The Power of A 1031 Exchange

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Using a 1031 exchange to do a “NO MONEY DOWN” deal, I exchanged one cash flow for two and upgraded my rental holdings.

In January 2000, I bought a 3/1.5 townhouse for $49K using conventional financing with 10% down. The property was a little distressed so it needed some work to make it rentable. I put about $8K into the rehab, then put the property in service as a rental.

I was pleased with this acquisition for a couple of reasons. First, the “as-is” appraisal my lender did showed a value of $63K. So, right away I was buying a property with 22% built in equity in an area where resale comps were in the high $80s and low $90s. Secondly, because the market rents at that time were about $775 per month, the property would generate a positive cash flow immediately. For those who like to see benchmarks, at this price and at this rent, my DCR was 1.60 and my Internal Rate of Return over an eight year holding period was projected at 31%.

Over the next four years, rent increased to $860 per month, while the market value of the property more than tripled my purchase price. I decided to sell the property to capitalize on a rapid appreciation and a hot seller's market. I located a couple of new construction condos that would make suitable replacement properties and put them under contract, then, listed my property with my favorite real estate agent and negotiated a 1% discount in the standard commission. I had a written offer in hand four days later offering $153500, with no seller concessions.

I opened a 1031 exchange escrow account at my bank trust department and settled on the relinquished property in early July. The settlement company wired a little over $100K to my exchange escrow agent. The first condo under contract for $92,900 settled in early September while the second condo under contract for $94,900 settled in early December.

When all the dust settled, I had reinvested all my exchange funds into the acquisition of two new properties, with no money out of pocket. Though I have the same equity after the exchange that I had before entering the exchange, I now have two properties each generating the same cash flow that I was receiving from only one property before the exchange. Additionally, after the exchange, I have two brand new properties with brand new carpet, fixtures, and appliances, instead of the one 20-year old property I had prior to the exchange.

Now, there are some of you reading this who will wonder why I put $50K cash from my exchange funds into each replacement property acquisition. We can discuss the value of leverage and the accelerated appreciation to be gained from acquiring more than two properties using smaller downpayments. The reason is pretty simple. The condo project I selected had 96 units under construction and these two were the last ones available.

Dave T
Pawleys Island, SC

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The Power of A 1031 Exchange

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