A Millennial’s Guide to Building Wealth With a 1031 Exchange

 

Millennials could be the next wave of real estate investment property owners. According to a recent report from Harris Interactive, 55 percent of millennials said they were interested in real estate investing.¹ As America’s largest age group, these aspiring investors recognize the potential wealth-building benefits of owning real estate.

Whether investing through online platforms, crowdfunding marketplaces, or directly in rental property, millennials have emerged as an opportunistic, well-informed, and eager class of investors who recognize the valuable role investment real estate can play in a well-diversified portfolio.

Suppose you are in the 26-41 age group and considering a commercial real estate investment (or you have already invested). In that case, you will want to become familiar with a provision in the U.S. Tax Code called a 1031 exchange. This strategy, which investors have used for over one hundred years, allows you to defer capital gains and depreciation recapture taxes when you sell your investment property. That means more principal being invested into new real estate, allowing you to grow your foundation and have a larger amount of monies to obtain potential income from.

The 1031 exchange has been a valuable wealth-building tool available to investment property owners for many years. It enables you to put the entire proceeds of a property sale to work when investing in a new property. There is no limit to how many 1031 exchange you can do either, allowing you to defer taxes for years, even decades, and possibly indefinitely.

Exchange Rules

There are many moving parts to a 1031 exchange, and the rules that govern an exchange must be strictly followed. For example, there are timelines that need to be met. From the day you close on the property you are selling (called the “relinquished property”), you have 45 calendar days to identify the new properties you intend to purchase (called the “replacement property.”) The timeline allows for a subsequent 135 days amounting to a full 180 days from sale to close on your replacement property, but you should know these periods not only run concurrently but come up quite fast.

In addition, you must have a facilitator, or Qualified Intermediary (QI), to complete your 1031 exchange. The QI is responsible for holding the proceeds from the sale of your relinquished property in an escrow account to ensure that you never have receipt of the sale proceeds. It is also wise to have your attorney and tax consultant as part of your team, to ensure all things run smoothly.

Definition of a “Like-Kind” Property

In addition to the rules above, the IRS states that your replacement property must be “like-kind” to the property you are relinquishing. However, virtually any investment property is considered “like kind” to any other investment property under IRS rules. For example, a rental home, industrial property, farmland, strip mall, or apartment building would all be considered “like-kind” to one another, even options that are considered passive investments to you.

1031 Exchange in Action

To give you a better idea of how a 1031 exchange works and how it may apply to your situation, let’s look at an example. Assume you are planning to get married, and you and your partner both own starter homes. You decide to rent one home for a while and enjoy the additional income it generates that is above and beyond your mortgage payment. Eventually, you get tired of the hassle of finding new tenants and dealing with property repairs. You need to decide what to do with the property.

If you purchased your home for $180,000 and it’s now worth $250,000, you might think selling it is smart; That’s a tidy profit. However, by selling, you will pay capital gains tax on the appreciated value of $70,000. At a 20% capital gains tax rate, you would owe the IRS approximately $14,000. In addition, you could be taxed for deprecation recapture, which can be as high as 25% of the depreciated portion. Don’t forget, any state taxes, local taxes, and others that may rack up your tax bill.

Say you instead, decide to enter into the 1031 exchange. So long as you meet all exchange requirements, you could defer the $14,000 capital gains tax payment and your depreciation recapture. This would allow you to put your entire sales proceeds to work and enable you to purchase a replacement property of greater value, that could possibly generate higher income as well.

Talk to a Professional

As a member of the largest demographic in the U.S., you have plenty of company that views investment real estate as an essential asset class that may help you accumulate wealth.² You also have many ways to invest and own commercial property. If you are considering an investment, or you already own investment property and are looking to upgrade, our team can help you explore your options.  

---

 

Source: A Millennial’s Guide to Building Wealth With a 1031 Exchange

https://www.creconsult.net/market-trends/a-millennials-guide-to-building-wealth-with-a-1031-exchange/

Commercial Lending Trends – June 2022

Build-to-rent single-family homes gaining popularity.

Millions of Americans, especially younger generations, are unable or unwilling to purchase their own homes. Reasons may include a lack of downpayment or poor credit, while other potential buyers are waiting for the market to soften and interest rates to go down.

Even though these people may not be ready to purchase, they still want the benefits of owning a single-family home: a yard for pets and kids, more privacy, and a sense of community. And that’s where savvy real estate investors are stepping in.

Large real estate investment firms like DR Horton, Lenner, and Invitation Homes are getting into the single-family build-to-rent business. This activity includes building single-family homes on empty lots in existing neighborhoods or, in some cases, building entire communities of rental houses with workout facilities, pools, and playgrounds.

The investment in new-build, single-family rentals seems to be picking up steam. In 2020, $3 billion was invested in this sector. Those investments rose 10-fold in 2021 to 30 billion dollars, and are anticipated to reach $50 billion in 2022. Even though build-to-rent homes currently represent only 5% of the building market, that’s nearly double its average. With vacancies of single-family rentals low, and rents rising by 13% over last year, the new-build single-family rental market looks like a pretty solid long-term investment strategy.  

Despite the work-from-home trend, office space is still in high demand.

Finally, there is good news for real estate investors with office space in their portfolios. Numerous indicators point in a more optimistic direction regarding workers returning to the office.

New office tours, a leading indicator for new leases, rose 20% from February to March of this year. While these numbers are still lower than pre-pandemic levels, they’re up nearly 10% over March 2021. In addition, CBRE Group, a leader in commercial real estate services, conducted a survey of office-based companies that was even more encouraging.

Of the 185 companies surveyed by CBRE, 36% said that a return to the office was already underway. Another 41% said they anticipate employees returning to the office by the end of 2022. These businesses expect 19% of returning workers to be in the office full-time, with another 61% working a mix of hours from home and in the office. While returning to the office looks imminent for most, many companies are revamping the office experience. Nearly 45% of companies surveyed report that, as opposed to numerous satellite offices spread around the city or state, they are moving to larger, more centralized office space. In addition, they prefer for this space to be located in or near their city’s central business district.

This demand for new office space drives rents in the right direction for investors. According to Moody’s, asking and effective rents rose by an average of 2.5% during the first quarter of 2022. This was the largest increase in rents since the beginning of the pandemic.

 

Private investors are snatching up high-value retail space.

Real estate investment trusts (REITs) and institutional investors have long been the major players in the commercial retail sector. This was especially true regarding high-value retail space acquisitions of $50 million or more. In 2021, private investors decided they’d like a larger piece of that pie.

Last year, private investors took over 45.5% of the retail market share, investing more than $6.5 billion in high-value retail space. Recent reports show that private lenders will continue to outspend institutional investors to acquire high-value retail investments.

According to Real Capital Analytics, 47 high-value retail transactions, defined as worth at least 50 million dollars, were completed in the first quarter of 2022. Private investors closed 32 of those deals, often out-bidding larger corporate investors. Of particular interest to private investors are grocery-stored-anchored shopping centers, which account for 31% of all retail purchases made by private investors. In an interview with the WSJ, Jim Michalak of Plaza advisors says, “Private investors have migrated to acquiring shopping centers because of better yields, compared with other real estate.”  

Hoping to curb inflation, Feds raise rates again.

To slow inflation, the Federal Reserve has raised its benchmark interest rates by ¾ of a percentage point. This is the largest one-time rate hike since 1994. The goal of this rate hike is to bring inflation down to 2%, without increasing unemployment above 4%.

This increase in rates is sure to affect an already softening real estate market. After the announcement, the 30-year, fixed mortgage rate climbed to 6%. Nearly double the interest rates at the beginning of the year. Real estate buyers and sellers aren’t going to be the only ones hit by this increase.

Small businesses that rely on bridge loans or a revolving line of credit to keep afloat will have some difficult decisions to make. Namely, is expanding operations right now worth the increased monthly interest payments?

There is a small silver lining concerning this rate hike: savings. Interest rate hikes mean a higher annual percentage yield (APY) on money sitting in savings accounts, certificates of deposit (CDs), and money market accounts. The Federal Reserve is set to discuss interest rates again this July. According to Powell, they expect to raise the rates again, possibly up another 75 basis points.  

Good news for industrial real estate investors – vacancies are down and rents are up.

The industrial real estate sector has remained relatively strong over the past couple of years and shows no signs of slowing. In the first quarter of 2022, industrial vacancy rates fell to 3.4%. This was the sixth quarter in a row industrial vacancy rates fell. Vacancies remain low, despite the fact that developers built over 90 million square feet of industrial floor space in the first quarter of 2022. There are another 531 million square feet of industrial space currently under construction. None of this new inventory is expected to have much of an impact on vacancy rates. Based on the high demand for new industrial space, rents keep climbing. In the first quarter of 2022 industrial rents rose 7% over the previous quarter, bringing the national average to $7.62 per square foot. Unfortunately, for some investors, port cities are skewing this national average.

Industrial rents in port cities have been rising, year after year, at a rate of more than 23% annually. While rents in non-port cities have still been strong, their growth rates have topped off at only 16% annually. Even with interest rates and the cost of construction rising, investors are still seeing high ROIs in the industrial real estate sector.

 

Source: Commercial Lending Trends – June 2022

https://www.creconsult.net/market-trends/commercial-lending-trends-june-2022/

Bidding wars have overheated the market for homebuyers now they’re coming for renters

 

When Donna Jones and her husband looked to rent a house in northern Virginia in February, they often received the same response: sorry, but someone else offered to pay more rent.

“We didn’t even know you could do this,” Ms Jones said.

Bidding wars have long been a staple of boiling real estate markets, where buyers compete with offers above the seller’s listing price. Today, these contests are becoming more common in the rental market. Real estate agents from New York to Chicago and Atlanta say they are seeing more people than ever bidding above asking to rent houses and apartments they will never own.

 

A growing number of white-collar professionals, some of whom have recently sold homes, are reluctant to buy due to record home prices, rising mortgage rates and limited supply. They’re renting instead, helping to drive a frenzy for rental properties of all kinds and fueling the trend of offering rents above asking prices, real estate agents said.

 

Despite forecasts of a housing market cooling in 2022, U.S. home prices are still at record highs, even with mortgage rates soaring in recent months. The WSJ’s Dion Rabouin explains what is driving demand, evidence of a slowdown on the horizon and what it could mean for the economy. Photo composition: Ryan Trefes

  In parts of Atlanta, so many people are vying for the same homes that Re/Max agent Peter Beckford said he rented $3,500-a-month townhouses to couples earning nearly $1 million. dollars per year. “All of these candidates are extremely qualified,” Mr. Beckford said. A New York City panel last week approved rent increases of 3.25% for next year in properties covered by the city’s rent stabilization rules, the largest increase in nearly a decade. But for the city’s unregulated rental stock, which accounts for about half of all apartments, rent hike season is on. In popular upscale neighborhoods, more tenants are overbidding, real estate agents say. “We politely recommend it,” said Adrian Savino, managing director of brokerage firm Living New York. Large rental landlords also report having more business than they can handle. “In any given week, we get over 13,000 leads for just 200 homes available,” said Gary Berman, general manager of Tricon Residential in an earnings call in May.

The median asking rent in the United States topped $2,000 for the first time in May, according to real estate firm Redfin, and it has risen 15% over the past 12 months. If more high-income people enter hot rental markets and the supply of new homes to rent or buy does not increase significantly, rents should continue to rise, housing analysts say.

Rising interest rates also mean builders are likely to build less because fewer people can afford a new home when borrowing rates are higher, said Taylor Marr, deputy chief economist at Redfin. “I think we are in a very difficult situation right now with the prospects for new construction.” Many renters don’t stop at offering a higher rental price. Some follow other parts of the homebuyer’s playbook, like writing “choose me” love letters that introduce themselves to a landlord and make an emotional appeal. Others ask previous owners to write them recommendations, as if they were applying for a job. In Chicago, the Brixbid.com website is facilitating an influx of people bidding on rent. Owners start the auction with a suggested price. The tenants then have the choice to underestimate them or to bid even more. Some apartments are now 10% to 15% outpacing demand on Brixbid, said company co-founder James Peterson.

Chicago realtor Jodi Dougherty of Downtown Apartment Co. told her clients to write their best offers on any rental inquiry they submit. Many applicants lose out when they assume the asking rent is sufficient, she said.

Earlier this month, a client succeeded by pre-emptively bidding $1,000 over the asking price for a three-bedroom apartment near downtown Chicago that was listed at $4,000. “We didn’t win it by landslide, by any means,” Ms Dougherty said.

 

Donna Jones and her husband TJ have offered more money for their townhouse in Ashburn, Virginia. It’s not just upscale units in affluent neighborhoods where renters feel pressured to pay more than asked. For several months, Atlanta housekeeper Tabutha Robinson and her family had been looking to move out when in April Mrs Robinson found a three-bedroom house priced at $1,325. The listing agent, Torrence Ford, warned her that there were already other applications on the house. “I felt like if I just went up on the offer a little bit, then maybe I’d get it,” Ms Robinson recalled. She offered $1,500, a bit for her budget, she said, but what it took to finally rent a house. “I ran it by the owner, and they were so thrilled they went with them instantly,” Mr Ford said. Ms Jones has also entered the bidding war. “Ready to pay $50 more,” she began writing on her inquiries for rental homes in the greater Washington, DC area.

Yet even though she and her husband TJ have careers in government contracts and the military and say they have good credit, they were always outbid. At one point, they considered dressing in military gear for house calls in hopes of impressing some homeowners.

Then, in March, when a four-bedroom townhouse in Ashburn, Virginia came on the market for $3,000, the couple pounced. They offered an extra $200 and were accepted.

“It was scary because in the end we were just putting in applications without seeing them,” Ms Jones said. “It is not normal.”

---

Source: Bidding wars have overheated the market for homebuyers now they’re coming for renters

https://www.creconsult.net/market-trends/bidding-wars-have-overheated-the-market-for-homebuyers-now-theyre-coming-for-renters/

Renters are staying in their apartments longer paying more

 

Dive Brief:

• Apartment residents are staying in their homes longer, despite sharp rental rate increases.
• The number of renters remaining in their apartments rose by 3.5 percentage points year over year in April to 57%,according to Carrollton, Texas-based RealPage. In more affordable class C apartments, 65% of renters have renewed in the past year in comparison to 53.4% in class A. Apartment retention averaged 51.5% from 2010 to 2019.
• When renters renew their leases, they’re spending more. In April, residents paid 10.7% more when compared to their previous lease, according to RealPage. However, that is 18.7% below what a new renter paid versus the previous resident of the same unit.

Dive Insight:

The disparity in the price increases between renewals and new leases isn’t an accident. Many apartment operators try to thread the needle between introducing higher rates to existing residents while trying to keep them in their apartments.

“With our current customers, we are really cognizant of what we’re doing there. We’re not pushing renewal rates 13% to 18% like we’re seeing with new lease rents, ”said Samantha McQuown, vice president of business operations for King of Prussia, Pennsylvania-based Morgan Properties, the No. 3 largest owner of apartments in the country, according to the National Multifamily Housing Council. “That’s definitely something that we take into consideration. It is so important to keep our customers happy. It’s important to keep our customers in place.”

It’s more than just customer service driving the disparity in renewal rates. When a resident moves out, a unit sits empty and isn’t earning income. Then maintenance comes in and makes routine checks and repairs as part of what apartment managers call the “turn process.” If the residents stay longer, maintenance isn’t as needed.

“It might become even more prevalent where people want renewals because labor is so tight, ”said Andy Newell, CFO for Monarch Investment and Management Group, the No. 20 manager in the country. “The more we lean on maintenance people, the more there is a premium on just renewing the lease.”

Renewal rent growth

Generally, renters, at least at the upper end of the market, seem to be absorbing these increases, according to Parsons. “There are a few cases where you had people who got really good deals last year, particularly in the big cities like New York and San Francisco,” Parsons said. “Then their renewal comes up and it's closer to market. Concessions burned off and they are going to be a little more challenged. I don't think that is a massive trend, but I think you're seeing some of that.”

Residents of large coastal cities have seen rents skyrocket to record levels. Tenants paid a median of $3,870 on new leases signed in New York City in April,according to Bloomberg. The weighted average asking rent for an apartment in San Francisco clocked in at $3,500 last month, still $600 lower than prior to the COVID-19 pandemic, according to local real estate media outlet SocketSite.

However, renewal rates aren’t increasing at the same level across the board. In more expensive class A and class B apartments, they’re rising 11% to 12%, according to RealPage. In class C apartments, they’re increasing by 7.1%. “Renewal [rents] in class C are growing below the rate of inflation right now,” Jay Parsons, vice president and deputy chief economist for RealPage, told Multifamily Dive. “So, it’s a much better deal to renew in a C than [to] rent something else.”

---

Source: Renters are staying in their apartments longer paying more

https://www.creconsult.net/market-trends/renters-are-staying-in-their-apartments-longer-paying-more/

Investor demand for multifamily? It’s been insatiable

 

Insatiable. That’s the best way to describe investor demand for multifamily assets during the last five years.

Need proof? Consider a bulletin released late last month by Yardi Matrix. According to the company’s research, Yardi Matrix tracked more than $215 billion of U.S. multifamily property sales in 2021. And these properties traded for an average of $192,100 a unit.

Both of these figures are all-time highs, according to Yardi Matrix.

The company found, too, that 4,500 multifamily properties in the United States sold at least three times during the last decade. That’s about 5.3% of all U.S. apartment properties.

According to Yardi Matrix, investors have been most interested in smaller apartment properties that target working-class residents, mostly because these properties have the potential for higher rent growth. When investors purchase these properties, they tend to have lower rents even though they sit in markets with above-trend rent growth.

This gives investors the opportunity to raise rents on these properties, increasing their returns on investment.

The investment numbers that Yardi Matrix tracked are rather impressive. According to the company’s report, transaction activity in the multifamily sector bottomed out at $13.3 billion in 2009. Increasing steadily each year, this figure rose to a then high of $128.7 billion in 2019.

In 2020, a year of decline related to the COVID-19 pandemic, multifamily transaction volume fell to $95.5 million. Then came 2021, and a record-setting $215.3 billion in transaction volume. That is an increase of 67.3% when compared to the prior record-setting year of 2019.

Last year also set new highs for the number of multifamily properties sold — 6,488 — and the total number of units traded, 1.34 million.

Pricing has been on the rise, too. After bottoming out at $62,344 in 2009, the average price per unit has jumped all the way to $192,105 in 2021. That figure climbed 21.6% in 2021, the biggest one-year increase in decades.

---

Source: Investor demand for multifamily? It’s been insatiable

https://www.creconsult.net/market-trends/investor-demand-for-multifamily-its-been-insatiable/

eXp Commercial National Meeting

 

Join us in our virtual eXp Commercial Campus on the third Tuesday of every month for the eXp Commercial National Meeting, where we'll share exciting announcements about what's coming up and how you can get involved at eXp Commercial!

If you're not an eXp agent yet, you can register here!

Interested in becoming an eXp Commercial Agent, you can contact us here.

Download the virtual eXp Commercial Campus here. 

All times are shown in PT. 

+ Google Calendar

+ iCal Export

 

 

https://www.creconsult.net/market-trends/exp-commercial-national-meeting/

What is Debt Yield and How Does it Apply in Commercial Real Estate

Debt yield hasn’t traditionally been a primary commercial real estate loan underwriting metric, but more lenders are incorporating it into their criteria. In the current real estate market, measuring debt yield ratios provides lenders with a stable assessment regardless of unusual or changing conditions.

What is Debt Yield?

Debt yield is a standardized way to measure net operating income (NOI) against total loan value. The ratio is simple to calculate, but it’s an accurate measure of risk that can be used to evaluate individual loans or compare different loans.

How to Calculate Debt Yield

The math required for a debt yield calculation is simple and easy. The debt yield formula is: Debt Yield = Net Operating Income / Loan Amount For example, consider the purchase of a property with $300,000 NOI and a loan of $3 million. In this example, the debt yield is 10 percent ($300,000 / $3,000,000 = 10%).

What Does Debt Yield Tell You?

Lenders use debt yield ratios to determine what their return would be if a buyer immediately defaulted on a commercial real estate loan. Loans with low debt yields are considered riskier, as the lender would receive a smaller return in the event of foreclosure. Higher debt yields are less risky because the lender would receive a larger return and could recoup their losses faster.

Once lenders know what annual return they’d receive, they can calculate how long it’d take to recoup the loss on a foreclosed property. This is done by dividing 100 percent by the debt yield ratio (annual return). The result is the number of years that it’d take to recoup all losses. Recoup Time = 100 / Debt Yield Assuming the above debt yield of 12 percent, the lender could recoup their investment in around 8.3 years (100% / 12% = 8.33 years). Borrowers can alternatively use the ratio to calculate the maximum loan amount a property can qualify for. If the allowed debt yield and net operating income are known, then the loan amount is the NOI divided by the debt yield. Maximum Loan Amount = Net Operating Income / Debt Yield

If a lender requires a minimum debt yield of 10 percent, the maximum amount that the above example could qualify for would be $1.2 million ($120,000 / 0.10 = $1,200.000).

(Of course, any maximum loan amount would also be subject to loan to value (LTV) and debt service coverage ratio (DSCR) requirements. If a lender considers all three of these ratios, whichever has the lowest permitted loan amount is the one that sets the maximum amount borrowed.)

How Debt Yield Applies to Commercial Real Estate

Lenders appreciate that debt yield ratio is insulated from variables that can skew loan to values, debt service coverages, and even cap rates. As extremely low-interest rates and spiking property values make accurate loan risk assessment more difficult, debt yield provides a consistent risk measurement when underwriting commercial real estate loans.

Debt Yield vs. Loan to Value

Loan-to-value ratios depend heavily on the value of a commercial property, and this ratio is susceptible to large swings in property values. Borrowers can potentially get much larger loans when property values increase drastically, and lenders can be underwriting an underwater loan if property values then drop drastically.

In contrast, debt yield ratios aren’t impacted by changes in property value. The loan itself is the underlying denominator, and not how much the property is worth. So long as net operating income doesn’t change, debt yield won’t change after a loan is underwritten.

Debt Yield vs. Debt Service Coverage

Debt service coverage is based on the annual debt payment, which is affected by interest rate and amortization schedule. Thus, DSCR can be skewed by extreme interest rates (currently extremely low) and/or long amortizations. The DSCR for variable-rate loans will also change as interest rates increase.

Debt yield is based on the loan amount, and thus won’t change with interest rates or amortization schedules. It is thus a more consistent measure in many situations, even though both measurements use net operating income.

Debt Yield vs. Cap Rate

Although cap rate also looks at net operating income, this is based on the value of a property. Cap rate is thus susceptible to some of the same issues as loan to value is, and which debt yield is insulated against.

What is an Acceptable Debt Yield?

The Comptroller’s Commercial Real Estate Lending booklet recommends a minimum debt yield of 10 percent, and most lenders that consider this metric follow that recommendation.

In certain situations, lenders may allow a 9 percent debt yield for desirable properties in major markets (e.g. New York City, Los Angeles). Ratios of 8 percent for truly exceptional properties are quite rare, although not altogether unheard of.

Notably, debt yield is based on current net operating income. Projected rent increases or NOI growth isn’t considered when calculating the ratio, so adjusting projections generally won’t have an impact on whether debt yield meets a lender’s minimum requirement.

---

Source: What is Debt Yield and How Does it Apply in Commercial Real Estate

https://www.creconsult.net/market-trends/what-is-debt-yield-and-how-does-it-apply-in-commercial-real-estate/