The right way to reinvest your 1031 tax deferred exchange
A win-win story of how an investor sold his property for top dollar and traded in for top cash flow
I have a client who is in the midst of a 1031 exchange and is feverishly trying to purchase an investment property that makes good financial sense. (Side note: if you do not know what a 1031 tax deferred exchange is, it essentially allows you to sell a property, delay paying capital gains taxes on the property by re-investing the money into another investment property, saving you thousands in taxes, this could be a great benefit but has tight time restrictions on the new purchase.)
So this investor has 10 days left to identify a property and he has been looking all over Denver (an overvalued market) where he sold his property. Not being able to find a replacement property he was starting to lose hope that he may actually have to forfeit this 1031 tax benefit. That is when we met.
I asked him what I ask every investor. “What is your number one objective that you wish to accomplish with this new investment property”. His response was “Strong cash flow”. He however has looked all over Denver and could not find a suitable replacement property to replace the strong cash flow he was receiving.
Why are you selling?
I asked the obvious question (Why did you sell your current property) and received the obvious reply (because I bought it right, the values have risen drastically so I thought I could sell now and make a big profit) Well this makes great sense and something any prudent investor would do. Right?
This is where most people lose focus
O.k. so you have a great cash flow property because you bought years ago and got a good price because at the time it was a buyer’s market. You are making good cash flow because your purchase price was low. Because the market is strong you sell for top dollar and then cannot find a replacement property (WHY IS THIS) this is a simple case of too narrow of a focus. (Trying to buy in a seller market). The same market that allows you to sell for top dollar will not allow you to buy at a good price.
Buy low and Sell high
This simple concept is something everyone knows and very few people actually do. Not because you are unaware of the need to do this it is simply because you do not know how. It is as simple as buy in a buyers’ market and sell in a sellers’ market.
This gentleman was right on target by selling as he is in a sellers’ market. The missed strategy was trying to buy in the same seller’s market. Doing so would totally negate any benefit he made. So he is half way there. He sold for top dollar
Now to buy for top cash flow.
To gain best cash flow you want to buy in a buyers’ market .
Attributes of a Buyers Market
Job growth: it is the creation of jobs that provides for economic progress.
Population growth: a growing population provides a continued need for housing.
Undervalued markets: markets that have high affordability ratios have long term capabilities of producing long term appreciating property values.
Local city programs to attract businesses: some cities have 5, 10, and even 20 year growth plans. They are most intentional about having a prosperous and growing community. While some cities are shrinking in populations others are growing. (Which one of these cities do you want your next investment)?
Path of progress: within a growing city, is the city growing in one direction? Often a city (or market) may be expanding in one or two directions (perhaps toward a major highway where commercial is booming). When this happens the values in this market will follow the direction of the path of progress. Occasionally the opposite end of the city may be flat as it represents an older part of town and a lower economical makeup.
His Sell High
This investor sold property in a Sellers’ market after buying years earlier when it was a buyer’s market. After having watched his investment grow in value and watching Denver peak out as a sellers’ market where a cash flow hovers around a 5% cap rate, He seen his chance to sell for top dollar. This is a market where a market correction is about to take place. He did as any seasoned and prudent investor does; he got out and sold when the market was high.
His Buy low
Now he is also being a prudent investor by buying in a buyers’ market where prices are low. He purchased multi-family apartments in a buyers’ market where cash flow hovers around 10%.
Ride the wave of economic prosperity.
You can see how much sense it makes to buy in a buyers’ market, rides the wave of economic prosperity. Then later sell when that market reaches a sellers’ market.
Then simply repeat the process.
“Happy investing .“— Larry