Determine the cap rate for your investment
If you are switching out investment property in a 1031 exchange for the first time, you might choose a property based on emotions, or you might just go with the first property you find because of time limit stress. At Diversified Investment Strategies, we can help you through this process, so that you choose the property that is right for you and the type of exchange that is best for your future.
There are a lot of factors to take into consideration. Here are a few you should work through with a professional before purchasing an investment property:
- Determine the annual rent you can expect to receive from a residential rental property. If the property is already rented out, checking this information is simple. If not, do some research on similar properties in the area. At DIS, we can help you out with that!
- Estimate the annual expenses of owning the property. This includes taking many factors into account, such as projected vacancy costs, real estate taxes, utilities that you’ll be paying, property and liability insurance and potential repair costs.
- Calculate your annual net income. This is the annual rent minus the annual expenses.
- Calculate the property’s capitalization rate, or “cap rate.” This is the annual return you can expect for your investment. Divide the net income by the cost of the property. At DIS, we can help you with this as well!
The higher the cap rate, the better the annual return on your investment will be. However, cap rates can vary by how the net income is derived, meaning which costs are used or not used, so we must make sure to evaluate the costs carefully to get a true cap rate. You should also consider worst-case scenarios and what the cap rate will be if your investment property is vacant. Will you still be able to afford it?
Check out this NOLO article for more information on cap rates and choosing investment property. The best decision you can make is to work with professionals who are familiar with all of this!
If you are trying to defer federal capital gains taxes with a 1031 exchange, this is our specialty at DIS. We understand that it can seem stressful to find a Qualified Intermediary before selling your current property, and then to have to find potential replacement property within 45 days of selling and then close on property within 180 days of selling.
Still, you don’t want to impulsively exchange property that you will later regret! At DIS, we have a comprehensive team of tax advisors, attorneys, real estate brokers, FINRA registered representatives and registered investment advisors to help you with the entire 1031 exchange process! We can help you determine the appropriate investment strategy, such as a DST, UPREIT and other options.
Here are some of the benefits of a 1031 exchange:
- More to Invest – When federal income taxes are deferred, you have greater leverage and more equity available for reinvestments.
- Less Management – Options such as a DST, 721 UPREIT or Triple Net NNN offer you passive ownership property possibilities, with little to no day-to-day management responsibilities.
- Diversification – One property can be exchanged into many. For example, your property can be exchanged for condos, single-family homes, multi-family homes, Triple Net NNN investments, commercial real estate and more!
- Greater Earning Potential – Since more of the capital is reinvested than would be if taxes were paid, there is more opportunity for greater earning potential.
- Compounding Effect – Deferred taxes can continually create a positive compounding effect by reinvesting on each exchange. The deferred tax liability can be forgiven upon death, giving your heirs a stepped up basis on inherited property.
Contact us at Diversified Investment Strategies and we’ll help you choose the 1031 exchange that is right for you!
Bryan Hakola
Diversified Investment Strategies
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