From a plugged-in reader and landlord in San Francisco:
As a [landlord], I’m seeing rents zoom past dotcom levels and also [Gross Rent Multipliers] are at all-time highs. When do you think this cycle will peak?
I have significant capital gains and want to sell my commercial property with a commercial property solicitor similar to Kaiser Solicitors in the UK. Once I’ve sold the commercial property, I want to buy multiple SFHs via 1031 exchange, and live in each for a couple of years to cash out $500K tax-free a piece. There has to [be] a point in time to pull the trigger where commercial property peaks and SFHs bottom. Some of you sound like astute investors, what do you think?
Bottom line is, I’m getting old and would rather be holding cash in this uncertain economy.
And speaking of getting older in the Bay Area, “[w]ith almost 18 percent of its population over 60, San Francisco is already the grayest major metropolis in the country. By 2020, it is expected that more than 21 percent of the population will be over 60 as Baby Boomers age and lifespans increase.” Oh, and “30 percent of the subsidized affordable housing being built or in the pipeline in San Francisco is for seniors.”
? Bay Area Rents Surge, But Housing P/E Ratio Remains Out Of Line [SocketSite]
? S.F. faces silver tsunami [San Francisco Business Times]
Free financial advice on the internet is the most costly advice you will ever receive.
Pay an accountant. BTW, you can’t use a 1031 exchange to shelter the gain from the sale of commercial property in the purchase of a principal residence.
I’ll give you some advice that is worth exactly what you are paying for it. If your primary objective is to hold cash because of the uncertain economy, then sell your properties for cash. Capital gains tax rates are obscenely low. Just pay them and be happy with your “significant capital gains.”
I agree with anon. Why try to save the 15% cap gain tax(OK, and the 9% CA income tax). Even at 24%, it is still very low.
I just don’t think it is worth the multiple of 2 years you need to spend in each of the SFR.
The investor’s plan is great, and just an FYI taxes on the sale of any investment property are as follows:
15% Federal Capital Gains
9.3% State of CA Capital Gains
25% Depreciation Recapture
One of the posters is correct, you can not 1031 directly into a primary residence, but you can 1031 into a rental home and later convert that rental home into a primary (as I think was the investors intention).
We advise clients to rent the property for 2 years before moving in, so as not to raise any red flags with the IRS. Also, keep in mind, if you live in a home that was originally acquired as a 1031, you will not qualify for the Section 121 exemption (homeowners exemption of $250K/$500K) until you have lived in the home for 2 years and also owned the house for at least 5 years (relatively new tax wrinkle that only applies to 1031 properties converted to a primary)
To learn more, visit our web site resource page at http://www.ax1031.com/download/
There is no escaping of the 9% state tax and depreciating recapture, so we are still talking about the 15% cap gain tax.
Of course, consult a CPA is OP’s best bet.
The “Silver Tsunami” is exactly why residents had better become A LOT more vigilent and engaged with City Hall to make sure this City appeals to tourists. Without tourism dollars, we’re screwed because old people (take that as whatever age you like) don’t spend nearly as much money for goods and services as folks in their 30s, 40s, and 50s do. Time to re-tool the Board of Supervisors.
My view is that we need to understand two markets here: the residential rental market and the residential investment market. The rental market is driven primarily by job growth, changes in supply (albeit is small since new units are a small % of existing stock), and the price of substitutes (e.g., owning).
Job growth on the margins is in Tech and Financial Services. Both of these sectors (based on the headlines) are heading for choppy waters.
Supply on the margins is probably rising as a number of projects are are hitting the market and some of these units will hit the rental pool. And it is not clear that the pipeline is shutting down yet.
The price of substitutes is probably flat given that prices are falling but financing costs (LTV more so than rate) are rising.
The investment market has to retreat given the increasing cost of financing. Lenders have re-discovered risk. Property investors may also adjust their required risk premiums. This should lead to lower GRM’s.
A final consideration is that the captial gains tax rate is not going any lower. Given the above scenario, you might find that putting the aftertax proceeds into a savings account will put you ahead over a 2-3 year period.
One caveat: none of this takes into account inflation. Real estate is a wonderful inflation play when it is financed with long term debt.
Poster John is incorrect. The homeowners exemption allows you to avoid both state and federal taxes. He will have to recapture depreciation however upon th sale. John’s good advice is for OP to consult a CPA.
Johnson is correct. 1/.757 = 1.321 A 100% guaranteed 32.1% return is pretty significant if you asked me. Especially when the OP is talking about multiple homes (minimum $1M dollars).
If it’s rents you really want to discuss (or you’re looking for those comments), have we got a thread for you: Bay Area Rents Surge, But Housing P/E Ratio Remains Out Of Line
I’ll leave the tax advise for the other posters and concentrate on the RE side of it. While rents are gaining, most properties are locked into rent control, so value gains in most smaller apartments and mixed use buildings have been pretty modest lately. The one exception is mostly vacant 2-6 unit buildings buildings that can do the TIC/condo route as these are getting a premium.
On the other hand, if you’re talking a larger property with more than 10 units, you have to consider the Lembi effect
http://thefrontsteps.com/2008/01/15/ask-us-lembi-juggernaut-selling-units/
Yes, they have been paying premiums for their properties in the past 3 years, but it looks like their access to cheap and highly leveraged money is over (I’ve recently heard a rumor that they had typically 90%+ leverage on many of their purchases). Anyway, you probably won’t be able to get the value that LEmbi comps indicate in this market with tightening commercial credit.
As for the plan to switch into houses – well, I think houses are a pretty volatile investment at this point, so when you consider that a home value could go up or down 5-10% in the short time frame that you would want to sell, it makes it pretty risky I’d think. Add the additional 6% brokerage commission on the house on the back end and I agree – saving the cap gains tax is probably not worth the headache. I’d think diversifying part of your portfolio away from SF real estate by selling some of your commercial properties and moving that into an alternative equity investment would be the most conservative/defensive play. You could keep some of your commercial holdings to stay in the SF real estate game, and maybe even do the apartment to house 1031 with a house or two if you’re looking to live in SF for a while. Overall though, I’d think about diversifying away from SF real estate if you want a more conservative retirement strategy.
Miles – thanks for the link to the Lembi update. It will be interesting to see what happens to the multi-unit market if Lembi not only stops buying but starts selling. Some of the posters at TFS seemed to think that Lembi had a winning strategy. From some recent purchases that I saw, he was buying properties with 1 – 2% cap rates and just blowing out the competition with overbids. How is that a money-making strategy? He apparently had access to cheap money – but was his interest rate less than 2% on this “cheap” money? Was he assuming that he could double rents overnight?
I think that this is just more evidence of a commercial bubble too that’s in the process of deflating. I think that the buyers of some of the big office buildings are going to suffer too when the $100 psf rents fail to materialize.
From a marco economic point of view, the current cycle of mortgage resets is expected to peak this March. Add 5-9 months for them to reach market and 30 – 60 days to season and you have a rough time-line of when I would expect to see the best bargains in SFHs. The double wammy here is the holiday season if you add the surplus of inventory due to foreclosure activity and the seasonal slow down in buyer activity, November through early January could create a perfect storm for bargain hunters in the bay area especially if you consider we are starting this year with higher inventory than we started last year.
Just to protect my ass, 9 months is a long time to project given the volatility of election years, every politician in america will be trying to cook up some piece of legislation to control the mortgage meltdown, so it’s possible something could get passed that slows down the process. Cheap rates and crazy lending probably extended the last bull market 2 years longer than it should have been, so there may be an extra 10% fall priced into today’s market. Another caveat, some neighborhoods such as presidio heights and cow hollow seem to be defying ths downturn so these generalizations probably do not apply to all areas of SF.
If we end up in a full blown recession it may not fully hit the masses psychologically until 2010 or 2011 when the second wave of option ARM mortgage foreclosures hit. Remember, the majority of bay area mortgages in 2005 and 2006 were option ARMs. Unfortunately, in a serious recession even rents begin to backslide as people move back in with parents or take on roommates so income properties sometimes become vulnerable to some erosion also. I expect income properties will have a less spectacular fall than SFHs though. Given the uncertainty of 2010 and 2011, I would try to close escrow on my sale in November and use the next couple of months to identify and scoop up SFHs. Just my 2
cents worth. Remember, sales of new homes and new cars often slide before recessions are fully formed and we are 4 months into both of these declines. If I had to guess, sell this fall and buy this winter.
And here, once again, is the credit-suisse chart of resets by type and value.
http://calculatedrisk.blogspot.com/2007/10/imf-mortgage-reset-chart.html
As you can see, wave after wave of resets out to 2012.
And here’s my 2 cents worth Norman, if you can afford to put 20% down on a fixed mortgage and have a secure job and don’t mind being underwater for a decade then go for it if you want. Otherwise, save your pennies and the longer you wait the more house you will get for your buck.