Man that is a tough situation @Bryan Case
Improve Your Rents or Sell The Properties
Are the properties in an area which has significant appreciation potential in a 5-7 year window? We've made the greatest increases in our net worth from short bursts of significant appreciation. While I would base a business plan on that entirely, it should be considered.
That said, negative cashflow is unwise. How realistic are those hold costs? They could be a touch low if you consider CapEx and a are looking at a long term hold.
Can you quickly reposition the current properties to be profitable, for example increase rents with a light remodel? Are the rents at market? Can you convert a basement into another room? Are you by a high turnover / high demand place like a university where you can rent by the room (increase effort, but higher profits)? Essentially, have you tried everything to make the properties perform better?
I would look for opportunities to reposition the property or if that doesn't get you positive, then reposition the equity. A 1031 is a perfectly viable vehicle to move the equity into new properties, although you need to consider the transactional costs when making this decision. Also, the time limit can be super stressful (I've done two in the last 14 months and the second one nearly shortened my life span). You can easily find yourself with an equal or worse deal if you can't perform in the 45 day limit.
I'm personally a huge fan of @Doug McLeod approach, if you have the knowledge and time.
Do You Need Cashflow?
There is the argument of cashflow Vs equity investing, and we can get blue in the face discussing it. But before we bother, you have to ask yourself, what is the outcome you need from owning these properties. My father in law own a rental out right, and gets about 7% CoC returns. I've tried to encourage him to get a HELOC and reposition some of the equity into another property, but he is quite happy with his investment. They use the cash as part of their retirement lifestyle. "It is a higher return than any of the bonds we own, it is inflation protected, and if I happen to benefit with some appreciation, all the better." This year, the cashflow bought them a cruise in the carribean and a nice long stay in hawaii. If you don't need the cashflow now, then...
Owning Outright Vs Loans
I'm square in the loan camp.
The Power of Leverage: Real estate mostly appreciates over time, either at the pace of inflation as they are a tangible asset, or a fair bit above it when demand outstrips availability. Let's take cashflow out for just a second (we'll get there). If you buy 3 houses cash for 100k and they go up 5%, you just increased your net worth by 5k. If you buy two four-plexes for 320k with 100k invested, and they go up 5%, your net work just went up 16k. It is a 3x difference due to the leverage.
Epic Rates: I LOVE that I can buy real estate on credit in the united states. There are so few investment vehicles which allow that, and many countries which won't even offer loans on properties. Right now, interest rates are at a retarded historical low. I can lock down capital at 4%, with near certainty that within 5 years, inflation will strike and rates + rates will rise significantly. If you could borrow money at 4% and with careful planning know with high certainty you could get a 10% return, how much would you borrow? I will take all that I can (safely).
Using math: IRR
If you want to take a lot of the arguments out of this, just calculate the internal rate of return (IRR) for each situation. It will help balance equity growth, cashflow, purchase and sales cost, and time in one equation. It is a doozie, but worth the time. BP has some super nice articles which will walk you through the process: http://www.biggerpockets.com/renewsblog/2010/09/02...
Good luck buddy.
