Real Estate Investors — If Duplexes Are More Than $400K In Your Area? Get Outa Dodge Now

Posted @ 11:12 pm - Filed under 1031 Exchanges, Real Estate Investing, Purposeful Planning, San Diego Property Owners, Real Estate Markets, Market Correction

As a San Diegan for over 40 years now, I’ve seen all the markets since LBJ was in office. My first listing that sold was a 3Bed/2Ba for $18,500, with FHA financing. In those days, FHA loans took 60 days to close — VA took 90. Really. But I digress. While I’m in mid-digression, here’s a picture of San Diego so you can understand our biggest problem. Problem? Sure — Where the heck do ya go on vacation, when you already live in Paradise?

I use San Diego only as an example. It’s truly a unique area in so many ways, but when it comes to it’s real estate history — it’s not alone by any stretch. Most of California for that matter is in the same boat. But then, so is every other destination in the country with prices at or near what we now have in San Diego.

Here’s what I mean.

There are literally hundreds of duplexes within a 30 mile radius of my office that have a market value, give or take, within shouting distance of half a million bucks. And those are post-correction values. If you’re reading this and wondering what kind of staggering rents these places must command, you’ll be disappointed.

I can show you 2-unit properties from dawn ’till dusk in the price range of $475-600,000. Throw out the low and the high, you’ll find rents per side for 2Bed/1Ba units of $950-1,450 monthly. We don’t need to do those numbers, do we? Of course not, because these numbers are silly when looked at from any angle.

Oh, what the heck, let’s do one, so you’ll have a story to tell your buddies at work.

If you found one (and I’m thinking of a particular duplex here, though not for sale) with a value of $525,000 and rents of $1,250 a side, what down payment might be required? Here’s where it really gets silly.

Let’s assume you like interest only loans, fixed for seven years. The interest rate will be 7%.

The silly part is almost here.

With gross scheduled income of $30,000 a year, and operating expenses of say, $10,500, your net operating income would be $19,500. If you put 40% down, your cash flow would be…a tad over..I’m sorry, (Silly Part Here) let’s start over. Your negative cash flow would be over $200 a month — with 40% down.

Counting your closing costs, the cash required to close this once in a lifetime opportunity would be roughly $225,000 or so.

Is that silly, or is it silly? The numbers are more or less equivalent in many areas around the country. The northwest, the rest of California, some parts of New York, are just a few examples. There are more.

If a duplex is going for over $400,000 in your area, don’t buy. If they’re your units? Get outa Dodge, and trade (probably tax deferred) your equity to a growth region with prices and rents that make sense to regular folk. Here’s why.

There are, of course, exceptions to every rule, but unless you’re gonna live in them, having innocent investment capital tied up in them makes no sense whatsoever. Let’s say you own a duplex (or any small rental property) with numbers similar to our example — or at least with similar results. It’s my opinion we’re at or very near the bottom of this market correction. (Remember, you read it here first.) Within the next 6-18 months it’s probably just as likely as not, your property will start to increase in value again. Don’t get hung up on the timing here, because it doesn’t matter when they start going up again — just that you agree they will, at some point.

You surely must, because if your units never rise in value again, this discussion is moot, right? Right.

I challenge you to be nakedly honest with yourself. If you’re one of those, who like me, live in a high priced region, would you buy your own units at today’s value? We both know the answer to that, don’t we? As a matter of fact, why don’t you really be honest, at least with yourself. Admit you think anyone who’d put 40% down on your property for the privilege of losing more than two grand a year probably wasn’t ever on M.I.T.’s recruiting short list. Yet, by keeping your equity in high priced regions that make no sense, you’re throwing that equity in the trash. Harsh, but true nonetheless.

Once we fight our way through this correction, and prices once again begin their upward climb, the number of investors interested in pouring more than a couple hundred grand down the drain, so they can lose money, will shrink. Ya think? And remember, we’re talking about one itty bitty duplex here, not some impressive multi-story apartment building. A duplex.

What should you do?

You should take whatever net equity you have, and put it on a bus headed outa town. There are places where you can find homes, and 2-4 unit properties at prices much more attractive. Most of my San Diego clients who’ve already escaped to a lower priced growth area, have found out what it’s like to have nice investment problems. For example, imagine getting a refund on a big Nordstrom purchase then heading over to the Dollar Store to spend it all. It can be exhausting.

I remember one particular client who traded (via IRC Sec. 1031) one San Diego area duplex for six rental homes in another state. He decided that first experience was pretty cool, so he did it again, taking another duplex and trading into yet another state. This time he bought a couple rental homes, a duplex, and a huge fourplex. He’s now enjoying six figures of annual write-off, which of course he can’t use. (pesky IRS regs) He bought all these properties at prices far below his expectations. In the end, he wound up with four times the property he’d owned in San Diego, with better capital growth potential, (duh) more future flexibility, and he doesn’t have to manage ‘em.

Furthermore, because of all his newly acquired tax shelter, (depreciation) he’ll be able to extract tax free cash when, in the future, he exchanges for more property. He knows how cool that feels, because he’s already done it once, and bought a much needed new truck with his tax free profits.

Lesson: Purposeful Planning is something that keeps on giving — but sometimes if you snooze, you lose.

It will be difficult to sell/exchange your small rental properties if they’re in places like San Diego. It will only get harder as time goes by. It doesn’t matter if you need to grow your capital or if cash flow is your goal. List your properties for sale, find the growth area you prefer, and get outa Dodge.

Preferably by around 4:30 yesterday afternoon.

This entry was posted on Thursday, August 30th, 2007 at 11:12 pm and is filed under 1031 Exchanges, Real Estate Investing, Purposeful Planning, San Diego Property Owners, Real Estate Markets, Market Correction. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.