Sell 1 SFH and buy 2 more, or hold?

Question

Hi BP community. I have a question about selling and buying.

I owned 1 duplex and 2 SFHs in Miami, Fl, but recently sold 1 SFH and looking to sell another SFH due to Section 121 rules (to avoid capital gains). Not thrilled with selling this SFH since it has a 3.25% mortgage. The property has a 45% LTV.

So my question is, given today’s R.E. environment, should I sell the property and buy 2 additional properties, or should I just I just hold on to the property although I would have to pay capital gains on the property (a $40k capital gain tax).

I would appreciate advice from the experienced BP community.

Robert C. · Answer

Hi Clay.  Thanks for the detailed response.

1. This SFH is valued at apprx $750k and I have $420k in equity and it will qualify for the Section 121 Rule as per my CPA. Cap Rate is 4% and net cashflow after all expenses is $30k per year. ROE is apprx 7.8%.

2. Taking a $150k 2nd mortgage would bring my cashflow to $0

3. Assuming assuming 7% interest rate on the 2nd

4. Market in S. Florida is tough and it's difficult to get cashflow unless you put a large down payment.  I think the Cap Rate would be in the 3s as far as %

5. The reserve will not be an issue  as fortunately I have some cash available.

My Retirement Planner (I just retired in November) suggested I sell all my rental properties (1 duplex and 2 SFHs) since real estate rich but cash poor and thinks I should put more into the stock market as it provides a higher cash flow than the properties (although there's an argument that the properties perform better as a total return).  I sold one SFH already which did not have a mortgage and paid off my primary residence.  I am looking to sell the other SFH, however keeping the duplex for a few more years, or maybe much longer (bought it in 1995) because it is in an area being gentrified and property values should move higher once we see real estate have a good appreciation period.

Thanks,

Robert

Clay Edmonds · Answer

I think the first question I'd ask is:

What do you ultimately want to do with the equity from this property?

That answer may make the decision much clearer.

If you're planning to sell because you want to take some of your wealth out of real estate and use the money for other purposes, then I'd absolutely have your CPA look closely at whether selling now allows you to take advantage of the Section 121 exclusion while you're still eligible.

If you're going to sell anyway, capturing an available tax benefit can certainly make sense.

But if the primary reason you're considering selling is simply to get the equity out so you can buy more investment property, I'm not sure I'd be so quick to give up this particular asset.

You have two things working in your favor:

A 3.25% first mortgage and only about a 45% LTV.

That means you have roughly 55% equity in the property while carrying exceptionally inexpensive first-mortgage debt.

If the property is cash-flowing properly, I'd investigate accessing some of that equity through an investment-property HELOC or fixed second mortgage while leaving that 3.25% first mortgage completely untouched.

And here's something many investors don't realize: there are second-position investment-property programs that can use DSCR underwriting.

DSCR—Debt Service Coverage Ratio—essentially looks at the property's rental income relative to its housing/debt obligation. Depending on the particular program, that can allow an investor to access equity based primarily on the property's cash flow rather than qualifying in the traditional manner using personal employment income.

That could create an entirely different strategy:

Keep the existing property and its 3.25% first mortgage.Access a portion of the 55% equity in second position.Use that capital toward another acquisition.Finance the new investment separately, potentially with another DSCR loan.

Now instead of selling one property to buy another, you may be able to keep the existing property and add another property to the portfolio.

Obviously, leverage isn't free money.

I'd want to know what the existing property cash-flows today, what the new second-position payment does to that cash flow, how much equity you're actually pulling out, and what return that capital can generate in the next acquisition.

I'd calculate:

1. What return am I currently earning on the equity in this property?

2. How much equity can I safely access without destroying its cash flow?

3. What's the cost of that second-position capital?

4. What return can I reasonably generate by deploying it into another property?

5. What reserves will I have after doing it?

There's also an important distinction regarding the $40K tax number.

You don't owe capital-gains tax today simply because the property has appreciated. Generally, selling is what realizes the gain and creates the taxable event. Your Section 121 concern is really whether you have an opportunity today to exclude qualifying gain that could be reduced or lost if you wait too long to sell.

That's a CPA conversation, particularly because depreciation taken during the rental period can affect the tax calculation.

So I'd bring the decision back to your objective:

If you want to take capital out of real estate, selling and taking advantage of Section 121 may make sense.

If your objective is to grow the portfolio, I'd first investigate whether you can use DSCR-based second-position financing to put some of that 55% equity to work without selling a good cash-flowing property carrying 3.25% debt.

You may not have to sell one investment to buy the next one.