1031 Exchange, Selecting markets, CRE vs Residential

Hey there, 👋!

Today, you can expert to learn about:

• 1031 Exchange

• Selecting a market

• Commercial vs residential real estate valuations

🏘️ Unmasking the 1031 Exchange: The Investor's Secret Weapon

If you've ever played Monopoly, you understand the thrill of trading in those little green houses for a grand red hotel.

But what if you could do the same in real life—trade in one property for another—and defer taxes in the process? That's where the 1031 Exchange comes in.

A 1031 Exchange, named after Section 1031 of the U.S. Internal Revenue Code, allows investors to swap one investment property for another without being immediately subject to capital gains taxes.

It's like trading in an old car for a new one, but instead of cars, you're dealing with real estate, and instead of avoiding a trip to the DMV, you're avoiding a hefty capital gains tax.

But, like all good things, there's a catch. To take advantage of this tax-deferring magic, you have to identify a "like-kind" property to buy within 45 days of selling your old one and close the deal within 180 days. The new property must be of equal or greater value.

Let's imagine you're a real estate investor, and you own a rental property in downtown Los Angeles that you bought years ago for $500,000.

Fast forward to today, the property's value has doubled to $1 million. You decide to sell, but the capital gains tax on your $500,000 profit could be a huge hit.

Enter the 1031 Exchange. Instead of selling the property and paying taxes, you decide to exchange it for a beachfront condo in San Diego worth $1.2 million.

By using the 1031 Exchange, you're able to roll the gains from your original investment into the new property, deferring the capital gains tax.

Now, you have a new investment property with a higher value and potential for greater returns. Plus, you managed to avoid a hefty tax bill, at least for now.

This is the power of a 1031 Exchange - turning the taxman's frown upside down while growing your real estate portfolio. 🏘️➡️🏖️💰

2️⃣ Picking Your Property Playground: Choosing a Real Estate Market

Choosing the right market can make or break your real estate investment. Here's what you should consider:

- Economic Stability: Look for markets with a strong and stable economy, which can support consistent rental demand and property appreciation.

- Population Growth: A growing population often leads to increased housing demand. It also means that people want to move to the area and investment dollars are coming in to service the population.

- Rent to Price Ratio: Rent to price ratio is a math equation for rent to price. The higher rent to price is, the higher return on investment dollars you’ll get. Example of rent to price is rents are $1000 and purchase price is $100k/unit – rent to price is 1.

- Landlord Laws: Some areas have more landlord-friendly laws, making it easier for you to manage your properties and deal with tenants. This also means if a tenant is non-paying, it makes it easier for you to evict them. Generally speaking, red states have better landlord laws.

- Economic Diversity: Markets with a diverse economy are less likely to be hit hard if one industry declines. This also means your tenant base is different and you can serve students, military, white and blue collar professionals for example.

Remember, a profitable real estate investment is not just about the property itself, but also about the market in which it's located.

3️⃣ Commercial vs. Residential: The Valuation Variation

Commercial and residential properties are valued differently. Residential properties are often valued based on comparable sales, or the "comp" approach, which involves comparing the property to similar properties that have recently sold in the same area.

Ex. If your neighbor has a 3 bed, 2 bath with updated kitchen & bathroom that sells for $350k and you have the same house, but unrenovated, your house might sell for less.

On the other hand, commercial properties are typically valued based on their Net Operating Income (NOI), which is the property's income after operating expenses are deducted. Note, the NOI is before the mortgage.

This approach considers the property's earning potential, making it suitable for properties like industrial and office buildings, retail centers, and multi-family units with five+ units.

Remember, commercial properties can offer higher returns, but they also require a deeper understanding of real estate valuation and management. Knowing which approach suits your investing style and financial goals is the first step towards a successful investment journey.

That’s it! Are there any topics you want me to cover?

Stay tuned for next week’s email.