70% equity and 30% debt. Should 1031 into similar?

Question

i have a commercial property that I'm considering unloading. Equity position currently 70%. Would like to 1031 into a multifamily in Orange County. I've done the math and if I go into a property with a 4% cap keeping the same equity/debt ratio, I think I can cashflow pretty well.

My question is: is this advisable? I hear about everyone going 20 or 30 percent down and not being able to cashflow. I'd like to both appreciate and cashflow, and by going with a huge down payment, I think I can do it, even in Southern California.

BTW, I am a newbie, kind of fell ass backwards into my current situation, and would like to grow my inadvertant good fortune.

Mark H. Porter · Answer

Funny thing, Dave, is that if you talked like this two years ago we'd think you were nuts! The high-interest environment without (what we thought would be) a positively correlated cap rate has certainly messed up our traditional thinking.

A few years back I wouldn't have touched a class-B/C multi-family for under a 7.5% cap and 20% down with 25% amortization at a ridiculously low rate. Those were the glory days that I doubt we'll ever revisit.

Now, by putting down this large down payment, you're doing more than just reducing debt and making the numbers work for a positive cash flow. You're also making the banks happy as they are almost all considering, as a side-qualifier, a DSCR to ensure they'll get paid in the future. I've even had banks say they'll write the deal if I deposit 10% of the loan value back into a money market at their bank.

It's a crazy world -

Peter Mckernan · Answer

The 1031 exchange is the huge tax savings move to get some more doors and build up that wealth with equity movement to larger deals!

Dave Foster · Answer

@Seo Hui Han, in a high interest/low cap rate environment debt kills commercial deals. As long as your comfortable with your numbers and the sustainability of your cash flow there's nothing wrong with higher equity to get that cash flow.

Or the other way with 2 smaller properties like @Peter Mckernan said.

That's the beauty of the 1031. It allows you to be flexible to go not just from type to type. But also from one to multiple replacements. Since you can allocate your proceeds any way you want. Maybe even one cash purchase and one with more debt. It's all about what the numbers will support.

Seo Hui Han · Answer

Hmm...okay. To diversify, for safety's sake. Okay, that makes sense. Like I said, I was wondering why everyone was talking about deals where the down payment was well under 50%. I get that it could be a capital issue as well, but I never realized it was to protect assets.

Hmm...that's a lot to chew on. I did the math, and I think if I lowered my down payment under 50%, i probably wouldn't be able to cash flow on these expensive California properties.

Peter Mckernan · Answer

I would go two properties 35% down and 35% down. That would be my play, but just a thought. Even they are smaller deals the appreciation would be better and yes not all eggs in one basket.

Chris Seveney · Answer

Personally I would not put all my eggs in one basket, especially if I "fell into this position"

Sean Ross · Answer

@Seo Hui Han,

You certainly can 1031 exchange from your current commercial into a multifamily; no technical issues there.

To speak generally, multifamily properties tend to have more stable cash flow but lower income potentials than commercial. Commercial also tend to have longer leases and the tenants usually take care of more day-to-day stuff.

Would you be managing the multifamily yourself? If you don't cash flowing will be harder. If you do, you just want to make sure you're up for the management complexity (tenant communication, multiple leases, maintenance, etc)

If you want to unload your commercial property, remember that you can 1031 into all kinds of different assets, depending on what matters to you most. You mention cash flow several times, so I wonder if that's the most important variable for you...? There might be cash flowing options for you that are less hassle than multifamily.

Other notes:

- you certainly can, but don't have to, keep the same equity ratio when you 1031. It's much harder to deleverage in a 1031, but you're in a good enough equity position that doesn't seem like it's a top concern here.

- if you're buying and selling in California, just know that the California Franchise Tax Board scrutinizes 1031 exchanges more than any other agency in the US, even more than the IRS. You want to work with a QI that has a lot of experience with the CFTB. Happy to go through a free consultation with you on this front.

70% equity and 30% debt. Should 1031 into similar?

70% equity and 30% debt. Should 1031 into similar?

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