The 1031 Exchange And What It Means For Today's Commercial Real Estate Pricing
We've had multiple shutdowns, millions are still unemployed, and the global economy seemingly continues to slip into a further hellscape with each new day. So, why the hell are commercial real estate prices stagnant, or even increasing across all asset types?
If there were ever a blog post to inform today's CRE players about what's going on with the current asset prices, consider this your new copy & paste link. The 1031 Exchange is causing major price stabilization amongst commercial deals, and most buyers want nothing to do with it.
In a recent interview with Dwight Kay, Founder, and CEO of Kay Properties and Investments states, “Many investors are afraid of COVID-19 and the effects on real estate values, so we are seeing a variety of cash investors walking away from deals.” He goes on to include, "However, for those who are in a 1031 exchange, if they were not to complete the exchange, they would be subject to 40%-plus in taxes. As a result, even in the midst of uncertainty due to the Coronavirus, 1031 exchange investors are proceeding with transactions to defer a large tax bill.”
Now, here's where the buyers are getting discouraged and 1031-Exchangers are creating a double market vacuum. Kay continues further in the interview, “Many 1031 buyers are willing to transact at market pricing due to a looming tax bill...” says Kay. “...Many non-1031 buyers are taking more of a wait and see approach as they tend to be more of a discretionary buyer without a motivating factor such as a tax bill to defer. In the midst of an uncertain economic and pandemic environment, many non-1031 buyers are being incredibly cautious as they are waiting to see how these recent events will affect pricing in the future.”
1031'ers are more than willing to trade at market value to defer risk, while traditional buyers are seeking a COVID discount. This is creating a major rift between players, and for the foreseeable future, this trend will likely continue.
Not All 1031-Exchange Players think alike
The DST strategy, in particular, has become popular for exchange buyers looking to hedge against the downside of this recession. Kay states, “We are seeing many 1031 exchange investors increasingly searching for DST properties that are debt-free—with no long-term mortgages encumbering the property—in an effort to potentially reduce risk”. “...We are also seeing many investors who previously may have decided to purchase a single NNN property such as a pharmacy or retail building for $2 million to $5 million instead invest in multiple DSTs, which allows them to invest in multiple properties, multiple asset classes, and multiple geographic locations. Although this diversification does not guarantee profits or guarantee against losses, it is a strategy that many 1031 exchange investors are choosing in the midst of the market uncertainty from the pandemic.”
Unless a new bill is introduced to counteract the 1031 rulebook, this trend of exchanging properties is anticipated to continue throughout 2020 and most of 2021.