This deal analysis looks at a fourplex that my clients recently purchased in a 1031 exchange. These clients were extremely prepared, which made the process fun and a lot less stressful than a typical 1031 exchange. Thanks to their hard work, they were able to sell a townhome on the east coast and bought a great fourplex in a desirable area of the Springs. And the best part: they were able to defer capital gains taxes.
- Listen to the podcast “#69: Using a 1031 Exchange to Buy a Fourplex in Colorado Springs” on the Colorado Springs Real Estate Investing Podcast
- Watch the YouTube video (at the bottom.)
- Read the blog post. Note, the blog is an executive summary. Get the in-depth breakdown from the podcast or video.
My clients are a couple who currently live in Colorado Springs. They wanted to sell their paid off Virginia townhome and use the proceeds to purchase a fourplex in the Springs. They were renting out the home but decided after a tenant turnover that it was a good time to sell the out-of-state property and buy something closer to home.
The townhouse sold in the mid-500’s and they walked away with $530K they wanted to use to invest. They wanted to buy the biggest asset they could with a residential loan, which would give them fixed 30-year financing.
Because they were looking at such a large gain, they wanted to do a 1031 exchange. These exchanges allow sellers to defer taxes by rolling them into a replacement property. The goal with 1031 exchanges is to essentially continue this practice of rolling and deferring until you die, at which point your heirs inherit the property at the stepped up basis. While it may sound morbid, it’s a good wealth preservation strategy.
These exchanges require a lot of pre-planning because replacement properties must follow a strict set of identification rules. I was in touch with my clients months before they relinquished their property in order to make sure we could hit the ground running once it was under contract. I found out what kind of replacement property they were looking for and ran analyses so they had a good idea of what they were purchasing.
Investment Property Details
This is a townhome-style fourplex in the Rockrimmon area of Colorado Springs. All of the units are 2 beds/1.5 baths. With this type of layout, each tenant gets a yard and doesn’t have anyone above or below them. As a bonus, this part of town has stunning views that are very attractive to tenants.
Property Contract Details
I was able to lock this property up because it was only listed on REColorado as “Coming Soon” and not on the PPMLS service. Most multi unit properties do not allow showings, so I advised my clients to act on this as soon as possible.
Our usual team policy for 1031 exchanges is to get through the inspection period on the relinquished property before going under contract on the replacement property. However, when I saw this fourplex, I knew it was exactly what my clients wanted and we would need to jump to ensure they got it.
I wrote the contract so that it was contingent upon the sale of their townhouse to protect them in case the sale didn’t go through.
The property was built in the 1980s and only needed some cosmetic updates. Everything was in good, working order, though the appliances could stand to be upgraded. I’ve never seen an inspection report for a fourplex come back as clean as this one.
The only real repair my clients have to make is replacing the water heater in one of the units, which costs about $2500.
My clients were originally under contract for $979K. I didn’t expect it to appraise for that much, and as anticipated, the appraisal came in low at $900K. Luckily, the seller was also doing a 1031 exchange and was willing to work with my clients.
They met in the middle at $947K, which I think is still a great price for this property. They already intended on making a large down payment because of the amount they were getting from the sale of their townhouse. In that regard, there was not much impact to the amount they were spending, just shifting the numbers around on paper.
Property Financing Details
I used the Rental Property Spreadsheet to run the numbers.
My clients made a significant down payment of 56% because they put all of the proceeds from their townhouse into this fourplex. They bought down the interest rate, as well, to a great rate of 3.5%.
They initially planned on objecting to the non-working water heater, but it got lost in the shuffle of negotiations after the property appraised low. There was no need to blow the deal over a water heater, and my clients had a good, long-term perspective on that.
Each unit has a different monthly rent, but they average out to $1325 a month per unit. I think it’s reasonable to boost rents to $1400 or even $1450 as leases turn and tenants leave.
Property Operating Expenses
Electricity and gas are separately metered, and the prior landlord set up water and trash as a billback system. Since the leases convey with the property, that structure remains in place.
First Year Returns
With the current rents, my clients are making $20K in cashflow and have a cap rate of 4.5%, which is expected for this area. This is a great set it and forget it investment and it allows them to defer taxes.
If they raise the rates to $1400, their cashflow increases by $3K a year and their cap rate goes up to 4.8%.
1031 exchanges can be stressful, and it’s not often that the stars align like they did here. However, thanks to investors who did the necessary prep work, it allowed them to minimize the risk as much as possible.
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