Fed’s Beige Book Is a Mix of News for CRE

 

Interest rates are staying but there’s some welcome easing of commodity prices.

The Federal Reserve’s September Beige Book—more formally known as the “Summary of Commentary on Current Economic Conditions by Federal Reserve District”—is not going to make commercial real estate professionals jump for joy. But the bad news is already known and the good provides hope for some relief in construction.

First, the obvious bad, that inflation is still proceeding, as “price levels remained highly elevated.” That means don’t hope for an early cessation of interest rate hikes.

“Substantial price increases were reported across all Districts, particularly for food, rent, utilities, and hospitality services,” the report said, although nine of the Fed’s 12 districts “reported some degree of moderation in their rate of increase,” indicating that at least the rate at which inflation was increasing had slowed. That’s an important sign of eventually prices coming back under control. But that is still apparently some way off.

“The Fed still has an inflation problem and is committed to front-loading rate hikes as aggressively as possible,” Jeffrey Roach, Chief Economist for LPL Financial, said in an emailed statement. “The likelihood of a 75-basis point hike later this month could increase if next week’s inflation report surprises to the upside.”

Also, the Fed noted that parts of real estate continue to face challenges. “Despite some reports of strong leasing activity, residential real estate conditions weakened noticeably as home sales fell in all twelve Districts and residential construction remained constrained by input shortages,” the report said. “Commercial real estate activity softened, particularly demand for office space. Loan demand was mixed; while financial institutions reported generally strong demand for credit cards and commercial and industrial loans, residential loan demand was weak amid elevated mortgage interest rates.”

Among the districts that specifically mentioned real estate, Boston saw the outlook worsen, in Richmond activity was flat to moderately down, Atlanta had mixed commercial real estate activity, construction and real estate declined modestly in Chicago, and residential activity eased in San Francisco.

There was also some positive news in an important area: materials. “While manufacturing and construction input costs remained elevated, lower fuel prices and cooling overall demand alleviated cost pressures, especially freight shipping rates,” the report noted. “Several Districts reported some tapering in prices for steel, lumber, and copper.” But most contacts outside of the Federal Reserve system though price pressures would continue at least through the end of the year.

 

Source: Fed’s Beige Book Is a Mix of News for CRE

https://www.creconsult.net/market-trends/feds-beige-book-is-a-mix-of-news-for-cre/

Confused about the housing market? Here's what's happening

The slowdown in the otherwise red-hot housing boom has been stunningly swift.

The U.S. housing market surged during the pandemic as homebound people sought new places to live, boosted by record-low interest rates.

Now, real estate agents who once reported lines of buyers outside open houses and bidding wars on the back deck say homes are sitting longer and sellers are being forced to lower their sights.

That has both potential buyers and sellers wondering where they stand.

"As recession concerns weigh on consumer outlooks, our survey shows uncertainty has made its way into the minds of many buyers," said Danielle Hale, chief economist at Realtor.com.

Here are the major factors behind the topsy-turvy housing market.

Mortgage rates

The main driver of the slowdown is rising mortgage rates. The average rate on the 30-year fixed mortgage, which is by far the most popular product today, accounting for more than 90% of all mortgage applications, started this year right around 3%. It is now just above 6%, according to Mortgage News Daily.

That means a person buying a $400,000 home would have a monthly payment about $700 higher now than it would have been in January.

High prices, low supply

The other drivers of the slowdown are high prices and low supply.

Prices are now 43% higher than they were at the start of the coronavirus pandemic, according to the S&P Case-Shiller national home price index. The supply of homes for sale is growing, up 27% at the start of September compared with the same time a year ago, according to Realtor.com. While that comparison seems large, it's still not enough to offset the years-long shortage of homes for sale.

Active inventory is still 43% lower than it was in 2019. New listings were also down 6% at the end of September, meaning potential sellers are now concerned as they see more houses sit on the market longer.

Paul Legere is a buyer's agent with Joel Nelson Group in Washington, D.C. He focuses on the competitive Capitol Hill neighborhood, and he said he saw listings jump by 20 to 171 just after Labor Day. He now calls the market "bloated." As a comparison, just 65 homes were listed for sale in March.

"This is a very traditional post Labor Day inventory bump and seeing in a week or so how the market absorbs the new inventory is going to be very telling," he said. "Very."

Inventory is taking a hit nationally because homebuilders are slowing production due to fewer potential buyers touring their models. Housing starts for single-family homes dropped 18.5% in July compared with July 2021, according to the U.S. Census.

Homebuilder sentiment in the single-family market fell into negative territory in August for the first time since a brief dip at the start of the pandemic, according to the National Association of Home Builders. Builders reported lower sales and weaker buyer traffic.

"Tighter monetary policy from the Federal Reserve and persistently elevated construction costs have brought on a housing recession," said NAHB Chief Economist Robert Dietz in the August report.

Some buyers are hanging in

Buyers, however, have not disappeared entirely, despite the still-pricey for-sale market and the equally expensive rental market.

"Data indicates that some home shoppers are finding silver linings in the form of cooling competition for rising numbers of for-sale home option," said Realtor.com's Hale. "Especially for buyers who are getting creative, such as by exploring smaller markets, this fall could bring relatively better chances to find a home within budget."

Home prices are finally starting to cool off. They declined 0.77% from June to July, the first monthly fall in nearly three years, according to Black Knight, a mortgage technology and data provider.

While the drop may seem small, it is the largest single-month decline in prices since January 2011. It is also the second-worst July performance dating back to 1991, behind the 0.9% decline in July 2010, during the Great Recession.

Affordability woes

Still, that drop in prices will do very little to improve the affordability crisis brought on by rising mortgage rates. While rates fell back slightly in August, they have risen sharply again this week, making for the least affordable week in housing in 35 years.

It currently takes 35.51% of median income to make the monthly principal and interest payment on the median home with a 30-year mortgage and 20% down. That's up marginally from the prior 35-year high back in June, when the payment-to-income ratio reached 35.49%, according to Andy Walden, vice president of enterprise research and strategy at Black Knight.

In the five years before interest rates began to rise, that income-to-payment ratio held steady around 20%. Even though home prices surged in the 2020 and 2021, record-low interest rates offset the increases.

"Given the large role affordability challenges appear to be playing in shifting housing market dynamics, the recent pullback in home prices is likely to continue," Walden said.

A new report from real estate brokerage Redfin showed that while homebuyer demand woke up a bit in August, the latest increase in mortgage rates over the past week put it right back to sleep. Fewer people searched for "homes for sale" on Google with searches during the week ending Sept. 3 – down 25% from a year earlier, according to the report.

Redfin's demand index, which measures requests for home tours and other home-buying services from Redfin agents, showed that during the seven days ending Sept. 4, demand was up 18% from the 2022 low in June, but still down 11% year over year.

"The housing market always cools down this time of year," said Daryl Fairweather, Redfin's chief economist, "but this year I expect fall and winter to be especially frigid as sales dry up more than usual."

 

Source: Confused about the housing market? Here’s what’s happening

https://www.creconsult.net/market-trends/confused-about-the-housing-market-heres-whats-happening/

Why These CRE Sectors Provide Safer Harbors

 

At a moment marked by inflation, slowing growth and recession fears, CRE asset categories that offer long-term potential for reliable returns are in the spotlight. Those most often cited by experts reflect a wide range, from steady perennial performers to vibrant, cutting-edge specialties. A connecting thread among these diverse examples: long-term demographic and economic trends that can withstand shorter-term shifts in conditions.

Retail stalwart

Grocery-anchored centers remain the retail category that is least impacted by online shopping. At midyear, online grocery sales accounted for 13.6 percent of the total grocery market, according to the  latest Brick Meets Click/Mercatus Grocery Shopping Survey. That’s up 1.5 percent year-over-year, a sign of gradual growth, but the modest share of online sales points to robust demand for brick-and-mortar grocery stores.

A principal reason is that shoppers still like seeing and touching perishable items before purchase. And grocery visits drive customer traffic at adjacent inline retailers and service businesses, such as liquor stores, dry cleaners and nail salons and similar.

Such national grocery chains as Trader Joe’s, Whole Foods, Aldi, Harris Teeter and Stop & Shop make particularly effective anchors, said Mitch Rosen, managing director & head of real estate for YieldStreet. “These grocers appeal to a more affluent consumer base,” he said. “Look at where pricing has gone in that sector; it remains very strong.”

Life science leaders

Robust growth of a wide range of health-care-affiliated scientific advances, together with the aging of the population, demographic trends, favor life science as a safe ground-up development or conversion play. Despite an 18.5 percent year-over-year decline, venture capital investment totaled $20.8 billion during the first half, according to a report from Newmark. In the four leading hubs alone—Boston, San Francisco, San Diego and Raleigh-Durham—the renovation and construction pipeline totals 33.2 million square feet.

Investors have multiple geographic and investment category options as the demand for space continues unabated and markets of all sizes vie to participate. Ground-up development, expansion and adaptive reuse are all on the menu for R&D and manufacturing facilities, as well as for office support space.

“We are seeing tremendous interest from early and mid-stage life science companies doing small-batch manufacturing . . . that don’t need enormous factories,” said Aaron Jodka, Colliers national director of capital markets research. The three dominant hubs offer diverse opportunities and distinctive characteristics for makeovers. Greater Boston often favors conversions of older properties with good bones, while in San Diego and the San Francisco Bay Area, one-story, 1980s-vintage buildings are frequently eyed for makeovers, he added.

Industrial potential

Multiple indicators speak to the staying power of industrial assets, even in a downturn. At midyear, vacancy stood at 4.7 percent nationwide, a 120 basis-point year-over-year decline, according to CommercialEdge data. Although the general conditions that have made the sector an investor magnet are well known, the factors that shape prudent industrial investment deserve a nuanced examination.

“We rank industrial as offering a moderate hedge against inflationary effects,” said Ian Formigle, chief investment officer at CrowdStreet. Providing that hedge are typical lease terms of five to 10 years, and when tenants also assume operating costs like insurance, property taxes and maintenance in triple net leases, that helps insulate operators from inflation.

Decades of underbuilding is an often underappreciated factor in the sector’s current appeal. Until the middle of the last decade, Class A urban infill industrial properties were typically 1970s-era structures, noted Aaron Appel, co-head of New York capital markets for Walker & Dunlop. A mismatch between project costs and rents hampered development for years. That started to change only when demand finally enabled projects to pencil out.

“Tenants said, ‘I can pay 25 to 75 percent more than I have, and my business will benefit from a brand-new building,’” Appel recalled. “That building may have more bays, higher ceilings, fewer columns or allow simpler egress.” The pandemic and the closely related rise of ecommerce have further advanced the trend since early 2020.

Growth factors

Moreover, newly built Class A facilities provide efficiencies that permit manufacturing closer to the final distribution of goods. That trims transportation costs and reduces the risk of supply chain disruption. Chris McKee, principal and chief development officer for development firm CRG, identifies distinct regional factors that may offer hedges against an economic slowdown. The Sun Belt offers population growth; the Midwest has an abundance of skilled labor, lower living costs and stable economies; and in the Northeast, the limited supply of sites and long entitlement periods generate high demand for new product.

Acquiring and developing infill logistics properties near population centers is a common but still-reliable strategy. Dwight Angelini, co-founder & managing partner at Longpoint Realty Partners, names geographically diverse locations—northern New Jersey, Los Angeles, Dallas and Miami—as offering the greatest imbalance between warehouse supply and demand. “The challenge and opportunity is (that) these top-tier infill markets are inherently supply-constrained due to … challenges associated with sourcing, acquiring and developing” industrial product, he said.

Some experts favor advanced logistics and distribution facilities in markets with expanding populations. They cite the well-known trends of e-commerce expansion and reshoring manufacturing. Arizona Land Consulting is buying land in the western Phoenix suburb of Buckeye, Ariz. Its clients like the market’s comparative proximity to the Ports of Los Angeles and Long Beach, about four and a half hours away, reported the firm’s CEO, Anita Verma-Lallian.

Coastal markets where port authorities are investing in robust upgrades are sometimes overlooked indicators of long-term potential. East Coast ports are attracting increased container volume following much-discussed bottlenecks on the West Coast, noted Stephen Evans managing director at Black Salmon.

One example is the Port of Mobile, noted James Huang, president of eXp Commercial, eXp World Holdings. The port is engaged in a $368 million project that will deepen its channels 50 feet. When work is complete in 2025, the port will better serve Birmingham’s emerging distribution some 250 miles to the north.

Even in areas whose industrial markets are thriving overall, some categories may be underbuilt and offer superior safety. Such is the case in Contra Costa County, Calif., where the focus has been on larger, order-fulfillment warehouses at the expense of smaller, multi-tenant buildings. Combined with development costs 20 percent higher than will pencil out in the area, that is a formula for a low volume of new multi-tenant product.

“One can forecast that with little new supply and strong demand, rents will continue to climb for smaller-sized units in industrial buildings,” said Eric Rehn, vice president at Kennedy Wilson Properties.

Future snapshot

Growing construction costs may lead investment to thin out in coming months. “Rents have continued to rise to offset increased costs,” CRG’s McKee said of the industrial sector. “If that stops, we’ll see a significant downward pressure on construction starts. For now, we can’t build fast enough to meet the demand.”

The widespread bid-ask gap stemming from rising interest rates will be brought into alignment during the next few quarters. For many asset classes, that adjustment will occur in the next half year, but it will “take longer on CBD office buildings and convention center hotels as we adjust behaviors” in a post-COVID world, predicted Terranova chairman & CEO Stephen Bittel.

Jodka says his firm is seeing gaps between buyers and sellers, price adjustments due to higher borrowing costs and deals slowing down. “A slowdown is not unexpected, [nor is] a resumption early next year when interest rates have settled and buyers can more confidently underwrite borrowing costs.”

 

Source: Why These CRE Sectors Provide Safer Harbors

https://www.creconsult.net/market-trends/why-these-cre-sectors-provide-safer-harbors/

Tax Efficient Growth with 1031 Exchanges

Private real estate is often an attractive investment option for investors seeking tax efficiency. It creates some opportunities for tax deductions, but investors can also defer capital gains taxes on the sale of an investment property by engaging in a 1031 exchange. Doing so allows you to reinvest your entire sales proceeds into a new replacement property and creates the ability to “buy up,” purchasing a new property of higher value or better quality.

Since there are no limits to the number of times you can engage in a 1031 exchange, it’s possible to repeatedly roll your gains into upgraded property holdings, continually deferring capital gains taxes, and potentially growing your wealth through additional capital appreciation.

Engaging in a “Like-Kind Exchange”

The rules for a 1031 exchange are defined under Section 1031 of the U.S. Tax Code. A 1031 exchange allows investment property owners to defer their capital gains taxes on a property sale by purchasing a “like-kind” replacement property. However, the definition of a “like-kind” property is far broader than you may think.

The IRS defines like-kind properties based on the "nature or character" of the property rather than on the "grade or quality.” Therefore, virtually any real estate property is considered “like-kind” to any other piece of real estate property.

This means that you could exchange a single-family rental home for an industrial warehouse, a piece of raw land for a shopping complex, and so on. Since this definition provides significant leeway, it can also create opportunities for additional portfolio diversification across various property types.

Working with a Qualified Intermediary

To protect the preferential tax treatment provided by a 1031 exchange, it’s imperative to work with a Qualified Intermediary (QI) from the very beginning of the exchange process. A QI is an independent, disinterested third party, that is a person, company, or entity that facilitates a 1031 exchange. During a 1031 exchange, a taxpayer cannot ever receive proceeds from the sale of the relinquished property. Therefore, when engaging in an exchange, the QI must perform the transaction.

In this scenario, the QI acquires the property from the taxpayer, transfers it to the buyer, and holds the sales proceeds. Then, when the taxpayer is ready to purchase the replacement property, the QI uses the funds to acquire the property from the seller and transfers it to the taxpayer.

1031 Exchange Timelines

In addition to working with an approved QI, investors must also meet specific time restrictions, known as the 45-day and the 180-day deadlines.

The 45-day deadline requires you to identify your potential replacement property or properties within 45 calendar days from the day you sell your relinquished property. This identification must be in writing and submitted to your QI. You can typically identify up to three properties. In some cases, you may be able to identify more as long as they fall within specific valuation tests.

The 180-day deadline requires you to close on one or more of the identified properties by the 180^th day after you closed on the relinquished property. These two timelines run concurrently, so it’s important to note that if you take the full 45-days to identify your property, you’ll only have an additional 135 days to close.

Tax-Efficient Real Estate Investing

To learn more about the potential tax advantages offered by private real estate investments, download our complimentary ebook, “Tax Advantaged Investing: The Power of Private Real Estate.” Inside, you’ll find information about tax-advantaged income potential, Qualified Opportunity Funds, estate planning using 1031 exchanges, and more.

 

Source: Tax Efficient Growth with 1031 Exchanges

https://www.creconsult.net/market-trends/tax-efficient-growth-with-1031-exchanges/

No huge drop-off coming: Multifamily market expected to remain hot into 2023

Renters and investors are still seeking out multifamily space. And the demand for apartment living is showing no signs of slowing, according to Kia Crooms, area vice president of the Midwestern region for King of Prussia, Pennsylvania-based Morgan Properties.

We spoke with Crooms about the enduring strength of the multifamily market and why Morgan Properties is eager to expand its apartment holdings in the Midwest. Here is what she had to say.

Why has demand remained so strong for multifamily properties for so long? What are the factors fueling the long hot streak of this asset class?
Kia Crooms: The economy has certainly helped. There has been excellent job growth in the United States. Wages for individuals continue to rise. People have access to cash. At the same time, the supply chain issues persist. That makes it difficult to build as many new homes as people want. Renting, then, is a great option for people today.

Housing prices are high, too. That is inspiring more people to rent. We are seeing an excellent retention ratio when it comes to lease renewals. Folks are even selling their homes, taking out the cash, and downsizing to apartments and townhomes. They want the lifestyle and the lack of maintenance that comes with renting instead of owning.

What about rising interest rates? What impact is that having on the number of people who want to rent instead of buy?
Crooms: When interest rates are higher, people are more likely to rent. But our investors are still excited about multifamily properties, too. Our investors continue to be excited about different markets, especially when it comes to the Midwest. There are many markets in the Midwest that are always strong.

Morgan Properties has made several recent multifamily acquisitions. We entered the Indianapolis market with a property of more than 2,100 units. We have also recently entered the Chicago suburbs with purchases in Elgin, Palatine, and Schaumburg. We continue to find ways to build our portfolio.

Why make the move to Indianapolis? What attracted you to this market?
Crooms: As an organization, we are oversaturated with properties in the East Coast and Sunbelt regions. Indianapolis was an untapped market for us. We like the growth potential in the Indianapolis area. There are some good meat-and-potatoes properties there when it comes to Class-B assets. There is a Class-B market there that is untapped and in our wheelhouse. We do that section of the market well. We like to buy those properties and add value to them.

–          Morgan Properties’ The Gates of Deer Grove in Palatine, Illinois.

What are renters looking for today from multifamily properties?
Crooms: Coming out of a pandemic, people are now looking to be outside. They are looking for more space. They are looking for everything from outdoor kitchens and grilling spaces to fire pits that they can use in the evenings. They want to really live and gather with family and friends. That’s why we like the Class-B garden-style apartment communities. There are so many value-add opportunities. We can add a lot to the outdoor spaces in these communities.

The way people are living today, things like dog parks have become more essential to folks. They want that off-leash exercise for their furry friends. They want open kitchens outside or splash parks in tandem with swimming pools. Anything that involves spending time with family and friends is important today.

There is no one-size-fits-all list of amenities, though. What works in Michigan might not work in New Jersey.

Speaking of the pandemic, it seems like the multifamily sector held up really well even during the worst days of COVID and that the sector has emerged even stronger today.
Crooms: There were some industries that were hit hard by the pandemic, such as hospitality and retail. We did see some softness when it came to rent collection, but our team members were good at being that expert when it came to helping people source those funds. The government and other agencies offered financial assistance that we could connect people to. There were no off days for our staff during the pandemic. We were there to be of service to the residents.

Today, many renters are staying in place and renewing their leases. Many are doing this because they are nervous about making the move to buying a single-family home with how the interest rates are rising. They might not have the money for a down payment. This all makes multifamily a strong option for people.

Do you plan on acquiring more properties in the Midwest?
Crooms: We do. We are always looking for growth opportunities. Even if we wanted to rest, our investors and employees won’t allow it. It is so lucrative out there now in the multifamily space. We are interested in those value-add opportunities where we can find more meat on the bone by upgrading apartments and townhomes and the amenities in those spaces. That is in our wheelhouse. That is where we win and where we are always looking to expand and grow.

Do you upgrade these Class-B properties enough to turn them into Class-A space?
Crooms: Sometimes that does happen. It depends on the spend and the demographic we are trying to serve. It’s about what the market dictates for a property. We want to make the changes that people want to see, bring in what has been missing from a development. That’s the recipe. We’ve done it over and over, but every property is different. The same amenities don’t work everywhere. We do our due diligence when it comes to the market. We study what people want to see.

The multifamily market has been strong for so long. Do you see demand for apartments, from both renters and investors, continuing to hold steady or rise throughout the rest of this year and into next?
Crooms: We will continue to see strong numbers. Some markets might soften a bit, but I don’t see any huge drop-off happening. The supply chain issues have not been fixed yet when it comes to building new single-family homes. We still don’t have enough housing to get everyone’s heads into beds. Adult children who moved back with their parents will be leaving again to find their own places to live. People are branching out and getting their own apartments and townhomes. One household is now becoming two. Do I see occupancy in the multifamily sector softening a bit? Sure. But I don’t see a huge drop-off. Our occupancy numbers and demand for apartments will both remain high.

 

Source: No huge drop-off coming: Multifamily market expected to remain hot into 2023

https://www.creconsult.net/market-trends/no-huge-drop-off-coming-multifamily-market-expected-to-remain-hot-into-2023/

Commercial Real Estate Symposium October 25 2022 7 a.m. – 3 p.m. PT

Commercial Real Estate Symposium
October 25, 2022
7 a.m. – 3 p.m. PT

Hear from the industry’s top leaders, national economists and thriving entrepreneurs on the future of commercial real estate.

Register now for this FREE event.

Agenda

7 a.m.
Welcoming Remarks
James Huang, President, eXp Commercial

7:15 a.m.
Entrepreneurship and Small Business Financing
Charles Rho, President, VelocitySBA

8:00 a.m.
Using AR/VR Technology to Attract Investors to Your Property
Matt Bonds, U.S. President, RealSee

8:30 a.m.
The Future of Technology in Commercial Real Estate
Duke Long, Second Century Ventures
Obie Walli, CEO, Dealius
Ember Erickson, Co-Founder and Head of Revenue, Biproxi

9:00 a.m.
Inclusion in Commercial Real Estate
Jessica Nieto, ONEeXp
Donnel Williams, President, Black Real Estate Professionals Alliance
Desiree Patno, CEO, NAWRB

9:30 a.m.
Comparing Business & Real Estate Brokerage
Kylene Golubski, Executive Director, IBBA
Neal Isaacs, VR Business Brokers

10:00 a.m.
Corporate Services, RELO and Commercial REO
Dawn Conciatori, Vice President Referral Generation, eXp Realty
Eric Powers, CEO 7LCRE
Fred Schmidt, Managing Partner, Valuation Alliance

10:30 a.m.
State of the Commercial Real Estate Industry
KC Conway, Founder and President, Red Shoe Economics

11:30 a.m.
Global Opportunities in Commercial Real Estate
Meghan Kelley, VP Global Operations, eXp Realty
Renata Sujto, Broker of Record – International, eXp Realty
Samuel Caux, Managing Broker, France, eXp Global
Andrew Thompson, Designated Managing Broker, South Africa, eXp Global

12:00 p.m.
The Coming Digital Asset Disruption and How it Impacts Commercial Real Estate
Olivier Manuel, President, Rich Devices

12:30 p.m.
Vylla Title
John Tavarez

1:00 p.m.
JTC Americas
Justin Amos

1:30 p.m.
O’Connor Tax Reduction Experts
Shalonda Marshall

2:00 p.m.
TransGlobal
Philip Hu

2:30 p.m.
CommLoan
Jonathan Mangiapane

https://www.creconsult.net/market-trends/commercial-real-estate-symposium-october-25-2022-7-a-m-3-p-m-pt/

How To Lower Your Taxes As a Real Estate Investor

1031 Exchanges, Delaware Statutory Trusts, Opportunity Zone Funds, and Other Tax Reduction Strategies

When it comes to tax avoidance strategies, most real estate investors are probably familiar with the 1031 “like-kind” exchange, in which an investor can defer a tax liability — capital gains, depreciation, or even state and local income tax and the 3.8% net investment income tax — from the sale of a property by acquiring a similar investment property.

Essentially, this allows you to sell one property and purchase another without paying any taxes, provided you follow basic rules.

For example, one requirement is that you identify the replacement property within 45 days of the sale and conclude the purchase of the replacement property within 180 days of the sale.

Some investors even take the “swap until you drop” approach, whereby they continue to sell properties and acquire new ones without ever paying taxes on the sales.

In addition to the tax deferment benefits, a 1031 exchange gives your heirs a step-up in basis to current market value when you pass away.

For example, imagine that you purchase a property for $500,000, and it is depreciated over 20 years. The property is now valued at $2 million, and you and your spouse pass away. Your heirs would automatically receive a step-up in basis to $2 million, so they can sell the day after you pass away and pay no taxes.

There is one problem with 1031 exchanges for many investors, and that is the current frenetic property investment environment.

While the present market might allow an investor to sell their property at a record high, they will also be in the position of having to pay a steep price for their replacement property.

And with the 45-day clock ticking in the background, many investors may not have adequate time to identify a suitable replacement property. This kind of fevered market can lead investors to make less than sound choices. As my college property and tax professor, Dr. George Earl, once said: “Tax savings don’t make a bad investment decision good. It only makes a good investment decision better.”

The good news is that there are alternatives to the traditional 1031 exchange.

Delaware Statutory Trust

Instead of reinvesting the proceeds of your property sale into another investment property, you could exchange those proceeds into a Delaware Statutory Trust (DST).

A DST is a legally recognized trust that has been established to conduct business. Many DSTs hold institutional-grade properties; in this sense, they are similar to a real estate investment trust (REIT), but they offer investors the option to invest in them as part of a 1031 exchange, which is typically not possible with a REIT.

A DST has several important advantages. Firstly, it eases issues stemming from the time constraints of the 1031 exchange, as it is simpler (and quicker) for investors to identify an appropriate and established DST than a replacement investment property, particularly in the current climate.

Secondly, it enables you to remain invested in real estate as an asset class without the stress and time commitment of being a landlord. It can also be a particularly viable solution for investors whose mortgage exceeds their tax basis in a property.

DSTs generally require a five- to 10-year time commitment. They typically distribute income and potentially offer the opportunity for capital gain (or loss). However, to qualify for a DST, you must be an accredited investor.

Opportunity Zone Funds

Another option that investors should consider is a qualified opportunity zone fund (OZF). An advantage of this strategy is that it allows you to invest just your capital gains and your depreciation recapture. This enables you to sell the property, withdraw your tax-free basis and defer the additional taxable funds. Some (though not all) states are supporting these tax breaks by ensuring the state and local income tax rules are aligned with the federal tax regulations.

By investing in an OZF, you defer your taxes on the eligible capital gains (realized within the last 180 days) until the tax year 2026 (April 15, 2027 filing deadline). If you invest in an OZF before the end of 2021, you will also receive a 10% step-up on a cost basis. Many OZFs also structure a cash-out refinance of approximately 30 – 45% in time to pay your deferred tax bill by April 2027.

As with a DST, OZFs can provide annual income (generally from year four or five through to year 10). Further, if the property is held for 10 years (and one day), it receives a step-up in basis for both appreciation and depreciation. This means that the property could be sold without triggering any capital gains tax liability.

However, similar to a DST, it’s important to conduct due diligence on both the underlying investment and the manager of the fund. OZFs typically represent a 10-year investment structure, and you must be an accredited investor.

Deferred Sales Trust

One lesser-known but potentially beneficial option is a deferred sales trust. With a deferred sales trust, you can sell your highly appreciated assets, including investment properties, primary residences, vacation, and second homes, and defer the capital gains taxes and depreciation recapture taxes — perhaps indefinitely.

In a deferred sales trust, you are not the owner of the trust; you are a promissory note holder against the assets of the trust, and the trust makes payments to you. To effect this, you would sell your investment property to the trust, and the trust, in turn, would sell the property to the end buyer. The proceeds of the sale are paid to the trust at the time of closing on this simultaneous transaction.

One significant advantage of this approach is that an investor doesn’t have to contend with the 45-day time constraint inherent to 1031 exchanges. But there are other attributes to consider.

What if you could use the funds from a sale in 2021 to buy real estate later without having a tax liability? Imagine if you sold a property in 2007, at the peak of the last cycle, and you were able to park the money on the sidelines and then use it to acquire properties in 2010?

There are many different ways to structure a deferred sales trust, and it can even potentially be used in combination with a 1031 exchange or paired with an OZF. The deferred sales trust can be structured to pay just interest payments on your promissory note or principal and interest payments. If you choose principal and interest payments, then you would be responsible for some of your capital gains taxes and depreciation recapture taxes, if applicable.

But most investors that avail themselves of a deferred sales trust structure choose interest-only payments that are taxed as ordinary. This lessens your cash flow from the trust, but it also ameliorates your tax burden by deferring taxes owed on capital gains and depreciation recapture.

Deferred sales trusts are structured to run for 10 years, but they can be easily extended for multiple additional 10-year cycles. It’s worth noting that deferred sales trusts are a bit more complex than some other vehicles or strategies that investors might be considering, and there are carrying costs and trust establishment fees to contend with, as well. But, if you have capital gains that exceed $500,000, this could be a viable option to consider.

Whatever tactics you elect to utilize, the most important thing is to weigh these strategies against your short- and long-term objectives for the property, as well as your overall portfolio.

Tax strategies should be merely one facet of a holistic approach that fosters enduring value for your assets.

 

Source: How To Lower Your Taxes As a Real Estate Investor

https://www.creconsult.net/market-trends/how-to-lower-your-taxes-as-a-real-estate-investor/