Most investors have experienced a run up in real estate values; and with a prospective sale of a real estate asset pending, in consultation with their accounting professionals, they begin to explore how to defer substantial capital gains in the most efficient manner. Utilizing and executing a successful IRC 1031 Exchange Provisions is the principal vehicle that was retained in the recent Tax Act.
The IRC 1031 Compliance timelines require an “Identification” of your trade replacement property within 45 days of their completed sale of the relinquished property; and, then, an additional 135 days to complete the purchase of the new property that tax deferral transaction. Easy…Right!
Well, not so fast.
The challenge, in part, is to define your client-specific investment objectives:
- Defer your Capital Gain liability…. at what price?
- Replace/increase the cash flow of prior investment property;
- Secure a predictable and stable stream of income;
- Achieve a risk-adjusted return on that new asset.
- Make decisions that match up with your client-specific goals;
- A lot more than the “Art of the Deal” gamesmanship; it is the execution of your shorter-term (deferral) and longer-term objectives;
- Do you have an “Exit Strategy?”
What are the factors that impact those objectives?
- Location, Location, Location, as always…but, in addition,
- Who is the Tenant and tenant credit worthiness; Never more important;
- Who is the Tenant Guarantor: Corporation, Franchisee, and Personal Guarantors; who stands behind the tenant obligations, including rental payments?
- What is the lease contract base term?
- Impact on securing financing best solutions?
- Does that match your holding period as planned?
- Verify Lease Structure: Is it a true, absolute NNN?
- OR Is it being marketed, as a “Net Lease”, only to find there are contingent liabilities for roof and structure; parking lot; other common areas expenses?
- Listing Brokers say, “Oh, you meant absolute NNN?” Brokers, please…
- In the past, as an Investor, you were compensated for the additional potential liability of Double Net lease structure. There was a distinct price variance from absolute NNN (no landlord responsibilities, going forward) and NN (with some additional ongoing landlord expenses); you used to be compensated 50-75 bps…No longer; as these NNN properties have become “commoditized” as a fixed-income alternative;
- Part of the reason that these NNN assets have received some ‘investment cache’, in the last ten years is that Investors wish to get out of management operations, whether “hands-on or fee-based”;
- Rental increases: They can range from 1-2% annually to 5% every 5 years; to 7.5% every 5 years; to 10% every 5 years; to Flat rental structure like traditional Walgreens;
- Are there renewal options (always at Tenant’s option?)
- Is there a “FROR” First Right of Refusal provision for tenant to match offers and the timeline for notices and tenant response may impact your own 1031 schedules?
- Tax free states also impact selection for future filings and administrative issues;
So, candidly, there is a lot to consider, there is a ‘helluva’ lot more than simply comparing “Cap Rates”.
Also, you are not alone as a Buyer/Investor.
There will be literally, dozens of other investors, at exactly the same time frame, that you are seeking your 1031 Trade replacement solution; and they are your effective competitors. Our experience of years of successful 1031 executions, representing both NNN buyers and NNN sellers, suggests that investing the time to address the above issues are actual mission critical to your success. We will discuss how to structure your offers to secure best results in our next blog, based on your objectives; rather than feeling your are a ‘victim of tax circumstances’ and making decisions that you might not otherwise make, simply to avoid (I mean “defer”) your tax obligations.
We believe that you must negotiate from the relative strength of your position, whatever that may be. Acute NNN market intel informing your best options. 1031 Buyers have played a significant role in the last ten years to effectively ‘conspire’ with Sellers, who would rather ‘overpay’ for their 1031 replacement than pay their taxes. This has skewed price dynamics over time.
Our next blog installment will expose the actual process, both strategy and tactics, that produce successful 1031 completions in a highly competitive NNN market for the ‘Best-of-Breed’ NNN assets.
Remember, as stated in prior blogs, “ Not all Net Lease properties are the same”.
Sean O’Shea, Managing Director
The O’Shea Net Lease Advisory
700 S. Flower St. #2650
Los Angeles, CA 90017
(213) 226-8719 – Direct
(213) 226-8750 – Fax
(310) 433-8851 – Mobile
CA LIC #01438647
CA LIC #01844438