How exactly does one make a profit when flipping a commercial real estate building?
Hi everyone,

I recently came across some of the commercial real estate mogul youtube channels (Khoshbin, Mallah, Gillean, Etc) and I understand the whole process of flipping the building with value add, increasing occupancy, etc. 

The part I still have a hard time grasping is how you can refinance and take out a loan on the profit? So let's say you buy a property for 1 million and put in 500k and sell it for 3 million, that 1.5 million in profit would obviously be subject to tax and you would utilize the 1031 exchange to avoid that. 

But if you keep putting that profit from the 1031 into a bigger deal, how would you touch that hefty profit that you make? I heard you can refinance but don't you have to pay that back so you technically can't spend it? That's what I have a hard time understanding. 

Also, does the cash flow from tenants make the majority of the money on a deal or is it mostly coming from the flip part?

Sorry for the newbie questions, responses much appreciated!
[{"id": "gxo3mob", "text": "Are you familiar with how borrowing/debt (leverage) works to increase your returns?\n\nThe point of a 1031 is to continue to invest into your business and continue to grow your business and networth. If you want to pull your money out and swim in the proceeds like Scrooge MccDuck, then a 1031 isn't for you.  \n\n\nAs for whether you're making money from appreciation or cashflow (or both!) it depends on your market and how you're managing the property.", "replies": [{"id": "gxo5az3", "text": "Yes, I do understand utilizing debt to magnify your returns. I understand that the 1031 is an incredibly powerful tool to avoid paying capital gains tax and grow much quicker in the industry.   \n\n\nSo technically you would have to pay tax to realize the value add gains?", "replies": [{"id": "gxo5vrp", "text": "The 1031 avoids capital gains at sale.  A refinancing is basically a way to pull out realized value without a transaction. Both \u201ccapital events\u201d result in cash to the investor but the debt is not taxable.  One is not better than another it just depends on the specifics of the deal and the desires of the investors at that point in time.", "replies": [{"id": "gxo9v5b", "text": "What would an investor use the refi money for? To buy another deal or fund living expenses? And it has to be paid back eventually right?", "replies": [{"id": "gxobk1w", "text": "Anything they want. Typically for other deals. Cash now is better than waiting for cash later. You also assume that the sale of the property will still be able to cover the existing debt. That being said if you get it wrong and valuation drops that could be a liquidity issue.", "replies": [{"id": "gxoh2dr", "text": "Thank you for clarifying!", "replies": [], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}, {"id": "gxo5z66", "text": "To cash out? I thought about it, but, yes, I suppose you would have to. If you held the property for at least a year, it'd be taxed at the capital gain's rate which is going to be better than a corporate or individual tax rate.\n\nAre you looking to cash out to retire?", "replies": [{"id": "gxo9l5i", "text": "Ahh, I think I'm starting to understand that the cash flow is what gives you the real money from the property and the 1031 is what allows you to scale up to bigger deals that cashflow more?", "replies": [{"id": "gxobjld", "text": "For most markets, yeah, that's the secret.\n\nAnd don't forget to take into account tax deductions and credits. Cashflow might look somewhat similar or even better to fully own a building rather than finance it through loans, but interest expense and depreciation go a long way to boosting your bottom line.", "replies": [{"id": "gxoh00y", "text": "Gotcha, thanks! \ud83d\ude4f", "replies": [], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "gxo5mc7", "text": "&gt;utilize the 1031 exchange to avoid that\n\n\\*defer the CG Taxes, not avoid them.  \n\n\n&gt; heard you can refinance ...That's what I have a hard time understanding.\n\nYou have $750k tied up in the building ($250k down payment + $500 renovation costs). You refi at the $3MM, leaving in 25% equity, that's a $2.25MM mortgage. Here's where that money goes:  \n$750k: Pay off initial mortgage  \n$250K: Recoup down payment  \n$500k: Recoup renovation costs  \n$750k: \"Profit\" after refi  \nSo that leaves you with $1.5MM for your next project. That's how you continue to \"recycle\" your capital. Or you can take the \"profit\" and do whatever you want with it.\n\nYou can 1031 in a similar way. After selling the 1st property you do another deal, but bigger. You buy a $3MM property, put in $750k and raise the value to $5MM. You have $1.5MM in the deal and have increased your equity by $1.25MM.  \n\n\n&gt;does the cash flow from tenants make the majority of the money?\n\nThis all depends on the deal. In a very low Cap Rate area cash flow may be limited, but appreciation significant. Remember with a commercial property, the value is based on the profitability of the building. I like a deal that would ultimately have cash flow of at least 12% and 3%/year appreciation, which equates to another 12% return. When you combine that with depreciation and mortgage pay down, your total return can hit 30%+ pretty easily...well, it's a lot of work, but you get my point.", "replies": [{"id": "gxoa2kw", "text": "Thank you so much for this reply, that really helps me to better understand how 1031 and refinancing come into play, thanks!", "replies": [], "depth": 2}, {"id": "gxocr9v", "text": "Cash flow of 12% - on total cost or on your cash?", "replies": [{"id": "gxoz3y3", "text": "Cash", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "gxs27ro", "text": "Value Add", "replies": [], "depth": 1}, {"id": "gxsicbv", "text": "The proceeds from a refinancing are not taxed because taking a loan is not taxable... so that cash out is not taxable income... its just a loan. If I give you a loan, gov does not tax that as income to you. \n\nYou then use the profits from your forever and always increasing cash flow of your investment to amortize down your loan with after tax net income. EG you pay back the refi cash-out dollars you spent wildly on lambos with taxed NOI from your sweet property cash flow.. therefor you dont totally feel the pain of the tax man shutting down the party. Something like that... you never do not pay the MAN but you can defer it... \n\nalso, make sure that cash flow doesn't go anyway post lambo splurg. extremely bad news.", "replies": [{"id": "gxsjguv", "text": "That helped a lot thanks !!", "replies": [], "depth": 2}], "depth": 1}]