[Part 2] – 1031s, HELOCs, SB9, Boot, and More

What we know..Inventory is down.

Way down.

You know it. I know it. The person bidding against you knows it. The listing agent knows it. The buying agent knows it.

That low inventory is why triplexes and quads are going BANANAS right now.

But that’s not all we know.

We also know that landlords in California (and nationwide really) have been unable to raise rents or evict tenants for the past two years due to COVID-19-related prohibitions.

Which brings us to our first topic…

Tenant stagnation

Whether you’re already a multifamily investor or are in the market to acquire your first property, you need to know tenants are feeling pretty comfortable these days—especially in renter-friendly California.

These are just three of the COVID-19 hurdles landlords faced in the last two years; there are dozens of others still on the books, especially if you drill down to county or municipal ordinances (such as Los Angeles County’s rent increase freeze).

What that means is tenants aren’t as receptive to the normal “cage-rattling” of new owners. You know, the common tricks seasoned investors try to use in an effort to get existing, low-paying tenants to voluntarily vacate their unit so it can be refurbished and re-rented at market rates:

Tenants are comfortable. Tenants know their rights. Tenants are aware that governments are very renter-friendly right now.

But most of all, tenants aren’t super interested in moving right now, which makes achieving positive cash-flow from a newly acquired property difficult unless it’s occupied with renters paying market rates (which they almost certainly aren’t).

This segues nicely into our next topic…

Time to 1031?

Many mom and pop investors have seen a substantial amount of equity growth in their properties since 2020—now might be a perfect time to capitalize on surging real estate values by way of a 1031 exchange.

For those unfamiliar, a 1031 allows an owner to swap one investment property for another, deferring those pesky capital gains taxes in the process.

As a basic example, pretend you own a triplex in Costa Mesa—you bought it in 2012 for $1,000,000 and now it’s worth $3,000,000, yay!

Do a 1031 and you can sell that property AND pocket the $2,000,000 in capital gains tax-deferred as long as you park the money into a new investment property—a beach-side townhome in Venice—that consumes all the gains.

Of course, there are some rules to take into consideration:

• You get 45 days to identify a new investment to the IRS.
• You can only list three properties as potential investments.
• You only get 180 days to close on one of the properties you identified.

BUT, dealing with those rules is a LOT better than paying CapGains taxes.

Taking boot

Worried about paying out-of-pocket for property taxes and upkeep because your new investment is currently occupied with tenants paying below market rents?

That’s where boot comes in.

Referencing the previous example, let’s say you decide to invest your triplex proceeds into a more modest property—this nine unit multifamily in South Los Angeles, listed at $2,400,000. You can put roughly $1.5MM of your $2MM in capital gains into this new investment, tax-deferred.

The remaining $600,000 in profit?—That’s the boot. You keep the boot in cash and pay the tax owed on it. What you’re left with after Uncle Sam takes his cut (roughly $480,000), can be used to offset any temporary negative cash flows, as well as pay for property updates, annual management, and state/local taxes.

You can also use the boot to invest in a second piece of land (like this 2BR income property in Azusa or this vacation property in Scottsdale, Arizona).

HELOCs

Not interested in a 1031s or boot? Well, you can always consider a home equity line of credit (HELOC) instead. As the name suggests, this is where you borrow against the available equity in another piece of property you own (for most people, their primary residence) and use the borrowings like a line of credit to finance a large purchase (like an investment property).

There are two things you need to know about the current HELOC environment before you contact a lender about getting one.

SB9

Senate Bill 9 (SB9 for short) is a California state senate bill signed into law by Governor Gavin Newsom to combat the statewide housing crisis.

The bill legalizes lot splits in single-family residential areas without the need to secure neighborhood or planning commission approval. In other words, it lets property owners skip the costly and cumbersome step of filing a discretionary review or holding a public hearing.

Traditionally, lot splitting might only be of interest to very seasoned real estate investors or true property developers because of all the legal hurdles involved. But now lot splitting is something every property owner can consider (assuming they possess both a lot that can accommodate a split and the capital to develop another unit).

Now, the thing you need to realize about SB9 is, it’s very, very new (it only went into effect in January of this year). Which means most local municipalities are still figuring out how they’re going to enforce SB9.

Until these and other questions are answered by local authorities, lot splitting will remain something of a logistical nightmare for anyone other than a developer or a seasoned investor with many lot splits under their belt.

In sum…

Nothing worth doing is ever easy.

From orchestrating at 1031 exchange to overcoming the obstacle of legacy tenants paying below-market rents, there are any number of headaches that come with being a multifamily real estate investor.

Having said that, headaches come with anything—your job, your kids, heck, even sunny days cause problems (helloooooo sunburn!). There are far more positive outcomes related to multifamily ownership than there are negative, especially if you’re operating with a buy-and-hold mindset.

In the meantime, if you’ve got questions about the multifamily market, multifamily ownership, or what it’s like being a landlord with multiple properties to manage, email me your questions and I’ll get you the answers you’re looking for.

-Shannon

310-853-0335 | ShannonShue@KW.com

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PS – In case you missed it…

Last week I covered some basic multifamily investing concepts. In case you missed the email or just need  a refresher, here are the highlights.