28May

If you own an investment condo in Downtown San Diego, you’ve likely been wondering about your options. These are some of the most common questions I receive as an agent that specializes in Downtown San Diego’s market:

    1. What is my actual return on my investment?
    2. When is the right time to sell?
    3. Is this the best use for the money invested?
    4. If I sell, what kind of tax bill am I looking at?

I am going to go over some of these answers and give you my opinion as to whether or not holding a condo for purely investment purposes makes sense in Downtown San Diego. I’ll also be going over a 1031 Exchange and why we continue to see an increase in the number of sellers taking advantage of this tax deferred exchange.

What is my actual return on my investment property?

As an investor, we often look at the return on investment as the money we initially invested. While that might seem logical, it doesn’t represent your actual return on investment for a property you’ve owned for an extended period of time because your equity has likely increased dramatically. This changes the return on the money you have tied up in the property, which is what your true opportunity cost is.

Throughout the article, I am going to use a listing I currently have at 550 Front Street #705. The property was purchased from the developer for $595,000 and is owned free and clear. The property is now worth about $1,150,000 and after closing costs/commissions, the seller’s equity is approximately $1,086,750. The property rents out for approximately $5,000 a month, but after HOAs, property taxes, and insurance, the net would be about $2,372 a month or $28,469 annually. The return on equity in this situation is only 2.62%, which is low even on a conservative investment. This assumes there are no repairs, no management fees, and no vacancies. If we factor in any of these three items, that return goes down dramatically.

Prepared For: Example
Address: 550 Front Street #705
Estimated Value $1,150,000
Estimated Closing Costs: $63,250
Loan Amount: $0
Equity $1,086,750
Property Taxes: $816.58
HOA Dues (monthly): $1,711
Est. Insurance (monthly): $100
Total Monthly Expenses: $2,627.58
Estimated Monthly Rent: $5,000.00
Net Monthly: $2,372.42
Net Annual $28,469.02
Return on Investment: 2.62%

If we were to calculate the owner’s return on investment based off of their purchase price of $595,000, the numbers improve to a 5.1% but that is no longer their actual return. While that still isn’t great, it makes more sense if you factor in potential appreciation, but that isn’t a sure thing. The property has appreciated by an average of 4.3% a year based on what they purchased it for and what they would currently net.

I can do a breakdown for any investment property you want analyzed. Just email me at ryan@livingthesandiegolife.com or click the button and fill out the link below.

Investment Property Analysis

When is the right time to sell?

This is a more difficult question to answer and mainly based on the owner’s situation. That being said, there are times that make the most logical sense. I think right now is one of those times for people who own investment condos in Downtown San Diego.

Downtown San Diego is not an area that is really heavily cash flowing for investors, given rents have not kept up with values and increases in HOA dues. When I calculate the return on equity for most clients in Downtown San Diego, that number is often under 3.5%. But what about appreciation?

Since 2020, we have seen values increase at rates that are much higher than average, but over the last 18 months Downtown San Diego has slowed down. Inventory is now rising fairly quickly, which could signal a pull back in values. To be clear, I am not suggesting the market is crashing or anything of the sorts, I am, however, acknowledging that the market has weakened. In my eyes, this might be the right time to pull money out of Downtown San Diego investment property and put it to work elsewhere. I am not someone who likes the idea of owning a property strictly for appreciation unless I am using it as a residence.

As a side note, I actually like the current outlook for Downtown San Diego over the next 5+ years. With Horton and RaDD nearing completion, this could bring a wave of new high paying jobs, specifically in biotech, to Downtown San Diego. High paying jobs would likely lead to more demand, which is great for values. That being said, they haven’t announced any tenants and it is no secret that currently there is extremely low demand for office space.

If I sell, what kind of tax bill am I looking at?

If you sell an investment property for a gain, there will likely be tax implications. Similar to other investments, such as stock, it depends on how long you’ve owned the investment. Since real estate is typically held longer, we most commonly work with property someone has owned for at least 1 year. In this situation, any gains after expenses would be taxed as long term capital gains (see chart for reference below).

There is, however, a way to do a tax free exchange via a 1031 Exchange. The basic idea behind a 1031 Exchange is that it enables you to reinvest the money and defer your tax liabilities. There are rules behind doing a 1031 exchange, but here are several basic principals that are important for our discussion. (IRS Fact Sheet for Reference)

  1. In order to do a 1031 Exchange, it must be of “like-kind”. If you are selling real estate, whatever you exchange into must also be real estate. This does not mean if you sell a condo you need to buy a condo. This means if you sell a condo, you can exchange into a house, multi-family, commercial, etc. It just needs to be real property. This might sound straight forward, but 1031 Exchanges are not limited to real estate.  We aren’t discussing the other types of investments that qualify here.
  2. It must be a step up in value to do a full exchange of taxable funds. If you sell a property for $1,000,000, you will need to buy for $1,000,000+. This includes relief of debt (i.e. paying off a mortgage). It is not limited to just the equity, but rather the value of the entire asset.
  3. There are strict timelines with 1031 Exchanges. In general, once you sell the property you are exchanging you have 45 days to identify a replacement and 180 days to close on the replacement property. This gets a bit complicated because you have the ability to identify multiple properties within the timeline. You are also able to exchange into and out of multiple properties. For example, you can sell one property and buy two to satisfy the 1031 exchange. You can also sell two properties and buy one more expensive one.

This is a great way to put your money to better use without getting stuck with a large tax bill. Keep in mind, it is a tax-deferred exchange and it does not cancel out the tax liabilities.

Long-term Capital Gains Tax Rate for 2024 (Source – IRS)

Capital Gains Rate Single Taxable Income Married Filing Separately Head of Household Maried Filing Jointly
0% up to $47,025 up to $47,025 Up to $63,000 Up to $94,050
15% $47,026 to $518,900 $47,026 to $291,850 $63,001 to $551,350 $94,051 to $583,750
20% Over $518,900 Over $291,850 Over $551,350 Over $583,750

Is this the best use for the money invested?

I really like Downtown San Diego, but I believe there are other areas that make more sense from a rental property stand point. It is really difficult to make sense of the numbers when you look at the return on equity in downtown’s market given rising HOA dues and insurance costs. It is almost strictly an appreciation play, but as mentioned above, I would much rather invest in something that is great for both cash flow and potential long term appreciation.

As a rental property owner myself, I have my eye on 2-4 unit properties. Given San Diego’s growth in rental rates, combined with the potential to build Additional Dwelling Units (ADUs) on 2-4 unit property, there are so many great opportunities to add value in the long run. This not only increases cash flow, but property value. Keep in mind, the value of multifamily property  is typically derived from the amount of money the property is generating. San Diego continues to remain one of the most desirable locations in the nation. I feel that demand, especially in central San Diego, making multi family very appealing down the road.

If you want to discuss your current investment property and discuss future options, feel free to give me a call at (619) 228-6790 or email me at Ryan@LivingTheSanDiegoLife.com.

Investment Property Analysis

And Always Remember, It Matters Who You Work With!

Give me a call today at (619) 228-6790 or email me at Ryan@livingthesandiegolife.com for more information or to schedule a tour of the neighborhood!