1031'ing into a STR / LTR / or no rental at all

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1031'ing into a STR / LTR / or no rental at all

Reid McCutcheon
Investor · Springdale, AR · Member since 2017 · 8 posts · 3 votes

I think this is my first post. I signed up in 2017 but forgot I had an account here until I just recently started listening to the Bigger Pockets podcast.

Anyway, question for the group here. We currently have 3 single family homes we rent out as long term rentals. We also have another single family we short term rent.

I have a property management company that manages the long term rentals, but after everything is said and done on those, the monthly cash flow on them is only $1830.00. I say only because the total value of all three houses would be around $720k and the remaining equity between all three after mortgages would be around $525k.

I'm considering the option of selling all three and 1031'ing into higher cash flowing properties. My wife likes the idea of short term rentals. We now have a little over a years experience with our first short term rental. We 1031'd two LTR properties into one single family short term rental. Purchased it for $450,000 free and clear. We have it managed by Evolve, but we also have to be up there every week to make sure things are clean and in order (90 mile round trip) because the cleaners aren't amazing and the options for most service work in that area is hit or miss. We did gross almost $66,000 on it between when we started on April 1st of 2022 to March 30th of this year. But between management fees, cleaning, travel cost, upgrading, decorating, furnishing, painting, insulation, heating and cooling, plumbing, and supplies we spent about $66,000 of that amount. I'm thinking a lot of that first year stuff was a one off and this year will be better.

I do like the idea of short term rentals because I know they can make great returns, but I also want to know from people's experiences. The first year is usually the worst year for a return, right?

Now as far as my long term rentals, what do you all think. In the current real estate market with the new higher interest rates, should $500k be able to be 1031'd into either STR's or LTR's and make well over $1830 a month?

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Wayne Bolen
Leander, TX · Member since 2014 · 55 posts · 24 votes
3y

Sounds like you did a major renovation year 1, eating up all your profits, so from that perspective, yes you should expect to retain more in year 2. That being said, like Ryan mentioned, the STR craze peaked at the end of last summer. I don't think this is due to a lack of travel, but the market has been absolutely saturated in the past couple of years. In order to be a high performer going forward, you really need to find a way to stand out above the crowd. I see posts all the time in STR groups where people are desperate because their properties are not booking. In most cases, these are very average properties and they are competing with hundreds or thousands of other properties. If you move forward, be sure to buy the best properties in the best areas that you can afford. Then looks for ways to incentivize potential customers to choose your property vs others in the same area and price point.

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  • Ryan MoyerBusiness Member
    Property Manager · Orlando Kissimmee Davenport Salt Lake City, Park City · Member since 2019 · 991 posts · 1k+ votes
    3y

    What market is your STR in?

    Breaking even on an STR you have no mortgage on is a pretty poor return relative to what is available out there, even in the current market, especially given that you've got summer 2022 in there which was probably the hottest few months in STR history and may not be repeatable this summer.

    As to your question about year 1 vs. future years that mostly has to do with startup costs, so you should be able to subtract that part out and see what to expect going forward. Other than that in a normal market you do generally expect rates/occupancy to increase as you get more reviews and get repeat guests, but that is somewhat canceled out by the notion that you had summer 2022 last year and we may not see that hot of a market again for a while (STR supply/demand really hit a tipping point around Sept 2022).

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  • Wayne Bolen
    Leander, TX · Member since 2014 · 55 posts · 24 votes
    3y

    Sounds like you did a major renovation year 1, eating up all your profits, so from that perspective, yes you should expect to retain more in year 2. That being said, like Ryan mentioned, the STR craze peaked at the end of last summer. I don't think this is due to a lack of travel, but the market has been absolutely saturated in the past couple of years. In order to be a high performer going forward, you really need to find a way to stand out above the crowd. I see posts all the time in STR groups where people are desperate because their properties are not booking. In most cases, these are very average properties and they are competing with hundreds or thousands of other properties. If you move forward, be sure to buy the best properties in the best areas that you can afford. Then looks for ways to incentivize potential customers to choose your property vs others in the same area and price point.

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  • Michael BaumPro Member
    Olympia, WA · Member since 2016 · 8k+ posts · 7k+ votes
    3y

    Hey @Reid McCutcheon, it's a bummer you are using Evolve. You are giving away 10% for essentially very little. Currently they own your listing so you would have to start over with a new listing if you decided to take your current STR to self management. You are already doing the hard part.

    The first year of any STR (for the most part) is the thinnest. You have to build up a rep and reviews. Year two should be better and after that things should go well. I see that you essentially did a full remodel on the place so I would guess year two will be much better. Did you do a cost segregation?

    As for the 1031, it is going to be a crap shoot. It is all going to depend on where it is located etc. Lots to unpack here.

    For the 3 properties, are you pretty much hands off? What is the interest rates on those mortgages? It sounds like you don't owe a ton on them. I would most likely keep them in place and work to pay them off.

    I am doing the math (from what I see) and it sounds like these homes are class C or C+. Rents seem really low depending on where they are located. 

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  • Reid McCutcheon
    OP
    Investor · Springdale, AR · Member since 2017 · 8 posts · 3 votes
    3y

    The STR property is in Eureka Springs, AR. It's in a very good, if not great location. Easy walk to downtown, right across the street from the Crescent hotel. They only allow STR in commercially zoned areas. Luckily, this one is the only property commercially zoned within a few blocks. Last year, we had the house completely repainted, inside and outside, We had about half the siding on the house, which was rotten, replaced, redid the front porch, we replaced double exterior doors, got a lot of new furniture, redecorated all the walls, got a few new TV's, replaced an oven, blew insulation, had service work on the plumbing and the heat and air, and a lot of other things I can't even remember at the moment.

    But most of that stuff should be good to go for awhile. We aren't really having too much trouble renting it. There has only been two weekends it didn't rent and those were in February. I would like to see more weekday stays. But from our limited year of renting it, dropping the price seems to bring parties, broken items, and complaints from the guests about things like not having complementary bathrobes and house shoes. The higher price point seems to bring people excited to stay and they usually give 5 star reviews.

    I was thinking, with our first year at $66k gross but breaking even with no mortgage. How do people that are getting a 10% second home loan or 20% conventional make it work in this interest rate environment. My wife and I are taking our three year old to Seagrove, FL to stay for a week at the beginning of May. Five nights in a 1200 square foot 3/2 within a few block of the gulf. We're paying $2100 for our stay, that includes cleaning. We checked it out and the current owners bought in 2021 for $1.2 million. Seems like it'd be hard one to break even on if you have any kind of mortgage. And I see a lot of those types of prices still prevalent in very popular areas. The gulf, the Smokies, Broken Bow, OK. I'm thinking of looking in smaller places that may have specialized draw to the area that aren't so popular to the masses.

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  • Reid McCutcheon
    OP
    Investor · Springdale, AR · Member since 2017 · 8 posts · 3 votes
    3y

    @Michael Baum I agree. I didn't realize about Evolve until we already had a good amount of reviews. But if we dropped them at this moment, we'd be starting over with no reviews and no superhost status. 

    The three long term rentals I still have, I got them at good deals and I refinanced them all at 2.875% fixed 30-year in 2021. So in paying them off, there's really not a lot of skin left in the game other than raising the rents.  I owe $40k, $65k, and $86k on them. So really, overall there's just over $1000 a month total left on the bone between the three of them if they were all paid off. They are class C to C+. One of them might make an okay short term rental with its location in a B class area that's close to everything. 

    The rents are my fault. I have long term residents in two of them and I didn't properly have my property management company raise the rents. 

    They are all 3/2's. One has a two car garage. The rents are $1050, $1075, and $1250 with a 7% management fee. But the houses themselves, from comps, with a little spruce up could list for $240 to $250k each. Whether that's what they could get, I don't know. But that would most likely be new homeowners, investors couldn't make that work. 

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    3y

    @Reid McCutcheon, I don't know that anyone is sure of the direction that STRs will take in the future. When we first started with them the mantra was that you lose a little first year. You make a little second year. And third year you start to be meaningly profitable. All of our properties followed this path. But this was pre pandemic, and pre real estate market of the 2020s. The question on everyones mind is will competition finally saturate - if so then the only good STRs will be STRS that are where and what they should be. A house that just won't make your numbers as a LTR will be a great risk as an STR. Dont' know when that will happen. But just make sure that your prospects are really ideal for STR.

    Another option to think about - if you have jobs already - would be to go find LTRs that will cash flow (even minimally) with high leverage. A high interest environment shouldn't scare you if the numbers work. You're not paying the interest, your tenants are. That's more tax deduction for you. And the higher the leverage the more the amortization of the loans benefits you. This makes the IRR calcuation invaluable to you to see the true picture of what you're making. Monthly cash flow might not be the greatest. But your Internal rate of return is huge. And those properties paid off free and clear are a pretty nice nest egg for later.

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  • Michael BaumPro Member
    Olympia, WA · Member since 2016 · 8k+ posts · 7k+ votes
    3y

    Hey @Reid McCutcheon, so I guess you have to ask yourself if you sold these, could you replace them easily?

    You have pretty low amounts left with great mortgages. We might not see those rates for a good long while. So keeping them in place is probably the right way to go.

    How far under are the rents? Could you start sprucing them up to increase the rents?

    I just would have a hard time getting rid of 3 performing SFH's for one STR that could be a risk.

    It is a tough call.

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  • Leslie Anne Morris
    Real Estate Agent · Smoky Mountains, TN · Member since 2022 · 1k+ posts · 984 votes
    3y

    There are so many ways to do this. Consider not only cash flow, but also your net worth based on the equity you've built up. I did two 1031 exchanges last year. Sold a LTR and an STR out of my normal footprint. Got 2 more cabins in the Smoky Mountains...much better properties then the two I sold. Out of pocket I added about $50k in new cash. I expect to see annual net income double as a result.

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  • Zach Edelman
    Lender · New York, NY · Member since 2022 · 1k+ posts · 1k+ votes
    3y

    The experience you garner from the first STR though cannot be understated. Never going to be able to fully learn how to do STR and garner the high cashflow returns it offers by watching from the sidelines.

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