Is It Time For You to Get Outa Dodge? From Flip to Keep to See Ya!

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My all time favorite axiom was taught to me by Grandma one day at their Art Shack in Temecula. It was during summer vacation, I was about 10 or so, and it was HOT. Grandpa was in the middle of one of his signature paintings of the Grand Canyon, when without warning he stopped, put his brush into a can of something smelly, and said “Let’s eat!” We had some of Grandma’s homemade beef and vegetable soup, another post altogether. I asked Grandpa why he didn’t wait to finish the whole painting before eating. Whereupon Grandma smiled at me, and gave me my favorite axiom.

BawldGuy Axiom: ‘Bout the time the farmer got the ol’ mare to work without eatin’? She died.

Grandpa needed to eat. 🙂 Also, much to Grandma’s chagrin, he began braying with glee, followed by his well known belly laugh which rocked the shack. Ah, good times.

Real estate investors in formerly huge growth markets like San Diego (Palo Alto is another great example.), still want their capital — equity, if you prefer — to work for them as well as it has the last couple generations. Problem is, that equity simply isn’t being fed by appreciation the way the investor had so easily become accustomed. Yet they’re flummoxed by how seemingly dead in the water that equity is — and has been now for quite some time.

This is something flippers who’ve kept some of their best properties for long term benefits can profit from also. Take San Diego — please. Badda booom! An astute flipper can still make some impressive short term gains here, and many are. The intelligent ones can easily recognize which ones to keep. They can then carry out the strategy of applying cash flow to the loan balance, creating more capital growth without the outside help of appreciation.

Let’s look at that a second.

You’re a smart cookie, experienced in buying property in need of rehab, at distressed prices. One of ’em is a very well located home you snatched up for $250,000 in a pretty desirable San Diego neighborhood. After performing your rehab magic, at a cost of $30,000. you happily learn it will now rent for around $1,900 monthly. (It cost you $55,000 to close the purchase.) Also, it’s market value has settled in at about $350,000. The loan balance is roughly $200,000 with an interest rate of 5%. The monthly payment is $1,075 or so. You’re able to add give or take $325 a month to your payment. Here’s where you are in about a year.

Though you’ve gained maybe $7,000 in loan reduction, what you’ve really done is added a couple options to your menu. First, since you’ve owned it for over a year now, if you sell it, the taxes will be based upon long term capital gain, not ordinary income — a definite plus. Primarily though, you’ve also created the opportunity to trade that equity out of moribund San Diego into a real growth market.

If you sold for $350,000 paying 8% for commission/closing costs, you’d net close to $130,000. This will allow you to acquire a couple very well located duplexes in excellent neighborhoods in the Dallas/Fort Worth MetroPlex. (Though it could be any proven growth region with which you’re comfortable.)

Your cash flow would go from $4-6,000 annually to $7,500-10,000. Your tax shelter will rise from $7-8,000 to 10-12,000 a year. You produced this with your original $55,000 acquisition costs + $30,000 rehab — about $85,000 or so. You’ve now generated more cash flow and tax shelter, with a significantly better chance for future appreciation than if you’d remained in San Diego. Apply the cash flow to loan reduction as mentioned above, and in a few short years you’ve generated a fairly decent capital growth rate — without counting on appreciation for one second. None of this requires a degree from M.I.T. 🙂

The real benefit though, is how you created another basket for yourself. Just last week Jason Hanson made this point eloquently.

It’s one thing though to keep what began as a flip, and quite another to hold it hostage in a market in which it will languish. Yeah, you can do the loan reduction thing anywhere, and with the same predictable results. No argument there. But if you can do it in a better region, with 50-100% more property, with an end game resulting in far and away more retirement income, tax shelter, and equity in terms of dollars, why wouldn’t you do that?

The new paradigm in which we find ourselves has also removed much of the need for us to make use of the more sophisticated strategies and/or tactics. For example, I now advise clients to buy as much property as they can prudently afford, use the cash flow to rid themselves of the debt, enjoy the cash flow in retirement — OR — trade it to more or higher quality or more tax sheltered income — or all three if possible.

It’s entirely doable for most folks to acquire income property, free and clear it in 8-15 years, and either then, or somewhat earlier as circumstances allow/dictate, trade it to property(s) that will significantly and immediately improve their position.

Nobody has figured out how to keep plowin’ the field without eatin’. Remember this the next time you think one of your keepers might do better in another region. Chances are you’re right.

About Author

Jeff Brown

Licensed since 1969, broker/owner since 1977. Extensively trained and experienced in tax deferred exchanges, and long term retirement planning.

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