This real estate market, for the most part, is terrible. Though not the worst I’ve seen, it’s bad enough. Is it bad enough for you too? 🙂
What would motivate you to initiate a tax deferred (1031) exchange into another region in another state? I promise to give you more than one reason, but later.
Generally, there are two reasons folks invest or execute exchange. One is to end up with more money than they have now. The other is to create more cash flow. Pretty complicated.
The people reasons are infinite, and for the most part appropriate. Whether for growth or income, retirement is the #1 reason people invest in real estate. The end game is the highest retirement income possible. They also want to pay for their kids’ education. Or be able to take care of their parents if necessary.
Let’s take a mini-detour here for a BawldGuy Axiom: More is better than less. Sooner is better than later. More, sooner, is much mo’ better. 🙂
Paradox: Sometimes selling for less, means ending up with more.
Focus on what’s happening now. Loan underwriting has been tightened. Selling real estate is relatively more difficult, or as we’ve discovered in some markets, more than difficult. Prices have gone down — more or less in different markets — and IMHO will continue that trend in most of them. The plain truth is, your property ain’t worth what it used to be. With exceptions, it’s not that big of a deal though.
Let me show you.
Investors wishing to sell don’t like this atmosphere. They tend to get cranky. In my experience, that might be because they haven’t thought this market all the way through.
I’ve been through this kinda market a few times before. Been there, done that. It’s always the same, except for degree. This correction is worse than ’74-’75 — but in many ways, the early 80s downturn was much worse in terms of investor options. Skeptical? You haven’t lived ’till having to buy, sell, and/or exchange when interest rates are double figures. Doing a cash flow analysis using 15% as an interest rate on a regular basis wasn’t a catalyst for mood improvement. Go figure.
There are some real perks to a down market for those in the right position, given the correct focus.
Let’s talk about what the right position is.
The rightest position is having a buncha cash burning a hole in your Levi’s. Next best? An investment property(s) with sufficient equity to do some serious damange. The next in line is your home with lots of accessible and affordable equity. Affordable meaning, of course, you can easily make the potentially increased monthly payments that could result in takin’ money out.
Let’s talk, instead, about the investors owning income property with a good bit of equity.
Don’t get caught in the trap in which amateurs sometimes find themselves. They’ll use a formula found in some real estate investment book, telling them to make their move once their equity reaches a particular percentage of the property’s value. For instance, 40%. That figure might work well in one region, while it’s seriously way late in another.
There are too many factors involved to handcuff yourself to silly one size fits all templates. Numbers may or may not work the same in different regions. Assuming they do often results in faulty conclusions. Kingman, Arizona ain’t El Paso, Texas. Southern California isn’t Boise, and Kansas City just isn’t comparable to Phoenix.
This is where the pro comes in. I’m in San Diego. Let’s say you’re in, um, Kansas City. A duplex in San Diego goes these days for $300-450,000 give or take. In Kansas City you could probably go to Duplexes R Us and get a Baker’s Dozen for that much. 🙂 I exaggerate, but you get the point. So if you have a SD duplex worth $400,000 with only $150,000 <em>gross</em> equity, the average owner would probably role their eyes at the thought of exchanging their equity elsewhere — especially in this market.
Looking more closely, we see the net equity of the SD duplex is a little over $115,000. If that were a KC duplex, with a value of $180,000 and the same percentage equity to value — the net would be barely less than $51,000.
Let’s also agree the prices for both properties are easily less than they’d have received a couple years ago. Hence, the anxiety. “Why should I exchange, losing money in the process?” Of course, that’s a false statement based upon a false premise. Because your value has fallen from its high, doesn’t mean you’ve lost money. It simply means your crystal ball failed you — again — not telling you the exact day the damn thing was worth the most.
What’s the most relevant question at this point?
Will a tax deferred (1031) exchange result in your position being significantly improved? Yes? or No? If it’s not a no-brainer — don’t do it.
In many growth regions an exchanger can improve their position — sometimes more than significantly. The SD investor? (or investors in markets like SD) He could easily go from selling a single, 45 year old duplex to owning up to $1.25 Million in new or nearly new properties, depending upon his equity. The KC guy? His net wasn’t nearly as much, but given the same opportunity, they could just as easily acquire more than double the value of what they left — really. Remember, it depends on their equity position.
Still, I hear the whispering.
That is pretty cool, but don’t you understand, we’re taking a ‘loss’ here. Why do that?!
I’ll let the ‘loss’ comment pass. 🙂
We won’t even talk about the next 10 years, except to make one observation. The difference in capital growth and additional cash flow over that period of time, will be easily measured in tens, and very possibly hundreds of thousands of dollars. I’ve seen the difference hit seven figures. It’s my intention you take that statement literally. Your choices are crying in your beer about ‘what could have been’, or breakin’ out the champagne to celebrate your great judgment.
Now, tell me again about how much you’ll lose by selling your properties?
If you’re a regular here, you know I like to have fun while passing on my experience and expertise.
Today was no different, but there’s a serious lesson to learn.
Even without gaining any of the advantages shown so far, you can still sell for far less than you think your property’s worth and come out miles ahead.
Ponder what happens when you double or triple the value of what your equity controls. In expensive real estate markets you’re going up what, 0% a year lately? It’s more likely decreased in value, and you’re painfully aware of that fact. Those who’ve traded out of high priced regions like San Diego end up increasing their ultimate retirement income, net worth, and almost always their current cash flow.
Furthermore, they’re now in a much more flexible position, as instead of one property, they now have several. They’re all new. The increased tax shelter also has ’em grinnin’ . Their capital growth rate has almost shot off the chart — and without projecting a dime’s worth of appreciation.
Um, by the way? Their yearly after tax cash flow is far and away better than before the move.
For most, not exchanging out of areas like California, Arizona, the northwest, and almost the entire midwest, makes no sense.
This is the kinda market where selling for a so-called loss is actually the most profitable thing you could do. Really. Moving your equity, when it’s essentially mired in quicksand, puts your Purposeful Plan back into the game. Until you, as a real estate investor, realize this, your Plan will remain on pause. Meanwhile, your life isn’t on pause, and more importantly, well — tick tock. Another year, another birthday.
Time stops for nobody.
Don’t be a market captive. Instead, turn the market into your profit center. Learn how to win by selling for what you think is a loss.
In this market, sometimes you can truly ‘lose’ your way into a far superior position.
Try it, you’ll like it. Be dumb like a fox.
Photo: Mike Baird