1031 Tax Deferred Exchanges Made Achievable
Lessons learned from the benefits of net lease
Apr 5, 2010 | By Rick Liljedahl, CRE Net Lease Capital Advisors, Boston, MA
After a multiple exchange trial
by fire, one developer executive
goes 1031 full time…
My full-emersion introduction
to 1031began nearly five years ago,
when my then employer embarked
upon a property sell-off involving
45 distinct partnerships and totaling
in excess of $200 million. Of
these 45 partnerships, 28 elected
to defer capital gains taxes via
a 1031 tax deferred exchange. A
seminal event, this full liquidation
involved numerous moving parts
and unforgiving deadlines.
Under the guidance of a boutique
advisory firm, we turned
our focus to the net lease market.
Net lease properties can be purchased
readily, like off-the-shelf
products, in a range of sizes, assuring
availability for an exchange
when needed. Triple net leases
place the management of the real
estate on the tenants’ shoulders
and would enable the partnerships
to transition from active to more
passive ownership, backed by the
guarantee and cash flow of highcredit
tenant corporations. So, all
of the acquisitions would target
triple net leased properties, leased
to investment grade tenants, on a
long-term basis.
Two exchange alternatives presented
themselves: exchange into
highly leveraged (zero cash flow)
net lease property which allows
for minimal equity investment,
and exchange into cash flow net
lease deals which provide reliable
return. We studied each partnership,
its composition, tax structure
and particular objectives, and
customized strategies to achieve
their long-term goals.
A mix of highly leveraged and
cash flow properties was tailored
to suit the diversification and return
preferences of each partnership.
With the 45 day clock already
ticking, the team sifted the market.
In six months, we had downsized,
liquidated the entire portfolio,
purchased over 40 replacement
properties, and satisfied each
partnership’s requirement. And I had successfully written
myself out of a fine job! Intrigued
by the strategic advantages afforded
by net lease, I proceeded
to join the advisory firm I had
enlisted for the transaction, Net
Lease Capital Advisors, out of
Boston, which focuses entirely
on combining the net lease market
with finance and tax planning for
better seller outcomes. Today, I enjoy educating diverse
clients who, though they have
achieved success in their own
arenas, often lack awareness of the
benefits of net lease.
Lessons Learned
Execution: In 1031 exchanges,
the tax payer gets one chance.
Strict deadlines are triggered by the
sale of the relinquished property;
45 days to identify replacement
property, and 180 days to close.
The process of buying a quality
replacement investment in that
time can be daunting due to the
numerous moving parts involved,
from a changing property market
to the need to acquire funds in a
tightening financing environment.
Moreover, the seller of prospective
replacement property has an upper
hand in price negotiations, aware
of the deadlines the taxpayer faces,
and may even back out. The net
lease property’s ready availability,
long term lease, and corporate
guarantee of rent income provides
an effective antidote to the uncertainties
faced in an exchange.
Scope: A combination of highly
leveraged and cash flowing net
lease deals offers diversification
and may be combined to achieve
precise outcomes of investment return
and take-away cash. While net
lease properties are widely available,
niche experts can often locate
off-market deals and deals still in
the making, and are equipped to
generate a wider range of alternatives
tailored around particular
financial goals.
Financing: Financing may
drive a transaction, yet the finance
markets are retracting as a result
of the “subprime” upheaval and
spillover to the CMBS market.
In the past month, we have seen
several sales fail or stall due to
scarcity of acceptable financing.
Portfolio lenders are filling the
gap by offering a range of fixed
rate debt, priced over treasuries
or the Federal Home Loan Bank
(FHLB). Mezzanine loans behind
traditional CMBS loans now
achieve financing as high as that
associated with credit-financed
net lease properties. Providing
rates of below 6%, with loan terms
of between 10 and 25 years, these
lenders are sustaining a still active
market.
Alternatives for replacement
property, financing structures,
credit, and strategic goals are
numerous and changing. In this
climate, the advice of specialists
can be invaluable.
Tel: 781-878-4540 / Fax: 781-871-1853 / 800-654-4993 / nerej@rejournal.com / www.rejournal.com
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