1031 Exchange Buyers: ‘Essential’ for CRE Recovery
This typically active investor category is expected to regain its confidence quickly and take advantage of extended deadlines, estimates Tom Georges of Stan Johnson Co.
Since January’s first reported case of COVID-19 in the U.S., our economy has experienced massive volatility. We’ve seen unemployment numbers surge and millions of businesses closed with, by some estimates, at least 3 percent of all restaurants closing their operations permanently.
Uncertainty is the new normal, at least for the moment, as professional analysts and arm-chair prognosticators try to predict when businesses will be permitted to reopen on a wide-scale basis and what will be the extent of the long-term damage to the economy. Unfortunately, there is no magic formula or any single event that is likely to jump-start the economy and quickly take commercial real estate investment sales activity back to pre-crisis levels. In the meantime, one group of investors, 1031 exchangers, continues to be active in the market, and their continued activity makes them a very essential part of our recovery.
Since it was first introduced in the 1920s, property owners have utilized Internal Revenue Code 1031 to defer taxes on capital gains by exchanging the sale proceeds and retired debt of real property into like-kind property. As a result, 1031 exchanges have become tremendously valuable in providing investors a method for keeping more of their investment dollars, allowing those dollars to work for themselves and the overall economy. Additionally, 1031 investors help to support property values by keeping a steady supply of buyers in the marketplace that are motivated to act within the timing requirements of their individual exchanges.
Exchanges on Hold
At the onset of the health crisis, 1031 exchange activity, with all other investment sales activity, saw immediate and significant declines. Some estimate 1031 closings dropped as much as 33 percent in the mid-March to mid-April time frame. In the coming months though, investors will regain their confidence, and they’ll take advantage of the recent deadline extensions that pushed both the 45-day identification deadline and the 180-day closing deadline to July 15 for all 1031 exchanges with original deadlines falling between April 1 and July 14. With renewed confidence and longer timelines, experts predict we’ll see an increase in 1031 exchange closings as we approach summer, especially as today’s market conditions drive a flight to quality.
As exchangers hunt for high-quality investments, they will undoubtedly turn to the reliability and predictability of net lease properties, which can provide minimal to no landlord responsibility as well as consistent income from strong-credit tenants with solid balance sheets. While not without risk, many tenant sectors in the net lease space continue to thrive. Some of today’s essential businesses include drugstores, grocery stores, dollar and discount retailers, and home improvement stores. Also faring well during the COVID-19 crisis are essential medical facilities like dialysis and urgent care centers, along with last-mile logistics and much of the industrial sector. And buyers can easily find high-quality net lease assets for sale across all these property sectors and more, even in today’s environment.
How much the 1031 buyer will contribute to the recovery of the economy and the commercial real estate sector in the latter part of 2020 and into 2021 remains to be seen. For the past several weeks, buyers and sellers alike have paused on pending transactions to reevaluate the marketplace and their willingness to move forward. As we slowly approach what we hope is the end of the pandemic crisis and begin the recovery process, however, we believe that the 1031 buyer will continue to play a very essential part.
Tom Georges is a director at Stan Johnson Co.