Cash Flow + Appreciation in Los Angeles. Sale?

Question

Hi Biggerpocket Community,

First time posting -- I have enjoyed reading many forums, blogs, and podcast here in Biggerpocket - you are all my mentors. BIG THANK YOU to ALL

My husband and I are new investors.  We started our investment @ end of 2011 and have acquired 4 SFR ranging from $300K to $370K in Los Angeles, California.  We were fortunate to rent out the properties between $2,400 to $3,000 with no vacancy except when we remodeled the house after purchase.  We have rented out all our properties for at least a year now and just computed our actual cash flow vs our budgeted cash flow.  For each property, we generated between $700 to $900K cash flow each month.   In addition, based on the most recent comps and research, we estimated our properties have appreciated at least $70 – $100K+ each if not more (Crazy Southern California market).

We are debating on whether to sell 2 of our properties that have the most potential appreciation and least positive cash flow to take advantage of the seller’s market here in Los Angeles.  However, at the same time we feel if the property is cash flowing, should not we just continue to stay put?
  
We really need some advice on this, as we cannot decide what to do next.  What would you do in our scenario?

Thank you so much in advance for your input and advice.

Bill Exeter · Answer

Josh brings up an excellent point.  Do not let the 1031 Exchange guide the deal.  Make sure that economics, business and common sense leads the way.  The tax planning is certainly part of the equation, but should not lead you into buying a problem property.  You can always open/start a 1031 Exchange and then let it fail on purpose if you do not find anything that makes sense and that is suitable for you.

Matt Devincenzo · Answer

Another thing to look at with this, RE is cyclical we all understand that. Holding on for appreciation has it's merits, but the key is knowing when to sell. If you have a lot of appreciation and can sell now and have a plan to reinvest that cash for better cash flow, it may be good to do that now. Yeah you may miss out on another year or two or even 5 of appreciation, but better to miss out on some possible gain than to find out you realized a REAL reduction in value due to a market correction.

Sometimes it's better to miss out on a possible gain than to end up taking a real loss by staying on the merry go round too long.

Josh Prince · Answer

Helen W. I think what Matt Mason referred to was not the Article of the CA constitution limiting property taxes to 1%, but Proposition 13 -http://en.wikipedia.org/wiki/California_Proposition_13_(1978), which limits the ability of the assessor to reassess the value of your property for property tax purposes... so if you purchased something in 1980 for $100,000 and its now worth $2,000,000 in 2013, your property taxes will be based on the $100,000 purchase price, plus limited annual increases -- they cannot just reassess your property based on its fair market value.  Now if you sell it to me and I pay $2,000,000 for it, my property taxes will be based on the $2,000,000 figure.  Ultimately this means that properties in California are often retained, because selling real estate and buying a new property will generally cause your property taxes to rise.

All that being said, you are right that 1% is better than 4%.

Arjun K. · Answer

is your cash flow sustainable?  1YR does not make an average cash flow, when you factor in plumbing, roof, HVAC and other lumpy expense items.

Helen W. · Answer

@Bill Exeter

Thank you for the advice.  I will connect with you if I decided to go with the 1031 route.
 
@Matt Mason

It is interested to read about Article 13A of the Constitution of the State of California.  I had no idea the property tax in California is limited to 1% due to Prop 13.  I can’t image if we have to pay 3 -4% of property tax in California.

I have decided to list the properties on MLS in the next few months and see what kind of offer I can get from the potential buyers and go from there.  I do have an agent license for investment purposes,  so might as well put it to good use.

Thank you all again for the advice and input

Matt Mason · Answer

Helen W

All depends on what you plan to do with the money.  I will say holding properties in CA long term makes a little more sense than other markets, because of Prop 13 (since property taxes are the next biggest expense after mortgage interest generally, this can really add up over the years).

Helen W. · Answer

Hi Josh

Thank you very much for your input.  I have considered the tax implication and possibly utilizing the tax deferral vehicle of 1031 exchange.  The leases on the properties we are debating on selling will not be up for at least 3 more months.  So, I should have at least 4+ months to identify another property.

Definitely will keep in mind not to rush into a purchase just to take advantage of the 1031 tax deferral.

Really appreciate your advice!

Josh Prince · Answer

I have considered that question as well, however for me, the deciding factor is taxes -- I am worried that trying to 1031 exchange will push me into not such a good deal, and otherwise, I would rather not pay the federal + ca taxes on the gain.  If I could avoid the taxes I would sell my appreciated CA property and realize the gains.

Cash Flow + Appreciation in Los Angeles. Sale?

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