1031 exchange demand is driving the majority of transaction volumes during the pandemic. While some new opportunistic capital has entered the market, the majority of investment demand for CRE assets is coming from 1031 exchange buyers. The activity has not only helped to prop up transaction volumes but has also helped to stabilize pricing through the pandemic.
“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,” Dwight Kay, founder and CEO of Kay Properties and Investments, tells GlobeSt.com. “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.”
While these exchange buyers have helped to stabilize pricing broadly, they are also creating somewhat of a double market. Non-exchange buyers are looking for a COVID discount, and they are able to wait for it. “Many 1031 buyers are willing to transact at market pricing due to a looming tax bill if they were to not,” 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.”
Exchange buyers, however, are also looking for opportunity. Many are trading into other markets or asset classes. “We have seen many 1031 exchange investors opting to exchange out of their current properties and into new markets, asset classes and ownership structures such as Delaware Statutory Trusts, Tenants-in-Common deals and triple-net-lease properties,” says Kay.
The DST strategy in particular has become popular for exchange buyers looking to hedge against the downside of this recession. “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,” says Kay. “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 into 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.”
Kay expects 1031 exchange demand to remain a characteristic of this downturn into next year. “We do expect 1031 exchange transactions to continue apace through 2020 and 2021, unless that is, if there is a change in tax law that restricts or eliminates them,” he adds.
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