Clients with cash may have a real property shopping binge in their future.<\/p>\n\n\n\n
Key takeaways:<\/strong><\/p>\n\n\n\n Reading news reports about the state of the real estate market in the U.S., investors might well decide to wait out the market turmoil, particularly as it relates to pondering financing options. For investors with cash and a long-term outlook, though, this may be an optimal time to use the Sec. 1031 tax-deferred exchange to reposition their portfolio.<\/p>\n\n\n\n First, let\u2019s put the question of investment strategy aside and review how we got to where we are today.<\/p>\n\n\n\n You may remember the last time credit for real estate transactions dried up. After the 2007 financial crisis, the lending market stalled while lenders assessed their real estate loan portfolios and recalibrated underwriting procedures and policies. The policies that evolved during that time, due to drastic action by the federal government to spur spending and deter an even bigger recession, included unprecedented reductions in the federal funds rate. Known as quantitative easing (QE), those actions increased investment in the broader economy and in real estate assets. The Federal Reserve\u2019s purchases of Treasury bonds flooded the economy with cash needed to keep the U.S. economy humming.<\/p>\n\n\n\n In the last quarter of 2013, the Fed started to ease off on its QE program and decided to reduce its holdings in Treasury securities. By October 2014, after reaching $4.5 trillion in assets, the Fed halted those purchases. In early 2020, due to the COVID-19 pandemic, the Federal Reserve again initiated QE to stabilize the disruption in the monetary and supply chain markets. The use of QE measures during the early stages of pandemic, together with low supply and high demand, led the real estate market to surge in almost every region and for almost every type of real estate. With the U.S. economy stabilized by the end of the first quarter of 2022, the Fed completed a final round of Treasuries purchases. By that time, QE purchases had reached $6 trillion.<\/p>\n\n\n\n The expression \u201cwhat goes up, must come down\u201d addresses the circumstances the U.S. found itself in after QE stopped. QE measures, used over a long period, eventually contribute to market inflation and rising interest rates. A number of other factors over the past year\u2014among them, the war in Ukraine leading to higher energy and food costs, China\u2019s zero-tolerance Covid policies affecting global supply chains, rising wages and labor shortages\u2014contributed inflationary pressure. The Fed rolled out seven rate hikes in 2022 alone to stave off inflation. So far this year, there have been another three increases. The specter of a recession goes hand-in-hand with those rate increases. No doubt, you\u2019ve heard the predictions from financial analysts and pundits.<\/p>\n\n\n\n It\u2019s no secret to real estate pros that the market is incredibly sensitive to Federal Reserve actions. So in the second half of 2022, we witnessed an abrupt slowdown in financing for commercial and residential loans. Now we watch the lending markets daily, perhaps with eyes wide shut in disbelief, to see what the fallout may be from continued hikes.<\/p>\n\n\n\n With inflation moderating, National Association of REALTORS\u00ae Chief Economist Lawrence Yun has called on the Fed to halt increases. That\u2019s because a more stable interest rate environment will spur sales and reduce downward pressure on valuations. NAR\u2019s latest home sales data shows that, after the big pandemic-era runup, 31% of metro markets saw home price declines in the first quarter. The downturn has been more pronounced in commercial real estate, primarily because of office space vacancies due to hybrid or remote working policies.<\/p>\n\n\n\n The recent regional bank crisis is not helping, as most commercial real estate loans come from those banks. Some analysts are predicting as much as a 40% decline in real estate values because of the lack of credit and other market forces.<\/p>\n\n\n\n Agents and brokers who have been through previous cycles know that slumping prices are an opportunity for investors and borrowers who have stockpiled cash and don\u2019t need bridge, construction, acquisition or other financing. Such buyers are well-positioned to take advantage of the financing and valuation hiccups affecting various sectors of the real estate industry.<\/p>\n\n\n\n Additionally, investors can take advantage of the market by targeting real estate assets that already have land entitlements secured by the relevant governing authorities and that the owner must sell due to liquidity and other refinance deadlines on their existing debt. Our firm is hearing anecdotally on a daily basis that more lenders are accelerating or calling debt due before maturity due to defaults under the loan documents or even foot faults made by borrowers or their guarantors, coinciding with the liquidations of portfolio assets. These are unfortunate circumstances, but they can work to the advantage of long-term opportunistic real estate investors (as opposed to short-term speculators, who will not be able to avail themselves of the solutions discussed in this article for a number of tax reasons). Finding the right buyers in such circumstances can keep the wheels of commerce moving so that the market can recover more quickly, even in the face of an anticipated recession.<\/p>\n\n\n\n For many investors, the 1031 exchange provides the perfect vehicle for repositioning a real property portfolio.<\/p>\n\n\n\n Tax Regulations Sec. 1.1031(a)-3 provides a unifying definition of what assets comprise real property for Section 1031 tax-deferred exchanges. As set forth in the Tax Cuts and Jobs Act of 2017 (TCJA), assets that were formerly classified as \u201cintangible\u201d or \u201cpersonal\u201d may be like-kind replacement property, giving investors more selections for like-kind replacement property. For example, “land and improvements to land,\u201d which include those that consist of inherently permanent and structural components of land, unsevered natural products of land, and water and air space superjacent to land, are real property. Also, leaseholds, options, easements, and land development rights are real property.<\/p>\n\n\n\n Engaging in an \u201cimprovements\u201d or \u201cbuild-to-suit\u201d reverse exchange may be more viable given declining market prices and continued demand for certain classes of real property assets such as multifamily, industrial, and certain mixed-use properties for logistics, digital infrastructure and flex-work spaces. An investor can either (1) Target and \u201cpark\u201d a new real property acquisition that may be undervalued with an exchange accommodation titleholding party (known as an EAT) and use some combination of cash and short-term financing (such as private equity hard money loans or equity from pooled financing credit lines) to loan the funds to the EAT, who would then park the acquisition or replacement property during the 180-day exchange period on behalf of the taxpayer, or (2) Sell a targeted relinquished property using a qualified intermediary and instruct it to provide those funds to the EAT to acquire, park and improve a replacement property based on the 180-day exchange period for the relinquished property. The act of parking a property with the EAT is required so that the taxpayer does not hold title to both the replacement and relinquished properties at the same time.<\/p>\n\n\n\n If you have investor clients seeking to reposition portions of their portfolio and they in fact have real property they\u2019re considering selling, here are factors to consider in making a build-to-suit exchange work.<\/p>\n\n\n\n Any shift in a real property portfolio during uncertain times and under uncontrollable circumstances is going to make investors think twice before spending time and money to structure an improvements exchange. But as a racing fan, I often quote someone I have admired over the years, Mario Andretti, who famously said, \u201cIf things seem under control, you are just not going fast enough.\u201d<\/p>\n\n\n\n There is always opportunity in all markets and sectors. Investors who plan or who direct the planning of the composition of real property portfolios with commitment and intentionality are the dreamers and the makers of dreams. They create places, structures, shelters, and life-sustaining systems that are one of the major economic drivers of prosperity in the U.S.<\/p>\n\n\n\n \u00a9National Association of REALTORS\u00ae Clients with cash may have a real property shopping binge in their future. Key takeaways: Reading news reports about the state of the real estate market in the U.S., investors might well decide to wait out the market turmoil, particularly as it relates to pondering financing options. For investors with cash and a long-term outlook, … <\/p>\n\n
\n\n\n\nThe Last Credit Crunch <\/h2>\n\n\n\n
Inflationary and Recessionary Cycles <\/h2>\n\n\n\n
Once Again, Lending Dries Up <\/h2>\n\n\n\n
Good News for Bargain Hunters? <\/h2>\n\n\n\n
Working an Irresistible Acquisition Into a Tax Exchange <\/h2>\n\n\n\n
Making It Work <\/h2>\n\n\n\n
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Reprinted with permission<\/p>\n","protected":false},"excerpt":{"rendered":"