would sell a property in a highly appreciating market that cashflows.  You can refi and invest for cashflow with the money that you pull out from the property and keep this one to get rich!

I've used ROE as my main metric since snowballing equity like this a few years ago.

My ROE min is 7%.  That's $600 a month for each $100k of equity.  I am selling one now because it dipped (far) below that.

$500k in equity should be netting you $3k/mo cf.  Exchange and trade up.  

@Jesse Stein

I found myself dealing with the same refi vs. sell dilemma on a couple small mobile home parks I bought in a rapidly developing area.

I love the idea of refinancing your money back out, as you can keep a cash-flowing asset you're familiar with and recycle your capital into the next deal.

The key phrase though is "cash-flowing". The refi stopped making sense when I could get such a high sale price that it would be cash flow negative if I tried to refi for 75% of that value. Once cash flow—instead of property value—becomes the limiting factor on how much you can refi out, it's time to sell.

As for buying out of state, it's not as scary as it sounds. Just get some good team members in the area you want to buy.

Good luck!

Originally posted by @Ken Naim :

@Johann Jells Yes, but is that appreciation likely to continue? Also you cannot live on appreciation. Ideally you have a mixture of both.

When a property appreciates more than the market around it, it's a good time to take advantage and invest in another property that has potential to appreciate in a similar way while paying you more money to hold it.

 >you cannot live on appreciation. Ideally you have a mixture of both.

Why not?   It is easy to access the appreciation and, unlike the cash flow, the cash extracted  is tax deferred.   In the last couple months, I extracted ~$2m without paying any taxes on it.   I think I could live quite nicely on the extracted value from appreciation if that was my goal.  

I used a portion of the extracted money to buy another outstanding local property.  Most of the rest went into other investment categories.  

@Jesse Stein

Quick analysis with some assumptions.

$265K purchase with 60% LTV = $159K original loan

After 6 years of tenant paying down the mortgage, conservatively you have a balance of around $150K.

Current market value estimate: $600K

Potential HELOC amount: ($600K x 80%) - $150K = $330K HELOC at 4.75% variable rate on investment property (based on 760+ credit score).

If all $330K of HELOC funds were deployed into B-class SFH properties out of state at average purchase price of $150K each with 80% LTV + closing costs, you could acquire another 9 SFH rental properties. The HELOC monthly interest would currently be $1,300 per monthly (potentially tax deductible) versus the $1,800 net monthly cashflow from the 9 additional properties at $200 / month / each. This $500 net cashflow delta per month isn't quite worth it. Plus you are borrowing short on what is likely a long term investment. Not a good idea...

So, next option would be to take that $330K and purchase some off market deals out of state via wholesaler, broker or turnkey company that specializes in BRRRR strategy.

Maybe you can get into 3 properties, including the rehab funds with that $330K. Stabilize those properties within a 12 month period, refinance out most of that $330K, payoff the HELOC, rinse and repeat the following year.

In this case, you are initially borrowing short to force equity only to refi into long term debt. You do need a trustworthy local market team to execute the BRRRR strategy, but the chance for infinite returns is there.

Originally posted by @Johann Jells :
Originally posted by @Michael Plante:

If I had 600k to invest 
I would not be happy making $1000 a month 
would you?

You miss the point that he's actually made $5,600/month including appreciation. Cashflow chasers never seem to see this. I have decent cashflow but it's nothing on my appreciation.

 Short sighted.  His equity is gaining on a 1 to 1 ratio of PV to Equity.  If he sells his equity remains the same...but it's worth a 5 to 1 ratio of PV to equity.  This should also increase his CF.  Those that focus on building up equity in one property, don't see that their equity is actually cash lying dormant.  The built up equity is free cash (as long as they are not paying for it by out of pocket spending like paydowns).  That cash is worth much more liquid.

The property isn't the asset, the equity is.  The property is just the temporary resting place for that equity (dead cash) until it is released and starts working for you.  1 to 1, or 5 to 1...which would you rather have?

@Johann Jells and @Greg M.

One of the things I have come to appreciate on here is that we all have different opinions and avenues on gaining wealth. We are also investing in very different vehicles. SFH vs. duplex vs. multi's.

I completely understand purchasing an asset and continuing to feed it over a number of years until such time as you believe it will have appreciated. Heck, I have a sizeable 401k that is based on that very premise- though far more liquid - and it bears out this strategy.

In my market SFH's appreciate nicely and lately have sky-rocketed. But they don't cash flow and they are far more risky because your income is tied to one tenant.

@Jesse Stein holds an asset that is very strange in my market as in his- A duplex. In my market these are all the rage with inexperienced investors and cash laden retirees and semi-retirees. They have grown by leaps and bounds.

My multi-families do very, very well on both fronts. They are far less risky and I have stopped putting my money into them. When I sell I will not be drawing on a pool of "home" buyers, my audience will be with investors who are going to want to run the numbers and see that they are buying a profitable business. And their lenders are going to demand the same. As such I have a duty to professionally manage my buildings so that they not only appreciate by their location, but also by the income they produce.

I know you both to be very active and savvy on the boards and I am sure that carries over to your businesses.

For me, I know the work and stress that my purchase, repositioning and managing has produced and it will continue. I demand to get paid for my time, now (and of course later). It is my believe that a non-cash flowing or minimally cash flowing business is in fact losing money. You are paying in both your time and resources and no one is really capable of extrapolating that out 15 years to when a property appreciates. The compounding of those unrewarded stressors on the family and your resources. And at the point you wish to cash in that chip, you will have a line of people waiting to get paid for making that illiquid asset, liquid.

I completely understand your reasoning for what you do, and it is a method that best fits you. But I am always mindful of the stock trader and the gambler, every time they win they boast about it without realizing all of the costs (losses). I feel that some people who boast about their appreciation right readily forget the losses they have incurred- and I also can't imagine a way that they could ever be properly quantified.

One thing that I know is that to the extent that my buildings or business takes time away from my family, it pays for immediately, monthly... promptly allowing us the ability to travel, enjoy recreation and still have a large chunk to elevate our standard of living. 

We are all in this game for the same reason- just different avenues and timelines. 

@Jaquetta T Ragland   That is the big question; in my area I would answer your question as no. The only way I see to beneficially trade up is to buy far out of the area, probably in a different state.

 

@Jesse Stein Agree with many. Return on Equity. How much is that 40% down and increased equity working for you and much more could it work elsewhere. This should be a constant question on every property owned.

You don't need to sell per se, you could refi and pull some out increasing the return on equity. However, cashflow of course decreases the more you pull out as mortgage cost per month increases. 

Just do the math, cashflow annual / total equity = return on equity. If you are comfortable with that "return on equity" number, ie. beats stocks, bonds, etfs, insert your investment here.....then you have your answer.

@Jesse Stein Agree with many. Return on Equity. How much is that 40% down and increased equity working for you and much more could it work elsewhere. This should be a constant question on every property owned.

You don't need to sell per se, you could refi and pull some out increasing the return on equity. However, cashflow of course decreases the more you pull out as mortgage cost per month increases. 

Just do the math, cashflow annual / total equity = return on equity. If you are comfortable with that "return on equity" number, ie. beats stocks, bonds, etfs, insert your investment here.....then you have your answer.

@Chris Levarek   Thanks for your feedback Chris. Yes, I understand a cash out refi would decrease cashflow, but create a greater overall net if I correctly reinvest the cash out $ elsewhere. It gets a bit unclear to me though in that reinvesting cash out refi $ seems to increase my debt while the cash equity in my duplex is still just sitting there and could used to achieve the same acquisitions, but with less debt and more cash flow. I understand that the cash out $ is still working for me, but can it be as advantageous as selling? Just raising the question and I know there are many variables in the equation.

I'd also be curious to know your thoughts on HELOC vs cash out refi in a situation like this.

Much thanks.

Originally posted by @Mary M. :

Cost seg sounds good but generally its not beneficial for small investors.  Why? Becuase you take a chunk of the purchase price and write it off as an expense - so you need the income to offset and more importantly your depreciation goes way down so you lose that long term benefit. 

Cost seg works for large investments that can use the immediate write offs and who can afford the high cost of getting the report. 

1031s are useful if you have a lot of appreciation in a fully depreciated asset and want the ability to roll the entire sale price over into a new asset...yes there are draw backs and one needs to weigh the pros and cons.  (and I have done several 1031s :)j 

This is interesting. How much does a cost segregation cost? Immediate write off is good for some high w2 individuals.

 

Originally posted by @David Song :
Originally posted by @Mary M.:

Cost seg sounds good but generally its not beneficial for small investors.  Why? Becuase you take a chunk of the purchase price and write it off as an expense - so you need the income to offset and more importantly your depreciation goes way down so you lose that long term benefit. 

Cost seg works for large investments that can use the immediate write offs and who can afford the high cost of getting the report. 

1031s are useful if you have a lot of appreciation in a fully depreciated asset and want the ability to roll the entire sale price over into a new asset...yes there are draw backs and one needs to weigh the pros and cons.  (and I have done several 1031s :)j 

This is interesting. How much does a cost segregation cost? Immediate write off is good for some high w2 individuals.

 

10s of thousands of $$. I dont think you can use the w/os against non passive income. My suggestion is to ask your CPA.  

Cost Segregation is really only useful for certain high income situations. They are very expensive (ie 10-50k) and they are not for the average "joe" 
please discuss with your good CPA. 

1031s are different - they are inexpensive but have some restrictions that may or may not be useful to you.  Again, ask your CPA and a 1031 intermediary. These are advanced options that are useful only to certain situations 
 

Originally posted by @Mary M. :
Originally posted by @David Song:
Originally posted by @Mary M.:

Cost seg sounds good but generally its not beneficial for small investors.  Why? Becuase you take a chunk of the purchase price and write it off as an expense - so you need the income to offset and more importantly your depreciation goes way down so you lose that long term benefit. 

Cost seg works for large investments that can use the immediate write offs and who can afford the high cost of getting the report. 

1031s are useful if you have a lot of appreciation in a fully depreciated asset and want the ability to roll the entire sale price over into a new asset...yes there are draw backs and one needs to weigh the pros and cons.  (and I have done several 1031s :)j 

This is interesting. How much does a cost segregation cost? Immediate write off is good for some high w2 individuals.

 

10s of thousands of $$. I dont think you can use the w/os against non passive income. My suggestion is to ask your CPA.  

 Thanks for the info. 

Originally posted by @Mary M. :

Cost Segregation is really only useful for certain high income situations. They are very expensive (ie 10-50k) and they are not for the average "joe" 
please discuss with your good CPA. 


Not sure where you heard cost segs are in the 10s of thousands to get a study done. Last time I checked, and our firm does around 3,000 of them per year, the average is somewhere around $5,000-6,000. Still, you are correct that it is not for everyone, and you must have a certain amount of income from your properties beyond what your ordinary depreciation deduction will cover for it to make sense. For the sake of a little more clarity on the subject, unless one qualifies as a real estate professional, the depreciation will be limited to use against only passive income, which can include income from all of your rental properties combined. Unless you are a one property type person, the accelerated depreciation can be a very good strategy to scale.