Moving money, duplexes, and unicorns. This sounds like a seriously boring blog post, but this is fascinating stuff and I hope you walk away with insight and maybe some ideas for where to focus business if you work in real estate. If you’re not local, are these trends happening in your market? I challenge you to find out.
Increasing 1031 Exchange Sales: Here’s an image to show all 1031 Exchange sales in the Sacramento region over the past two decades. In short, a 1031 Exchange is a way an investor basically swaps one property for another to minimize the tax burden. Often investors from outside a market will move money into a lower-priced market too, but that’s not always the case. Anyway, here are all 1031 Exchange sales on one graph. I know, there are way too many dots here. But do you see two main clusters? There were more sales in the last rising market cycle and there are more in today’s market.
I spoke with a 1031 Exchange guy and he echoed this is exactly the trend he is seeing out there. When a market is rising, investors tend to move money. I will say the stats here are not perfect because these are only sales where agents have input a 1031 happening. However, I believe most importantly we still have an accurate trend to see about the frequency of 1031s happening. For what it’s worth, about 85% of these exchanges were single family homes, so clearly investors wanting to park money in Sacramento aren’t just looking to the 2-4 unit market.
Brand new duplexes: This might not seem like a big deal, but here are four recent duplex builds in Sacramento. This hardly seems like a trend or worth mentioning, but being that there are literally about a dozen new duplex sales over the past ten years, it’s a big deal to see four right now. The good news for today is it’s possible in some situations to build a duplex and make the numbers work. We have a severe housing shortage in California too, so seeing more multi-unit properties is definitely something we desperately need.
Unicorn advice: If you are going to build a duplex, keep your costs down somehow and do something modern as it seems like units with a modern / contemporary feel are the ones selling at the top. Also, sometimes we see out-of-town investors pay more for two-unit properties. That’s a very real dynamic. Know that unicorn buyers are out there and when I see 2-4 unit properties sell for too much it’s often a Bay Area buyer (or 1031 Exchange). But be careful about pricing too high because that’s a quick way to get zero offers (seriously). My advice? Price for the market instead of the unicorn.
REGIONAL DUPLEX SALES: Here’s a quick look at two-unit (duplex) sales over the past two decades in the Sacramento region. I committed graph sin by not explaining “region” on the image (it’s Sacramento, Placer, Yolo, El Dorado county). What do you see?
A DIFFERENT TREND: When looking at Midtown and Downtown there is clearly a different trend. The rest of the two-unit market hasn’t quite seemed to eclipse where prices were in 2005, but that’s absolutely not the case in Midtown. It just goes to show the market isn’t showing the same trend everywhere.
Anyway, I hope that was helpful. Thanks for being here.
Questions: What stands out to you about the images above? What have you noticed about the duplex market? Anything to add?
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An investor friend of mine has been selling duplexes in favor of single fam dwellings due to mechanics of it and overall maximizing return. Not sure whether he has it figured out or not? His line of reasoning appears sound. Higher rent per unit and less headaches that are a part of the biz.
Thanks Mark. It seems like some investors have their pet property types and they end up mastering that. It’s always fascinating to watch. I know someone who focuses on duplexes in my market and he’s been really successful. I find some investors will be heavy into 2-unit properties instead of 4-unit ones too.
Yes and we are heavy senior market (generally with money), with tight rental market thus rent boom has made sngl fam shine a bit.
Are we saying that building duplexes close in to Sacramento will be profitable now? Have rising rents reached the point where it pays to build from scratch as opposed to converting existing SFR to halfplex, etc? How far are we from that point where building them will make economic sense? How much further must rents rise to cover the construction cost and entrepreneur profit? Any ideas?
Hi Steve. Those are all great questions. I don’t know that I have exact answers, but I do know from a profit standpoint it has begun to work for a small pool of builders. I think part of the issue may be they’re finding ways to use skilled local labor on the cheap.
My sense is in some cases building a duplex is going to be better for the seller, but the numbers might not actually work for a buyer. When sharing aboutt these units last week on Twitter, for instance, people said things like, “It doesn’t look like the deal pencils out with rents.” Well, it might not. But a deal might pencil for the seller so to speak.
This is a good reminder that some investors don’t always buy only based on rent levels penciling perfectly. On that note, buyers for two of these sales were from San Jose and New York per Tax Records, which is also a good thing to keep in mind.
No matter what, it’s good to see this phenomenon since we desperately need units. A seller / builder sure better be cautious in their analysis though to make this work.
Good article Ryan, as always.
One of the other nice things about a duplex is that it is a great opportunity for a first time investor to buy the property with only 3.5% down and get a loan for up to $728,750 and use the projected rental income from the one unit to qualify. They initially have to live in the other unit. After a year or two, they can then rent out their unit and purchase another property to live in with only 5% down and now they own an income producing asset with a minimal initial investment.
Thanks Rick. Excellent point. You can even use FHA financing to get a duplex (not at the price you mentioned of course). I find it’s especially nice when seeing two houses on lot. That can create an excellent rental environment or a fantastic situation for a larger family with extended relatives.
Interesting Sacramento real estate conversation as always Ryan. Thank you.
Thanks Gary. I appreciate it.
Last year and 2018 I had some wannabe duplex buyers. One had experience with SFR rentals, the other a newbie. Sorting through scores of income and expense statements, my finding was that cap rates in median priced zip codes ranged from 4 to 6 for duplexes, the 6s usually in need of some work. The average cap rate was well under 5. SFRs ranged from 2 to 5 cap rate, with the average about 4.1 cap rate. Neither investor bought since Reits (and the rest of the stock market) make more sense if one is only looking at cap rate. I advocate sfrs for investors with less than 7 figures to play with. Reason #1 – liquidity. You can sell an SFR to an owner occ or an investor. There are few owner occ duplex buyers in Sacramento. Reason #2 Appreciation. Unless you bought at the rock bottom and sold at today’s stratospheric level, appreciation of duplex values seems to lag behind SFRs. Reason #3 the cap rate differential for sfr vs. duplex of similar quality and location is just a few basis points, which can quickly evaporate as a result of expenses.
Ask an investor would she rather pay $400,000 for a duplex paying $1100 per side or the same for a house paying $2000. At first glance the duplex is the better deal… But there are twice as many kitchen appliances to deal with here, twice as many HVAC systems, water heaters, main electrical boxes, two property management fees, the list goes on. Overhead maintenance, capital repairs, and expense eat up most of that $200 per month rent difference.
It gets even worse for leverage buyers. There is usually a .25% interest rate premium for investor owned duplex versus investor owned SFR.
Thank you Jim. I really appreciate your take here. Excellent commentary. Investors have lots to think through.
Most duplexes are being purchased as investments. Very true. I did check and since 2019 11.7% of duplex sales were purchased with FHA or VA (mostly all with FHA). There could be conventional owner-occupied units also, but that’s hard to really unpack for certain as many investors use conventional financing. Just wanted to throw out this tidbit as I thought it was fascinating.
Interesting information! I have not heard of 1031 Exchange Sales. I know investors due do this kind if thing, but never heard it called my that. This is not happening much in my area. Probably because our market is relatively flat. Great points on building a multi-family. I totally agree with your thoughts on style and not over-spending. Great post!
Thanks Jamie. I appreciate it. I always like to hear about the Cleveland market too.
The other interesting thing about your charts is the peak of the 1031 money was right about time for a market hiccup. My big concern right now is the collapse if you will of the 10 year treasury over the last 8 days. Some of the smarter people are predicting the 10 year to head toward 1%. If that is correct I see the RE market moving even further upward. All great info for RE agents and mortgage folks, but from my view point as a beat up old cowboy/appraiser, this will lead to a bad situation from the RE value standpoint. We are in year 12 of a typical 10 year market trend. This ain’t going to continue to climb until I am 85 without some sort of pull back. For a point of reference I am on the backside of 65. combine this with the stock market slide, the virus from China and the changes in the volume of transportation of bulk items and weakening crude oil prices, I see a cloud coming. Okay so this sounds like doom and gloom, I get it, and there is a good discussion to be had, but I am worried about all this and the debt levels of individuals, business and the US Government. I see this year 2020, as a very interesting year and oh yea, how about an election where the Hatfield’s and McCoy’s exist. Whew, makes my head spin. Thanks Ryan always great commentary and good thinkin stuff.
Thank you Brad. We sure do have some interesting dynamics lately. I’ve been having quite a few coronavirus conversations this week also. Ultimately if rates keep falling it’s only going to keep adding a steroid into the market.
Regarding the virus itself, here’s some of my thoughts regarding an effect on the real estate market. Fear is a real thing and for real estate it probably comes down to health in local markets. If it became a severe situation locally I can imagine some buyers not wanting to shop and sellers not wanting people in their homes. So the market could stall or decline. If this is a very temporary situation though and not something permanent, let’s be cautious about saying it’s going to permanently alter the market. We do have to watch confidence levels though. The market doesn’t like uncertainty and if people lose confidence that’s a big deal. Yet meanwhile rates keep going down. Can they offset the negatives regarding the stock market, economy, and health though? We shall see.
I am right in the middle of my second 1031 exchange, moving from older properties to newer properties and moving from CA to other states. It has been fascinating learning how other states operate. For example, the property taxes in AZ are much better. Nevada has been more friendly as well. Ohio is not friendly to investors at all, but prices are incredibly low. I am still trying to figure out Arkansas and Florida.
Thanks Ray. Congrats on your second exchange. That’s great. I’m glad to hear you’re finding out the scoop on taxes in other places too. On a side note I wish I had access to data to show exactly how much money is leaving California right now (and how that compares with the past few decades also). I know quite a few investors eyeing other states and deploying their portfolio elsewhere.
Ryan, I am honestly impressed that the agents note that the sale was a 1031. I don’t believe our information in the Birmingham market is as detailed but I am going to check it out. This highlights the importance of detailed MLS data. If a specific feature of an MLS sale is not noted it makes it impossible to measure the impact of that feature. For all the real estate agents who read this blog please include as much detailed information as possible in your listings so that it is easier to measure their effects.
Thanks Tom. Filling out the MLS properly makes a huge difference – especially since we can basically now export all fields to run data. In this case with exchanges it’s really not perfect as I mentioned in the post, but I believe there is enough to show a clear trend. So while not 100% accurate, we still see a solid picture. But your point is so critical. It makes a huge difference if fields are not filled out correctly. I pull some interesting data too such as multiple offers or original list price vs sales price in neighborhoods, so if it’s off, it can make the result less meaningful. Or even being sure to say cash instead of conventional adds up over time.
Great info as always Ryan. Have you looked into any of the areas just outside the midtown/downtown area? Curious on the stats for Med Center area, West Sac, etc. I would still assume these are stronger than say Carmichael or Fair Oaks but wondering if you have any insight on those popular areas that lay just outside of the downtown core.
Hi Richard. I’m not entirely sure what you mean by the question. Are they stronger? In what regard? I will say anything touching Midtown right now is tending to catch fire. Granted, a couple classic areas like East Sac and Land Park haven’t needed fire, but North Oak Park, Broadway Corridor, and West Sac have all benefited from what has been happening in Midtown for the past couple of decades. I don’t have any intense stats right now, but if you’re looking for something in particular let me know. That may stoke a fire under me or give me ideas for the future. I did actually pull some recent Oak Park stats. I might do a blog post about that, but you can email me if you wish to have the stats too.