Hello, my friends. Welcome to another episode of Ask Marco. Well, I am back in the office. I’ve been doing a lot of traveling this year and quite a bit, actually in the last couple of months, these live events are wrapping up all over the place. Mastermind groups, real estate related events and whatnot. So I’m actually doing a lot more traveling and I’ve been kind of buried over the last couple of weeks. So I apologize for not being available to put out some new episodes here, but I’m getting back on track. So just bear with me be patient. I will certainly get some new episodes put out and I’ve got some new guests queued up here for the weeks to come.
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Anyway for today, I am focusing on one specific question that I got from Lee. And this is interesting. I’m going to title this episode, “Help my wife and I disagree about what to do with our California property. ”
Now it doesn’t have to be a California property to apply to your situation. This could literally be anywhere in the country. It’s the concept and the principles in the question at hand, that is what I want to focus on here. So let me start reading Lee’s email to me and I’ll break it all down for you. So hopefully you’ll walk away with some ideas, principles, and a way to think about how to make the best use of your situation, especially when you are sitting on equity. So Lee writes and he says, hi, I am a new subscriber to your podcast, and I love all the info and education. You’re welcome. I walk every morning with my dog for an hour while listening to your podcast, I guess you are binge listening and going back to episode one, I have to imagine. I have a question about where to go from here and how to get started in real estate investing.
I currently live in Simi valley, California, but I lost my business of 36 years due to the shutdown. Very sorry to hear that I’m using this opportunity to take on a new career in Arizona, where we own vacation property. All right. So obviously you have a plan moving forward here, as far as where you want to live and what you might want to do, and very sorry to hear about your business shut down. So Lee goes on to say, my question is about the California home. We pay $265,000 for it. 25 years ago. It is now worth about $1 million plus. My wife and I disagree about what to do with the property. I want to sell, pay off our vacation home and start buying multiple investment properties. In other states. My wife wants to keep it and rent it out for about $4,100 per month for a couple of years before we sell it, I can give you more details, but I want to keep it simple in consideration of your time. I would appreciate any advice you could offer. Thanks in advance.
Well, Lee, thanks for the question. It’s a good question. First of all, for those who don’t know where Simi valley is located, it is north of Santa Monica, California, which is Northwest of downtown Los Angeles. So it’s probably a couple of hour drive from there. The semi valley market that Metro area has been hot, much like most parts of the country. And so I bring this up because it’s a variable, an element or a fact that you need to consider making your decision. So when you look at the metropolitan statistical area for Simi valley, which is made up of Oxnard and Thousand Oaks, we’ve seen over the last probably seven years, very strong appreciation, especially in the years of 2012 to 2014. A lot of it was double digit rates of appreciation, but it’s been coming down ever since.
And so the inflation adjusted annual home price appreciation over the last probably three years has probably averaged around three to 4% in some areas more so, but the trend and that’s what I want to focus on has been down. And that just means that the markets are becoming less affordable and there is a cooling off, even though demand continues to be strong and supply is an ongoing challenge. And it seems to be tight. The point is, is that on an inflation adjusted annual home appreciation basis going forward? You’re probably, and I’m just looking into the future here into my crystal ball, but it’s probably going to be between, I’d say 1 and 5% on average. And again, I’m talking about a large area, so it’s obviously going to be areas and neighborhoods specific. So with that in mind, the other things to consider is that the median home costs or housing costs there is very expensive.
So the affordability is low. Cashflow potential is extremely low and the rent growth on the flip side of this is been very strong. In fact, it’s in the, what I call the upper 90% or the top 10%, if you will nationwide in terms of rent growth. So rent growth has been extremely strong in many parts of Southern California. Now, with that in mind, you know, we want to consider a few things, first of all, from a capital gains perspective, and I’m not going to get into a tax conversation here, but you have to remember that if this is currently your principal residence, it sounds like you’ve moved. But if this is your principal residence between you and your wife, you can have up to a $500,000 capital gains exemptions, $250,000 per person. But if you filed jointly on your return, that can be up to $500,000 check with your tax advisor.
You know, as far as how that’s going to be handled beyond that, if you’ve moved and you are already claiming this as a rental, it is a rental, then you can sell it. If you choose to do that, if that’s the strategy here and do a 1031 exchange where you can move your gains or your equity tax deferred. And I’ll get into that a little bit more here in a minute, the question you need to ask, and this is what I think you and your wife are maybe, um, debating and maybe not seeing eye to eye on is what is the highest and best use. You always have to think about things in those terms. And that’s a phrase or a concept that I believe came out of the real estate industry is what is the highest and best use. Normally we talk about land.
What is the highest and best use of a piece of land? Is it a parking lot? Is it a house? Is it a retail strip mall? Is it an apartment building? What’s the highest and best use of that property, that real estate. And so you need to think about this in terms of your equity, what is the highest and best use of the equity in that property? Now, given the numbers you shared with me here, one of the things I look at as a litmus test right off the bat surface level is the rent to value ratio. And in this particular case, I’m just going to call it 0.4%. It’s going to be very close. You’re estimating a million dollars plus rents for 4,100 a month. You do the math divide that 4,100 per month into a million dollars. You get 0.4% as a rent-to-value ratio.
Ideally, I’d like to see that above 0.7% ahh 0.8, if you can get it in the olden days, however long, that was, it was not too hard to get a 1% RV ratio rent to value or even rent to price ratio that is kind of a sweet spot or the bulls-eye of a target. If you will. That is very much market-specific area-specific and to a very large degree neighborhood-specific because you’re not going to see those numbers in A-class neighborhoods. You’re more likely to see them in B minus type neighborhoods, certainly in C class neighborhoods. And we won’t talk about anything, you know, lower than that. So the 0.4% RV ratio is just telling me that if you own this free and clear, there’s no mortgage or a low mortgage, you’re probably going to cash flow. And that cash flow can be a couple thousand dollars a month, which is not all that bad.
It just depends on what your insurances and your property taxes, but even if it was like, let’s just say 75% of that $3,000 a month, well, that’s not too bad. However, you’ve got to look at it, not from a cash flow perspective in dollar terms, but what is your return as a percentage? And you’re looking at as, what you could be receiving if you had invested elsewhere using the equity you have in that property. So you don’t, you really can’t look at a cash on cash return here because you don’t have cash in it. At this point in time, you’re just measuring it based on how much equity you have. But if you took that and invested it elsewhere, now you can start measuring a cash on cash return and compare both your cash flow in dollar terms, as well as your return on investment or your cash on cash return.
So let me break this down a little bit. Hopefully, I’m not making this confusing, but let’s make it clear. The RV ratio you have of 0.4% just tells me that you are achieving a certain rate of return, even though may not be realized here, but you can. And I know this, you can achieve a 0.7 or 0.8% return on the RV ratio elsewhere. So what that means is this, you have this house, you have equity in it quite a bit. You can lease it for $4,100 a month. You’ll get anywhere from two to $3,000 a month, net cash flow from it. And that’s all well and fine. But when you take that $3,000 a month over the course of a year, divide that into the value of the property or the equity that you have. You’re going to see it’s a relatively small number. And that’s what really this RV ratio rent to value ratio is showing you.
But what if you were to sell the house, whether through a 1031 exchange, or maybe refinance it and pull equity out, take that equity, and let’s just call it a million dollars and turn that into down payments down payment chunks that you apply towards the acquisition of new properties in other markets, maybe geographically diversified across two or three different markets. And you built a portfolio, a large portfolio of properties that are now generating passive income, positive cash flow each month. How does that compare? Well, I just did a quick example here with my calculator and I said, okay, well, let’s just call the down payment 50,000. It doesn’t have to be that it could be 30,000. It could be 60,000. I would think that it would be in the range of 30 to 50, just depending on the market and price points. But at 50,000, we’re certainly talking about acquiring properties with 30% down, which is more than maybe you need to, but again, I’m being conservative.
So that’s 20 doors, whether that’s 20 properties or 10 duplexes or combination of single-family homes, duplexes, and fourplexes, let’s call it 20 doors, 20 doors at $50,000 down payment. Each is that million dollars that we’re talking about here of equity that you have in California. And let’s just assume that they’re generating on average $300 a month, net cash flow. This is, you know, true net after all expenses, et cetera. Now you’ve got 20 doors generating approximately $300 a month that’s today that can go up in the future. That’s $6,000 a month. And I think that is somewhat conservative. So that’s $6,000 a month is in my opinion, better than the two to $3,000 a month. You’re getting right now with this California property, take that and combine it with what I believe to be a significant slowdown over the next five years in terms of appreciation, that’s going on in some of these markets, like the market you’re in here in California, and you’re not going to have that same type of return unrealized return in appreciation going forward.
I don’t believe so. And I don’t think many people think that’s going to happen either. So you really can’t bank on price growth through appreciation. At the same time, you’ve got this cash flow that could be better in almost twice as good as what you’re getting here by repositioning that equity into a larger portfolio elsewhere, the financing is available to do that. So if you’re wondering, well, I can only get another 10 properties or a maximum of 10 conventional loans, maybe 20 between you and your spouse. Well, that’s true if you’re getting conventional financing, but there are other financing options such as the portfolio loans that we can help you with through Norada Real Estate Funding or through other non-QM lenders. So the financing is available out there. 30% down is not unreasonable, even do 25%, if not less. So you can certainly grow a large portfolio relatively quickly.
I would estimate that your cash flow is going to be at least double what you have going on here with the one property in California. So you can increase that you can gain a larger portfolio spread across two or three different markets. You have that geographic diversification. You can pick markets that are experiencing better growth, stronger growth, and have greater upside growth potential. Meaning the appreciation potential in these other markets are going to be stronger because of the fundamentals that are there, the supply-demand dynamics, the population growth, et cetera. So you can position yourself where you can take advantage of continued growth. So that’s the way I look at it. I look at what’s the highest and best use. What is my RV ratio on that property? How much dormant or dead equity do I have in there? I just call it dormant. What can I do with it?
In other words, what are the opportunities that are out there? And there are many, even though inventory is tight and you know, certainly our team can help you with that. Just talk to one of our investment counselors here, and we can show you the various market options and the types of inventory and properties and cash flows are the numbers that you can get from those. So this is what you need to think about, and I think that’s the conversation you should have with your spouse. And if that makes sense, then start, you know, doing a little more research and put your thinking cap on and see what opportunities and options are available to you. But I will say this I’ll conclude with this. If it were me, I would probably sell that property. And I don’t know what your situation is, but I would probably do a 1031 exchange take that equity, and build a portfolio of 15, 20, 25 different doors in two, maybe three different markets and focus on picking a balance of cash flow.
So that maximizes my cash on cash return. But at the same time, positioning myself in markets that I know or expect to see strong growth over the next two, three, maybe five years. And we can certainly talk to you about that. I’m not going to get into the markets here on this episode, but that’s what I would likely do if this were my situation, because I just don’t think that these Southern California markets are going to have the same price growth that I will see in other markets over the next two to five years, or even next 5 to 10. But that’s way out into the future. It’s kind of hard to predict that. All right, well, Lee long answer to your question, but I hope that was helpful to you as well as some of our other listeners. Appreciate the question. If anyone else has a question about real estate investing or finance, by all means, shoot it over to me. Just go to passiverealestateinvesting.com, and just click on the Ask Marco button. I am happy to answer your questions, whether through email or on the show, remember to subscribe to the show. If you haven’t done so already share the show with other friends and family, other like-minded people, and that is it for today. Thank you for listening. I will see you all on our next episode.
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