Loans enable the maximization of real estate investment, never more than in the case of a 1031 Exchange, in which no capital gains taxes are paid on the relinquished property when sold. Here, we will discuss three ways that a loan can accelerate investment returns:
- Short-Term: Identify more valuable properties to buy.
- Middle-term: Acquire a property that generates more profit year-to-year.
- Long-term: Generate more equity for future exchanges.
Short-Term: Identify More Valuable Properties to Buy
When identifying properties for a 1031 Exchange, including a loan option enables you to think bigger when identifying potential replacement properties. Instead of limiting your options to what you can get out of a direct exchange, you extend the value of the property you could acquire to that for which your exchange funds can be used as a down payment (potentially 5x or more the proceeds from the sale of the relinquished property).
Middle-Term: More Profitable Yield Year-to-Year
Once you transition into a bigger, more profitable property through a mortgage, you can command more rent from this property than from one of lesser value. This requires the property have revenue-earning potential (or can at least be created through an improvement exchange) greater than that of the initial property.
However, when exchanging a property, it is important to remember that the 35% capital gains tax is not subtracted from the proceeds, which supplies the exchanger with the full funds to use as capital for a property with higher rent yield.
Long-Term: More Equity for Future Exchanges
Whether the higher-earning replacement property revenue goes toward the principal on the loan, reinvested in the property, or taken as profit is irrelevant. The point is that however it is spent, the value of the portfolio grows both in (1) the equity gained by paying off the principal, as well as (2) the equity gained through land and structure appreciation.
Moreover, if you desire to exchange out of the replacement property into a larger replacement property layer, you could use the property’s success as precedent for a higher loan and therefore an even larger, higher-yielding property. This only increases the value of the portfolio more in the same way.
Conclusion
When investors begin to realize the financial advantages of pairing the 1031 Exchange with a loan, they are equipped to transition their portfolio from under-performing, high-maintenance properties to holdings that better suit their current budget and produce a much higher overall yield in the short-, middle-, and long-term. Schedule a consultation with one of our loan experts to build a profitable loan strategy for your 1031 Exchange.
