A Real Case: Doubled in Value, Losing Money to Hold
The era of making money on appreciation is over. Over the next twenty years, U.S. real estate investing returns to the textbook rule: you do not bet on prices, you build cash flow.
Freddie Mac data puts the U.S. housing shortfall at about 3.7 million units. America does not have too many homes — it has far too few. But high rates layered on high prices have pushed many people who should have become owners into renting instead. The median age of a U.S. first-time buyer was 30 fifteen years ago; today it is 40. That extra decade between 30 and 40 is the largest source of new rental demand in the market. This is exactly why Blackstone, KKR and Brookfield, with hundreds of billions under management, have been buying cash-flowing apartment and rental housing assets in bulk.
A friend came to me recently. He owns two homes in Bellevue, each worth about $1.5 million — the classic pristine trophy property. Over the past five years their value doubled, which sounds like a great outcome. But each rents for only $4,000 a month, a 2% cap rate. The annual net return from rent is just 2% of the value.
Worse, he took a floating-rate loan in 2022, and this year the rate has risen to 6%.
I will use this case to break the problem into three layers: opportunity cost, long-term holding cost, and whether to do a 1031 exchange or pay the tax and walk.
Opportunity Cost: Borrowing at 6% to Hold a 2% Asset
When your loan rate is 6%, you are borrowing at 6% to hold an asset yielding 2%. That is a clear mismatch. You cannot pay 6% while collecting 2% and reassure yourself that rents will eventually catch up.
If an asset's financing cost is meaningfully above its cash yield with no visible path to repair, it should not be held passively.
People hesitate to sell because the property made them money in the past. But the worst habit in investing is using past victories to justify future decisions. Rising before does not mean rising again; having made money does not mean it is still worth holding.
Now consider the price outlook for the Seattle Eastside. From January through July this year, the Eastside median price fell 10%. Much of that rapid decline traces to software engineers' fear of layoffs.
In the Seattle area, buyers of homes above $1.5 million are overwhelmingly high-income tech employees. The core driver of the Eastside's decade-long price surge was rapid tech growth and a continuous inflow of high earners. That force is now receding: hiring has slowed, layoffs keep coming, equity income is unstable, and many engineers are worried about their jobs. Once that sentiment reaches the housing market, homes above $1.5 million are hit first.
Three months ago I published an analysis comparing this Eastside decline to the Seattle housing collapse triggered by the 1971 Boeing crisis, and concluded the Eastside has at least another 30% to fall. With the fundamentals damaged and no sign of near-term repair, a high-price, low-rent, low-cap-rate asset is not something to hold long term.
Holding Cost: Rent Growth Cannot Outrun Maintenance
Many landlords count rent and forget cost. A $4,000 rent feels like $4,000 of monthly income. But the true cost of holding a property includes at least four items: loan interest, property tax, insurance, and maintenance.
Interest is high right now. Property taxes rise every year. Insurance is rising. And the older the house, the higher the repair bill. Roofs, furnaces, water heaters, siding, floors, kitchens, bathrooms — none of them stay intact just because you would rather not fix them.
Rents do rise, but rent growth rarely fully offsets the widening gap created by rising maintenance and holding costs. This is especially true for a $1.5 million older home, because its repair costs are priced off the size of the house and local labor rates, not off your rent. A new roof or a new furnace does not get cheaper because your cap rate is only 2%.
So the core problem with this type of property is: expensive asset, modest rent, meaningful maintenance, high interest. It looks like a high-quality asset, but from a cash-flow perspective it is a deeply inefficient one.
The Real Tax Bill on a Sale, and What 1031 Actually Buys You
Now the question most owners care about: sell and do a 1031 exchange, or pay the tax and walk away?
What many people do not realize is that selling a rental triggers not only capital gains tax but also depreciation recapture tax.
An example. Suppose the home was purchased for $700,000 and now sells for $1.5 million. On the surface that is an $800,000 gain subject to capital gains tax. But it does not end there. Suppose you depreciated $30,000 a year and rented it for ten years, for $300,000 of accumulated depreciation. That $300,000 is recaptured at a 25% rate on sale, an additional $75,000. Together, the tax bill is at least $230,000.
Most owners assume selling means a modest capital gains bill, then discover at closing that the number is far larger than expected.
With a 1031 exchange, those taxes are deferred. You sell the old property, roll the proceeds into a new investment property, and both capital gains and depreciation recapture are pushed forward. In theory, if you keep exchanging until death, your heirs receive a step-up in basis and the liability can be erased entirely.
You might ask: if I never get to touch the appreciation, what is the point? The point is cash flow.
Let me reframe it. If you sell, pay $230,000 in tax, and walk away with $600,000 in cash — what will you do with that money? If the answer is "I would invest it anyway," then you did not actually need $600,000 in cash. What you need is not the principal in hand; it is the principal producing steady cash flow.
People underestimate how much cash flow changes life. If you have $10,000 a month in positive cash flow, that is a second paycheck that requires no office, no timecard, no managing upward, and no fear of layoffs. Your principal is intact, your asset is intact, and rent keeps arriving every month. That is what makes real estate investing powerful.
When I actually evaluate a 1031 exchange, I focus on four questions.
First, is the replacement property new enough? I want no major capital expense for the next ten years. You are buying cash flow, not a repair project.
Second, what is the vacancy rate in the replacement city? Is population growing? Are jobs growing? What is the tenant quality? Many investors look only at rent and ignore tenant quality, but tenant quality determines how hard the asset is to manage.
Third, can one property be exchanged into two or even three? More expensive homes almost always have worse rent-to-price ratios. Splitting one large, inefficient asset into several smaller, efficient ones materially improves both cash flow and flexibility.
Fourth, what is the actual cap rate of the replacement property, and does it produce positive or negative cash flow? The point of a 1031 is not tax avoidance — deferral is only the mechanism. The real objective is swapping an inefficient asset for an efficient one.
Friday Harbor: A Market Where Geography Locks Supply, and What I Built There
That brings me to a project I developed and hold heavily myself: The Grove Townhouse community in Friday Harbor. There are 38 homes in the community; I purchased 24 of them, leaving only 14 for sale. Within my broader modular construction and development work, this is the product best suited to a 1031 exchange need.
Friday Harbor sits on San Juan Island, northwest of Seattle near the U.S.–Canada border, across a narrow strait from Victoria, the well-known Canadian resort city. It is one of the top three tourist destinations in Washington State, with abundant sunshine — 50% more sunlight hours than Seattle — and it is one of the best places in the world to watch orcas.
There are exactly three ways onto the island: public ferry, private boat, or seaplane. No highway, no bridge, no way to simply drive over from the mainland. That makes it not a typical suburban market but an island market where geography locks supply.
The island has only about 2,700 permanent residents but receives roughly 1.7 million visitors a year. Tourism is the economic backbone: restaurants, hotels, marinas, boat tours, whale watching, short-term rentals and retail all revolve around visitors.
Dig one layer deeper and you find locals also serving the many wealthy families who own vacation homes on the island. Friday Harbor is a private retreat for a number of America's wealthiest people. I met a luxury home builder there who was building a vacation home for the owner of a professional football team — construction cost alone exceeded $10 million, on top of $2 million for the land.
So a large share of permanent residents are servicing tourists, the wealthy, and high-net-worth households: yard work, home repair, auto and boat maintenance, remodeling, cleaning, property management, food service, marina operations. These are not low-quality tenants. They are the workforce the island's economy depends on.
Which creates the problem: those workers need housing. With no highway and no bridge, the size of the island's labor force is locked by housing supply. Without homes there is no way to attract new workers; without new workers restaurants cannot open, hotels cannot staff up, construction crews run short, repair labor runs short, and every service cost rises.
A friend of mine in construction lives in Friday Harbor. He told me half of his crew now lives on the mainland and commutes four hours a day by ferry. Workers put in six productive hours, but he pays for ten and covers $150 in ferry fare on top. Labor on the island runs extremely high — roughly 40% above Seattle city rates.
High labor cost means high construction cost. So for the past ten years the island has essentially built only luxury homes and almost nothing for the ordinary workforce. That created a closed loop: high labor cost drives high build cost, so no one builds ordinary housing; without ordinary housing, workers cannot move in; without workers, service costs rise further; and rising service costs push build costs higher still.
Under those conditions, a home listed for rent leases within a week. Island vacancy has held around 0.5% for years, compared with roughly 7% in Seattle.
It was against that severely imbalanced supply-demand backdrop that I decided last year to build housing ordinary people on the island can actually afford.
The community consists of 38 townhomes. Each is fee simple ownership — the same title structure as a detached house, not condominium ownership. The site is five minutes from downtown Friday Harbor. Every home has 2 bedrooms, 1.5 bathrooms, 1,100 square feet, and one parking space.
Build quality is deliberately solid: top-grade metal roofing, eight-foot ceilings, upgraded interior finishes including stone countertops and mini-split air conditioning, and soft-close hinges on cabinets and drawers.
Why specify materials that well? Because I am holding 24 of these long term. This is not a build-and-exit project for me; it is an asset I own, lease and manage myself. So from day one the design logic was not "how cheap can this be" but "how little maintenance will this need over the next five to ten years."
These homes sell for $500,000 and rent for $2,600. The first 12 homes I completed were fully leased within a week of listing. Tenant quality is strong: credit scores above 700, household income above $100,000, mostly steady blue-collar workers — in my view the ideal tenant profile — and all of them have indicated they want to stay at least three years.
Because I hold 24 of the homes myself, HOA dues are unusually low at $30 a month. The homes are brand new with good materials, so major repair expense over the next five years should be minimal. At 30% down, these properties produce positive cash flow.
Back to My Friend's Math
He owns two $1.5 million homes on the Seattle Eastside renting for $4,000 a month each. If he sells one $1.5 million property and exchanges into three Friday Harbor homes, monthly rent goes from $4,000 to $7,800. And because the Friday Harbor homes are new, maintenance drops by roughly $500 a month. Net monthly cash flow improves by about $4,300.
More importantly, he converts one heavy $1.5 million asset into three lighter assets of roughly $500,000 each, which makes everything downstream more flexible. If he needs cash later he can sell one, rather than being forced to sell the entire $1.5 million position. If he wants to hold, all three keep producing rent. If he wants to allocate to his children, he can do it one property at a time.
That is my core judgment on the future of real estate investing: stop worshipping appreciation, stop worshipping expensive trophy homes, and stop white-knuckling an asset with a 2% cap rate and a 6% cost of debt. The assets worth holding will be the ones with tight supply and demand, stable tenant demand, newer construction, low maintenance, and cash flow that actually shows up.
Friday Harbor is not for everyone. It suits three groups: owners of investment property that has appreciated sharply but produces poor cash flow and who are weighing a 1031 exchange; investors who no longer want older homes or repair headaches and prefer a newer, simpler, steadier cash-flowing asset; and those who understand the long-term trajectory of U.S. rental demand and want early exposure to a market where geography permanently constrains supply.
If your asset has gone from making you money to dragging down your cash flow, it is genuinely time to ask whether you should reposition.
