Several market forces are intersecting in 2014 to bring about a “perfect storm” for real estate investors looking to increase their cash-flows and overall portfolio holdings while avoiding the typical capital gains tax consequences. This is according to California-based, real estate finance and valuation expert, Mary Jo Lachica. Lachica, a 20-year veteran of the real estate industry, says, “We’re seeing four primary market elements colliding in 2014 to create this perfect storm: low interest rates, appreciation, value spreads between single-family residential and multi-family units, and the potential repeal of tax advantaged 1031 Exchanges for investors.” Unlike the movie, about the ill-fated fishing boat this “perfect storm” could be very fortunate and profitable for investors.
To recap and elaborate, the 4 market conditions are: 1) Historically low interest rates are still available, even for investment property. 2) There have been substantial appreciation gains in single-family residential housing in many areas of the country. 3) Multi-family unit properties have not kept pace with single-family residential value gains. 4) IRC Section 1031, which currently allows investors to defer tax on gains on real estate investments, is facing repeal due to a proposal released by the Chairman of the House Ways and Means Committee. If passed, the provision would take effect in 2015, making 2014 the last year to take advantage of this powerful tax planning tool.
The first 3 conditions combine to give investors the opportunity to get more ‘bang for their buck’ when purchasing their next investment property (or properties) and could potentially help to dramatically increase cash-flows and real estate portfolio holdings. “The fourth condition just lights a fire under your butt to investigate whether this is the right move for your portfolio or not,” said Lachica. She offered the following client example: owns a single family residence with a market value of $1.3 million that rents for $3,000/mo. with an underlying mortgage payment of $1,500. The client will have approximately $1 million to reinvest into new holdings. They have identified several four-unit properties that would almost double the client’s monthly cash-flows. Proceeds from an investment property sale can be used to buy 1 new property or split to use as down-payments to purchase two or more properties. She warns, “Individual markets and investor circumstances are very different so, this strategy is not going to be a perfect fit for every investor. They need to perform a suitability analysis before taking any actions.”
She goes on to say, “Quick fix and flip properties are not allowed to use the 1031 exchange provision. The property has to have been used as a legitimate rental for at least one year.” For investors curious in exploring their potential of capitalizing on this ‘perfect storm’ Mary Jo Lachica recommends the following 6 step suitability analysis. First, establish the fair market value (FMV) of the property to be sold. It’s highly recommended to get this estimate of value from a knowledgeable real estate professional and not from an online source due to the sometimes large value discrepancies online sources produce.
Second, with the FMV in hand, investors should contact their CPA and request an estimate the net capital gain if the property sold without performing a 1031 Exchange and what the ‘basis’ is on that property. Third, contact a qualified 1031 intermediary. Utilizing the information gathered about value, potential net gain and basis the intermediary will be able to determine the required minimum amount of property value that must be purchased and the minimum amount of mortgage debt. Both property value and mortgage debt amount, on the new property/properties can trigger a taxable event if proper limits are not met. Fourth, perform rent survey analysis of multi-unit properties for sale in the determined area of purchase that meet the minimum requirements the exchange intermediary provided. This will confirm properties exist that will achieve the cash-flow and holdings objectives. Fifth, contact a mortgage lender experienced with 1031 Exchanges and access to investor lending programs to get pre-approved for the financing needed to close on the purchase(s). Sixth, if any part of the puzzle is not quite fitting into the overall picture, go back to that piece and re-work it. For instance, if you don’t qualify for the financing on the properties researched, find out what you do qualify for and then go back and see if there are properties available that fit within your financing qualifications and meet your goals.
Completing these steps will help investors discover if the cash-flows and increased real estate holdings are sufficient to validate implementing the strategy. “Regardless of whether the 1031 exchange tax deferral is eliminated or not the other three market conditions definitely warrant a review of any investor’s portfolio and overall strategy in 2014,” Lachica advises.
Wikipedia defines a “perfect storm” as an expression that describes an event where a rare combination of circumstances will aggravate a situation drastically. It appears 2014 may very well prove to have the right “rare combination of circumstances” to benefit some savvy investors in multiplying their wealth. More information on 1031 Exchanges can be found by contacting Lachica at http://www.LinkedIn.com/in/MJLachica or via her website at http://www.MJLachica.com.