The Basics of Commercial Real Estate Property Types

Commercial real estate is the US's third most valuable asset class, right behind stocks and bonds. With an estimated market value of about $17 trillion, it’s understandable why many investors are adding commercial real estate to their investment portfolios.

Let’s take a quick look at commercial real estate basics, including commercial real estate types and asset classes, and the best opportunities for commercial real estate investing this year.

What Makes Real Estate Commercial?

Commercial real estate (CRE) is used for business or investment purposes and is usually rented to tenants to generate income. CRE is a massive asset class and includes everything from single storefronts and apartment buildings for sale to large multi-tenant office buildings and industrial distribution centers.

Multiple income streams are among the most significant advantages of investing in a multi-tenant commercial real estate building. That means the property still generates cash flow if one unit goes vacant.

Commercial real estate prices are generally higher than a residential rental property, so there is less competition from other investors. CRE investments can also be more management-intensive, with larger commercial properties usually having an on-site property manager and leasing office.

Commercial Real Estate Classes

Commercial real estate is categorized into one of three groups or classes:

• Class A property is newer buildings with the best amenities and highest rents in the best locations.
• Class B property is older with average amenities at at-market rents, often attractive to value-add investors for renovation or repositioning.
• Class C property is the oldest, with minimal amenities and below-market rents, usually with obsolete floorplans and in need of significant maintenance.

It’s important to note that CRE property classes are market-specific. For example, a Class A office building in Tulsa might be considered a Class C property in a more urbanized market like San Francisco.

Main Types of Commercial Real Estate

Commercial real estate properties are generally placed into one of five main types, according to the 2021 US Real Estate Market Outlook from CBRE and the Appraisal Institute’s Property Use Classification System.4,5

Office

• Central Business District (CBD)
• Suburban Office Business Park
• Creative/Loft
• Medical
• General Purpose
• Research and Development

According to CBRE, suburban office markets are forecast to grow faster than office buildings in a central business district (CBD). Business-friendly office markets such as Raleigh-Durham, Nashville, Tampa, Phoenix, and Dallas-Fort Worth should perform best for investors and tenants looking to rent office space in 2021.

Industrial

• Industrial Business Park
• Warehouse – distribution, refrigerated/cold storage, lumber yard, general-purpose
• Flex Industrial Space – reconfigurable with up to 85% office space
• Manufacturing – light, heavy, high tech
• Processing – food, minerals, refinery, solid wastes
• Research and Development
• Communication and Data Center

E-commerce will continue to drive the demand for industrial space, according to CBRE. Commercial real estate investors can expect more retail-to-industrial conversions as industrial occupiers search for last-mile delivery solutions.

Industrial markets to watch include Phoenix, Las Vegas, Salt Lake City, Texas, and Southeastern CRE markets such as Atlanta, Charleston, and Central Florida.

Retail

• Automotive
• Day Care Facility
• Laundromat
• Restaurant and Bar
• General Storefront/Street Retail
• Convenience Store
• Strip center
• Neighborhood Center
• Community Shopping Center
• Regional Center
• Super-Regional Center/Mall
• Specialty Retail Center

Retail store closures will likely continue this year, creating opportunistic investment opportunities in many retail markets. Adaptive reuse and conversion of Class B and C malls into higher and better uses will keep accelerating.

CBRE lists Phoenix, Austin, Denver, Charlotte, and St. Louis as some of the best retail markets to watch for commercial real estate investment.

Multifamily

• Multiple Units – buildings with more than four units, including garden, mid-rise, and high-rise apartments
• Student Housing – dormitory, fraternity/sorority, and both on-campus and off-campus housing
• Senior Living – independent and assisted living, retirement community, skilled nursing facility
• Group Housing – for people with disabilities or criminal backgrounds to reintegrate into society.

Multifamily vacancy rates should remain relatively low in 2021, with rents rising in many markets as more households rent rather than own. Affordable Class B and C workforce housing will remain in short supply.

Suburban multifamily assets in the Midwest and Southeast regions were recommended as the best multifamily investment opportunities by CBRE. Particularly promising cities include Indianapolis, Memphis, Cleveland, Kansas City, and Louisville.

Hotels

• All Suites
• Bed and Breakfast
• Casino Hotel
• Convention Hotel
• Economy Hotel/Motel
• Extended Stay
• Full Service
• Limited Service
• Luxury
• Resort and Spa

Normal hotel occupancy levels are not expected to return until 2023, with higher chain hotels suffering the most due to their dependency on business and group travel. Hotels and lodging facilities in drive-to destinations are predicted to recover the fastest by CBRE. Rural and interstate hotels and lodging facilities in small metros and rural areas in drive-to destinations may offer the best opportunities for investing in hotels.

Alternative Commercial Real Estate Types

With an asset class as large and varied as commercial real estate, some CRE properties are difficult to categorize into one of these five main types. Alternative commercial real estate properties have distinct, specialized uses or a combination of the aforementioned ones.

• Mixed-Use properties combine two or more uses, such as retail and office space on the first level, with multifamily units on the upper floors.
• Unique Purpose properties have a niche or purpose-built use and include parking lots and garages, self-storage facilities, sports stadiums, theaters, amusement parks, churches, and government buildings.
• Data Centers are colocation facilities leased to large cloud service providers and content providers. They have rapidly developed into a new subclass of alternative commercial real estate and are ideal for CRE investors looking for high-quality assets leased to long-term credit tenants.

Where to Find Commercial Real Estate Listings

Some commercial real estate property types will grow faster than others, although each type offers CRE investors unique opportunities. High-rise urban offices may be impacted more by employees working from home, while suburban office buildings closer to home better fit the hub-and-spoke model.

Retail property in markets such as Las Vegas is performing well, while other retail types offer investors the opportunity for repositioning to use better. The same is true of hotels, with hospitality and lodging properties in drive-to locations providing the best investment opportunities.

In most markets, industrial and multifamily commercial real estate performed exceptionally well and will likely continue to do so even during an uncertain economy.

 

Source: The Basics of Commercial Real Estate Property Types | Crexi Insights

https://www.creconsult.net/market-trends/the-basics-of-commercial-real-estate-property-types/

Should I Sell or Should I Hold? When is the best time for asset repositioning?

When it comes to selling their investment properties, clients typically ask me,’ Why should I sell?’ Great question. Why should you sell? The obvious answer is that you purchased the investment property as an investment, and it may not be doing as well as other investment opportunities, and after a while, you don’t realize the appreciation and thus maximization of profit from the property until you sell and acquire another investment property. So the question is really, ‘When should I sell? Clients really lose the perspective of the driving reason why they invested in an investment property in the first place. An investment property is just that; an investment. Treated as such, every investment must have a horizon and an exit strategy. If a property was purchased as an investment, then it makes full sense to profit as much as possible from the investment.

The real estate market, like any other market, will go through peaks and valleys. Trying to predict the exact moment of peak or the exact moment the market reaches the bottom is practically impossible. The real estate cycle has four phases; recovery, expansion, hyper supply, and recession. The complete real estate market cycle seems to have an average duration of about 18 years as there is good historical data to support that. So, where are we in that cycle now? How much more upside will we see before we reach the peak? The question really is, ‘What is your appetite for risk?’

Below is a chart of the real estate cycles dating back from the 1800s. The last real estate market crash started at 2006. We are almost 16 years into that cycle. Interest rates are still at all-time lows. Money is cheap, and the threat of inflation is very high. How long can government print money without paying the price down the road? How much road do we have left?

So when is a good time to exit an investment property? As with everything else, real estate is cyclical. Those of us that have been around for some time have witnessed several cycles in the real estate market. Since it is practically impossible to predict the peak of cycles, what strategy should you then use to maximize your investments? Keeping it simple, when evaluating if you should consider selling an investment property, it doesn’t really matter what the current real estate market is like. If you are looking to replace the investment property with another investment property, the ultimate decision to sell should also be based upon if you can increase your returns with the new replacement property, not what state the current market is in now.

There are a number of factors that can impact real estate prices; availability, investment potential, and interest rates, to name a few. Interest rates impact the price and demand of real estate—lower rates bring in more buyers due to the lower cost of money but also expand the demand for real estate, which can then drive up prices. As interests rate starts to inch up, the cost of money increases, and thus the appetite for real estate investments declines.

However, there are many ways that one can still protect their investments. 1031 Exchanges give investors a vehicle to reposition assets and mitigate risk. There are certain asset classes that inherently hold less risk and still perform as an investment vehicle. The questions really come down to; ‘How long do I hold on during this cycle? Do I have the time horizon to outlast another cycle? Is it time to reposition and take advantage of 1031?

As part of the team for our client’s investments, we specialize in building solutions around our client’s needs. We analyze the requirements, crunch the data, and present assets entirely based on their circumstances and the goals they are trying to achieve with their investment.

Have you thought of selling your property and would like to know what it’s worth? Request a valuation for your property below:

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Source: Should I Sell or Should I Hold? When is the best time for asset repositioning?

https://www.creconsult.net/market-trends/should-i-sell-or-should-i-hold-when-is-the-best-time-for-asset-repositioning/

1120 E Ogden

Retail / Office Space For Lease | 3,674 SF | $20/SF NNN
1120 E Ogden Ave, Suite 101 | Naperville, IL 60563
Broker: Randolph Taylor rtaylor@creconsult.net | 630.474.6441

https://www.creconsult.net/retail-office-for-lease-1120-e-ogden-ave-suite-101-naperville-il-60563/?wpo_all_pages_cache_purged=1

9301 Golf

Golf Sumac Medical Offices For Lease | 998 - 2,853 SF | $28/SF MG
9301 West Golf Rd | Des Plaines, IL 60016
Broker: Randolph Taylor rtaylor@creconsult.net | 630.474.6441
https://www.creconsult.net/golf-sumac-professional-building-medical-office-space-for-lease-9301-golf-rd-des-plaines-il-60016/

The Basics of a Commercial Building Sale

Commercial property sales generated over $400 billion in transaction volume in 2020, with apartment buildings for sale and office properties leading the charge. However, one of the biggest challenges that commercial building owners face is understanding when and how to sell.

This article explores some of the primary exit strategies commercial property sellers use to market a commercial building.

When is the Right Time to Sell?

Sophisticated commercial real estate investors always have an exit strategy to help maximize profits by selling when the time is right. There are three main exit strategies to consider when selling commercial real estate:

Loan Maturity

Commercial real estate loans have a 25-year amortization with a 5- or 10-year term. Even though monthly loan payments are amortized over 25 years, the loan will be called or due between five and ten years. Rather than refinancing the existing loan, some investors begin the building sale process at least 12 months before the loan is expected to mature.

Maximize Occupancy

The net operating income (NOI) a property generates largely determines the commercial real estate value in space for rent. In a 6% cap rate market, a building with an annual NOI of $500,000 is worth about $8.3 million ($500,000 NOI / 6% cap rate). On the other hand, a property with an NOI of $300,000 in the same market is valued at $5 million. Once a commercial building is leased up and reaches maximum occupancy, it may be the perfect time to sell.

CapEx Expenditures

Many commercial real estate investors hold the property and collect cash flow until significant capital expenditures (CapEx) are on the horizon. Items such as replacing a roof or repaving a parking lot can take a serious bite out of profits. Owners who aren’t willing to invest additional capital in their property may decide to sell to another investor, even if the selling price is slightly below market.

Three Ways to Sell Commercial Real Estate

When the time is right, there are three main ways for an investor to sell commercial real estate, including lots of land or apartment complexes for sale:

1. Sell directly to another investor: Motivated buyers with financing arranged or cash in hand may be willing to close quickly on the right property at the right price. Sellers should know the fair market value of their property by ordering a commercial appraisal and compiling buyer documents to help the buyer move fast.

2. Work with a commercial real estate broker: Depending on the market size, commercial brokers may specialize in specific real estates niches, such as medical office space or workforce multifamily housing. A good broker will guide an investor through the selling process from start to finish, although sellers should plan on paying a sales commission of between 4% – 10% depending on property type and sales price.

3. Sell as an FSBO: “For sale by owner” commercial real estate deals are prevalent in some markets. FSBO sellers choose to represent themselves and cooperate with buyers represented by a commercial real estate broker. Because there’s no co-broker involved, sales commissions are usually less. However, sellers representing themselves must understand the local retail real estate market trends to avoid leaving money on the table by selling too low.

Documents That CRE Buyers Need

Before listing a commercial building for sale, sellers should gather the documents buyers need. Having the correct information makes it easier to attract qualified buyers and avoids having the property fall out of escrow due to unknown defects:

• Order a title report through a real estate attorney or escrow officer, allowing seven to ten days for a complete description.
• Update the Phase I environmental survey if it is more than six months old, allowing two to three weeks for the ecological study to be complete.
• Compile a list of repair and service records on crucial building components such as plumbing and electrical, fire and safety equipment, HVAC, roof, and parking lot.
• Put together a rent roll with information on each tenant, including payment history, lease abstract, and scheduled rent increases.
• Run profit and loss statements for the current year and the previous two years to demonstrate the revenue growth the property is generating to potential buyers.

Prepare the Property for Sale

Sellers should do these things before listing and marketing a commercial building:

Pre-listing property inspection

Hire a professional inspector to review the overall condition of the building and identify necessary repairs. This prevents a seller from being caught off guard when a buyer does its inspection once the property goes under contract.

Do repairs

Make the repairs discoverable by the pre-listing inspection to help increase the sales price. Sellers who sell with deferred maintenance can adjust the asking price accordingly, letting a buyer know the lower price is compensation for repairs that need to be made.

Appraise the property

After repairs have been made, hire a certified commercial real estate appraiser to walk through the property, run comparables, and determine fair market value. Factors affecting commercial property appraisal include location, rent roll, property condition, market trends, and recent sales of comparable properties in the market or submarket.

How to Market a Commercial Building Sale

Sellers should be prepared to proactively find the most qualified buyers for their property instead of waiting for a buyer to come. Essential parts of a commercial real estate marketing campaign include:

• A property marketing flyer with high-quality photos, a location map, a list of surrounding amenities, and current rent rates and building information.
• Add the property to the listing page of the commercial real estate firm representing the seller. Include a downloadable link to the flyer, detailed listing information, and multiple ways to contact the broker.
• Virtual tours make it easy for prospective buyers to preview the property without having to go on-site, especially for out-of-town investors who are narrowing down their top choices before coming into town.
• List the property on free commercial real estate listing websites like Crexi, the industry’s fastest-growing marketplace, with over 500,000 commercial listings totaling more than $1 trillion in property value.

Understanding the transaction from both sides of the closing table helps savvy owners sell fast and for a fair price. By knowing the local commercial real estate market and comparing similar properties, sellers can better appreciate and communicate the actual value of their commercial building to potential buyers.

Source: The Basics of a Commercial Building Sale | Crexi Insights

https://www.creconsult.net/market-trends/the-basics-of-a-commercial-building-sale/

Everything to Know About a 1031 Exchange

For decades, real estate investors have applied tax deferral strategies like the 1031 Exchange to avoid paying capital gains taxes on high-value assets. SDIRAs, qualified opportunity funds, tax-loss harvesting, primary residence exclusions, and 1031 exchanges can all defer capital gains taxes on the property. However, these deferral strategies often rely on the type of property and the tax filing status of their owners. Real estate investors commonly use IRS Code Section 103 to exchange properties, thus transferring and deferring tax payments.

Pending changes to the IRS tax code could impede attempts to defer capital gains taxes through Section 103. The Biden Administration desires to curtail like-kind exchanges of high-value properties in coming years. The changes could affect the tax burden on various investment property owners. It could impact those who rent out vacation cabins and those who manage multi-unit properties. Follow below to learn more about 1031 exchanges and how proposed legislation could affect the ability of investors to defer real estate taxes by tightening 1031 exchange rules.

What Are Capital Gains?

According to a recent article by Grace Enda and William G. Gale for The Brookings Institute, "a capital gain is the increase in value of an asset over time." Technically, write Gale and Enda, "a capital gain is a difference between an asset's current value and its' basis,'" with the basis representing a property's "cost to the owner." When the value of an asset increases over time, investors must, by tax law, repay some of that accrued value in the form of capital gains tax. This property tax bill becomes due at the time of sale.

Theoretically, property owners can use proceeds from the sale to pay off any capital gains in property taxes based on the accrual of value throughout ownership. Capital gains taxes apply only to realized profits, not unrealized profits based on assessed value, which is how capital gains taxes differ from annual property taxes. As such, capital gains property taxes are not levied on property currently within an owner's possession.

Types of Taxes on Capital Gains

There are two types of capital gains taxes imposed by the IRS: short-term and long-term capital gains. In his article "Capital Gains Tax" for Investopedia, Jason Fernando explains that long-term capital gains apply to assets listed for sale after at least one year of ownership. According to Fernando, property sold after at least a year of ownership is subject to capital gains taxes at rates of "0%, 15%, or 20%, depending on the taxpayer's tax bracket for that year."

Short-term capital gains tax applies only to property the owner holds for under a year. In these cases, profit from a property's sale is "taxed as ordinary income." Properties for under a year are usually subject to much higher tax rates than the long-term capital gains tax. Real estate investors often seek ways to defer because capital gains tax can be as much as 20% of a property's sale price.

How Can One Defer Capital Gains Tax?

There are a few legal methods by which real estate investors can defer capital gains taxes. In his article "How Do I Avoid Capital Gains Tax When Selling a House? ", Certified Financial Planner Matt Frankel outlines five standard methods. According to CFP Frankel, property owners can defer capital gains tax post-sale through SDIRAs, qualified opportunity funds, tax-loss harvesting, primary residence exclusion, and 1031 exchanges.

SDIRAs

SDIRAs allow future property owners to defer this tax by "owning real estate within a retirement account" (Frankel). Property owned within a self-directed IRA is not subject to capital gains taxes upon sale, even when "you sell for a profit." Taxes are only due when you finally withdraw from your IRA.

Qualified Opportunity Funds

Qualified opportunity funds are another way property owners defer capital gains tax. Opportunity funds encourage real estate investors — usually developers — to invest in economically depressed areas, often designated opportunity zones. A state or local government might offer tax incentives to encourage developers to invest in underserved communities. These tax incentives might include reduced, deferred, or forgiven taxes on capital gains.

Tax-Loss Harvesting

Another way real estate investors avoid taxes on capital gains is through tax-loss harvesting. For Forbes, John Schmidt and Rebecca Baldridge explain tax-loss harvesting as "when you sell some investments at a loss to offset gains you've realized by selling other stocks at a profit" (Can Tax Loss Harvesting Improve Your Investing Returns?)."

What does this mean? You only pay taxes on your net profit or the amount you've gained minus the amount you lost, which can reduce your tax bill significantly. In addition to lowering taxes owed, real estate investors often engage in tax-loss harvesting because it "frees up cash so you can buy new assets that may be more likely to generate positive performance."

Primary Residence Exclusion

Identifying a property as one's primary residence can lower one's tax burden. In her article "What Is the Section 121 Exclusion?", Lea Uradu explains that Internal Revenue Service Section 121 "allows homeowners to exclude up to $250,000 ($500,000 for joint filers) of capital gain from the sale of their primary residence."

With a primary residence, only capital gains exceeding this amount are reported and subject to CG taxes. While Section 121 is helpful for homeowners and often a life-saver, it rarely helps real estate investors with multiple properties. There are a few exceptions, however. If a property owner chooses to live in their rental property several years before selling, they could limit the CG taxes that come due when the property sells.

1031 Exchanges

In his article "How Do I Avoid Capital Gains Tax When Selling a House? "Matt Frankel identifies 1031 exchanges as "the most effective, commonly used strategy by real estate investors to avoid capital gains taxes." For those unfamiliar with the term, 1031 exchanges are also called "like-kind exchanges." One thousand thirty-one exchanges allow the owner of an investment property, such as a rental property, to sell their property and "use the proceeds to buy another investment property."

Until this new property is acquired, taxes on capital gains are deferred. When one wishes to sell this newly purchased property, the owner can "complete another 1031 exchange." This allowance permits property owners to "use the 1031 exchange strategy to defer capital gains tax indefinitely."

What Exactly is a 1031 Exchange?

Writing for Investopedia in his article "1031 Exchange Rules: What You Need to Know," Robert W. Wood explains like-kind exchanges in further depth. Wood notes that though 1031 exchanges allow real estate investors to defer taxes on capital gains, several restrictions exist. For instance, 1031 exchanges apply only to qualifying like-kind sales of property or other assets. Typically, a replacement property is of equal or more excellent value than the original asset. Misunderstanding the properties and situations to which 1031 exchanges apply could legally and financially imperil investors.

While the rules surrounding like-kind exchanges are "surprisingly liberal," Wood writes that "there are traps for the unwary." Special 1031 exchange rules apply to rental properties, vacation homes, and depreciable properties.

Recent changes to the Internal Revenue Code have tightened restrictions on applying 1031 exchanges to rental properties, particularly vacation homes. In 2018, the Trump administration altered the legal definition of 1031 exchanges. From then on, 1031 exchanges applied only to real estate. ​​Additional charges are expected in the coming months under the Biden Administration.

Current 1031 Exchange Rules

In his article "1031 Exchange Rules: What You Need to Know" for Investopedia, Robert W. Wood notes that like-kind exchange rules apply to timing, property type, and property value. First, Wood identifies two current 1031 exchange "timing rules." These include the forty-five-day Rule and the one-hundred-eighty Rule. According to Wood, the first timing rule relates to classifying one's replacement property. After a property sells, proceeds from the sale transfer to a qualified intermediary. The property seller cannot take possession of these proceeds until the initial forty-five-day period has expired. Otherwise, one could "spoil the 1031 treatment."

The seller must also inform the qualified intermediary that they intend to designate a replacement property during this period. The replacement property must be specified to the qualified intermediary during this time. If you are unsure which property to acquire, you can identify up to three properties to your qualified intermediary.

Of course, there is a second timing-related delayed exchange rule. The 180-Day Rule requires a seller to complete the purchase process of their replacement property within one hundred eighty days after selling their relinquished property. There may be a gap between the first property's sale price and the replacement property's purchase price. If this occurs, the real estate investor must pay CG taxes on this amount. Sometimes, this profit from real estate investing can be offset and exempted from immediate taxation. Investors must remember that 1031 exchange rules vary from state to state.

Like-Kind Exchange Rules for Vacation Homes

One thousand thirty-one exchanges require investors to exchange a relinquished property for a like-kind replacement property. As such, property owners cannot replace the personal property with investment property and vice versa, expecting to defer tax on capital gains. Matt Frankel explains in his article "1031 Exchanges: The Basics, Rules, & Requirements ". The Certified Financial Planner explains that in a 1031 exchange, "you can't sell an investment property, acquire a vacation home for you and your family, and call it a 1031 exchange." However, property owners can "sell a single-family rental home and acquire a retail building, as long as both assets" are business or investment properties.

There are ways to defer payment of capital gains during a vacation home or rental property sale. Robyn A. Friedman explains in the article "A Treasured Tax Break for the Smart Real-Estate Investor" for The Wall Street Journal. According to Friedman, property owners can convert their vacation home "from personal use to business use by renting it out for at least 14 days a year for two successive years before the sale." After this two-year period has concluded, the owner can exchange their vacation home and "defer capital-gains taxes as long as they continue to rent for a minimum of 14 days a year for two years after the sale." However, property owners must remember that only real property is covered. Friedman writes that "personal property is excluded from like-kind exchanges." Property owners should also not forget that rules surrounding tax-deferred in 1031 exchanges will likely change during the Biden Administration.

How 1031 Exchanges Could Change Under the Biden Administration

Rules surrounding deferred exchange and real estate tax as defined by the Internal Revenue Code could change significantly in the coming months as the Biden Administration weighs their consequences and benefits. According to Will Parker in his article "Biden Proposal Would Close Longtime Real-Estate Tax Loophole" for The Wall Street Journal, Biden's proposal would "abolish 1031 exchanges on real-estate profits of more than $500,000" for a single person. Any amount over $500K (or $1 million for married couples) could not be deferred and would be subject to annual tax on capital gains.

Parker writes that the desire to abolish exchanges of high-value properties has arisen from a flaw in the tax code design. According to Parker, "in theory, capital-gains tax from these deals eventually gets paid." However, many of today's real estate investors "buy and sell properties this way until they die, passing the capital gains on to their heirs tax-free at death."

Sometimes, investors pass capital gains taxes from commercial real estate, like multi-unit property for sale. The Biden Administration believes that these loopholes in Section 103 "disproportionately allow the very wealthy to avoid taxation." In addition to eliminating 1031 exchanges on high-value properties, the new administration plans to change the capital gains tax rate. This administration hopes to "raise the top rate paid on capital gains and dividends to 39.6% from 20%."

When Would Changes to Section 103 Occur?

As Lynn Mucenski Keck writes in her article "Like-Kind Exchanges To Be Limited Under Biden's Tax Proposals," changes to the Internal Revenue Code are challenging to implement. According to Keck, "many practitioners are still grappling with the impact of the TCJA on their tax planning." For those unfamiliar, the TCJA refers to the Tax Cuts and Jobs Act of 2017. Keck writes that the Biden Administration plans to implement their new changes to Section 103 by the end of 2021.

As such, the new "limited 1031 deferral provision [would apply to] exchanges completed in tax years after December 31, 2021." Those who have entered into exchanges under today's tax code would still be able to take full advantage of the 180-day time slot currently allotted. Though adjusting to these changes to Section 103 might be difficult, this buffer should help real estate investors and their financial planners navigate new property exchange rules.

 

Source: Everything to Know About a 1031 Exchange | Crexi Insights

https://www.creconsult.net/market-trends/everything-to-know-about-a-1031-exchange/

What is Owner Financing for Commercial Property?

In most commercial real estate transactions, the buyer finds a property, negotiates a purchase contract with the seller, obtains financing from a commercial lender, and closes escrow.

However, a growing number of property owners are discovering that they can directly provide financing to buyers to sell property faster, ultimately generating more potential profits from interest income.

Owner financing for commercial properties gives buyers and sellers more control over the transaction and enormous profits by cutting out the traditional commercial lender as a middleman.

What is Owner Financing for Commercial Property

Some commercial properties for sale by owner (FSBO) offer buyers owner financing. When a real estate sale by the owner occurs, the seller accepts regular monthly payments directly from the buyer instead of the buyer having to go through the time, trouble, and expense of obtaining a commercial real estate mortgage.

Depending on the market in which the investment property for sale by the owner is located, owner financing may go by a different name.

The terms seller financing, owner carryback, the owner will carry, carrying the note, commercial owner financing, and the owner brought financing are all used to describe owner financing. In some regions, owner financing is referred to as a ‘land contract,’ even if the property is a building versus commercial land for sale by an owner.

Pros and Cons of Owner Financing

There are several benefits and potential drawbacks to buyers and sellers who agree to owner financing:

Seller benefits include:

• The ability to sell a problematic property at a reasonable price with a faster closing and fewer days on the market.
• We are accruing monthly interest income for the seller as part of each mortgage payment from the buyer.
• We are paying capital gains tax pro rata with each buyer's mortgage payment instead of in one lump sum.
• The ability to sell the note to a real estate note buyer.
• Option to foreclose and take the property back if the buyer defaults on the owner-financed mortgage.

Seller drawbacks include:

• Sellers must conduct due diligence on the buyer when providing owner financing.
• Sales proceeds are received as part of mortgage payment instead of upfront.
• An attorney is needed to draw up loan documents, and an escrow company is used to collect and track buyer mortgage payments.
• Economic cycles may affect mortgage payment collection from the buyer.
• While the seller can foreclose if the buyer defaults, the seller may not want the property back.

Buyer benefits include:

• The buyer does not have to meet traditional lenders’ requirements of a commercial bank.
• Potentially easier to qualify for owner financing offered by a seller.
• Close of escrow usually is faster with owner-financed commercial real estate.
• Easier to negotiate owner financing terms such as interest rate, payment due date, and time of the note.
• Lower closing costs due to the absence of bank fees and financing costs.

Buyer drawbacks include:

• Not all sellers are willing to offer owner financing.
• Sellers may demand a higher price in exchange for carrying the note.
• Owners offering owner financing may also be less inclined to negotiate on purchase contract terms and contingencies.
• Sellers offering owner financing may still investigate buyer credentials such as credit, assets, and liabilities.
• Missed mortgage payments to the seller can lead to foreclosure and loss of property.

How Owner Financing for Commercial Property Works

Now let’s look at an example of how owner financing in commercial real estate can work.

In this scenario, we’ll assume the owner is offering owner financing to sell a difficult property, reduce upfront capital gains tax liability, and earn interest income. The buyer benefits by making a lower down payment and getting a very fair price on the property at an attractive interest rate:

• Purchase price = $2,000,000
• Down payment = $200,000 (10% of purchase price)
• Amount financed = $1,800,000 (owner carryback)
• Interest rate = 8%
• Amortization = 30-year repayment schedule
• Term = 10 years (remaining loan balance must be paid in full)
• Mortgage payment = $13,207 (principal and interest)
• Total interest received by seller = $1,499,460 over 10-year loan term
• Total payments received by seller = $1,756,531 (principal and interest) over the 10-year loan term
• Balloon payment received by seller = $1,542,928 at the end of the 10-year loan term
• Total proceeds received by seller = $1,756,531 (principal and interest) payments + $1,542,928 balloon payment = $3,299,459
• Original owner carryback amount = $1,800,000

Owner Financing Terms to Know

The terminology used and structure of an owner-financing mortgage document (also known as a promissory note) is similar to what traditional commercial real estate lenders use:

Amortization

Amortization is the schedule of periodic payments, including principal and interest. In the above example, the owner carryback amount of $1,800,000 is amortized over 30 years even though the loan term is for ten years.

Term

The loan term is until the borrower must pay off the remaining balance. While most residential mortgages have 30 years, commercial real estate loans typically have terms of 5, 10, or 15 years. In our example, the time of the owner-financed loan is ten years.

Balloon

The balloon is the remaining loan balance principal that must be paid at the end of the loan term. In the above example, the seller receives a $1,542,928 balloon payment in addition to the periodic mortgage payments already received from the buyer. The buyer and seller could agree to finance the remaining principal balance with a new owner financing note, or the buyer could obtain financing from a traditional commercial lender.

Promissory note

A promissory note details the terms and conditions of the owner-financed mortgage, including:

• Loan amount
• Repayment term
• Interest rate (fixed or variable)
• Repayment schedule
• Payment frequency (monthly, quarterly, etc.)
• Payment amount (principal and interest)
• Property taxes and insurance are included in the payment amount
• Balloon payment details
• Late payment fees
• Prepayment penalty
• Due-on-sale clause (requires loan to be paid in full if the buyer sells the property before the end of the loan term)

Owner financing for commercial property can create a win-win situation for sellers and buyers. Sellers who provide owner financing can benefit from faster marketing time, additional profit from interest income, and spreading the payment of capital gains tax over a more extended period.

Buyers who buy property from a seller carrying the note can benefit from having flexible loan terms, a faster close of escrow, and lower loan fees since no commercial lender is involved in the transaction.

 

 

Source: What is Owner Financing for Commercial Property? | Crexi Insights

https://www.creconsult.net/market-trends/what-is-owner-financing-for-commercial-property/