Unexpected events and economic changes impact real estate investors every year, but 2020 stands out like no other. The global pandemic abruptly and dramatically disrupted multifamily housing, office, retail, and hospitality sectors of the industry. Inevitably, savvy investors shifted focus and strategy as long-term tenant trends and investment opportunities started to emerge.
Location and asset class are always key factors in a real estate transaction, and they will play an even bigger role in 2022. If you are thinking about selling your investment property, consider the flexibility of a tax-deferred 1031 Exchange. Here are 10 trends impacting the location and asset classes of 1031 Exchange properties in the new year.
One of the more notable changes in renter trends is the flight away from dense, urban, gateway cities such as San Francisco, Los Angeles, and New York. Due in large part to the pressure felt from COVID-19 and social unrest, dense urban centers lost their appeal as desirable amenities such as bars, restaurants, entertainment, and public transit were no longer available. For many, working from home became a new productive lifestyle. Multifamily renters, seeking higher quality of life, looked to suburban and less dense urban markets offering more available space, parks, and affordability.
The pandemic also placed significant, and often insurmountable, pressure on small to mid-size retailers, restaurants, and companies without adequate reserves to weather the storm. Coupled with municipalities’ residential and commercial eviction moratoriums, many property owners found themselves stuck in limbo with non-paying tenants and no sign of relief. Larger tenants with strong corporate balance sheets were less impacted, or at least have more staying power because of sufficient reserves.
As the workforce stayed home, the efficiencies of ecommerce were revealed and shifts in retail spending dramatically accelerated online. As e-commerce sales grow to represent a larger portion of total retail sales, CBRE predicts the U.S. will need an additional 1.5 billion square feet of industrial space within the next five years. The benefits of this trend are not for institutional capital alone. Small and mid-sized investors can co-own high quality industrial assets, such as Amazon Fulfillment Centers, through 1031 Exchanges into DST properties.
Broad implementation of work from home (WFH) policies by employers will undoubtedly impact the location preferences of multifamily renters who are no longer beholden to a particular city for employment purposes. While some outlets have reported a mass exodus from all large cities, the data shows that a few cities such as San Francisco and New York City have experienced significant decline, while most others have held steady. This begs the question of whether COVID-19 provided the motivation for individuals to move, but not the opportunity.
Moving while “stay-at-home” orders are in place along with the threat of contracting COVID-19 is a difficult proposition. Especially for those with children and parents who are trying to adapt to online learning. The number of individuals moving from one city to another declined significantly in 2020 compared to a year earlier. We project 2021 to be a record year for relocation as coronavirus vaccinations become widespread and children enter summer break.
Across the nation, the demand for suburban office parks is rising as more skilled workers move back to suburbs, due to concerns about housing costs, education quality, and the civil unrest experienced in some larger cities. The smaller suburban offices are attractive to employers as well, with lower leasing costs, closer proximity to supply chain operations and manufacturing, and the ability to attract well-educated workers desiring less-crowded communities.
That being said, the work-from-home workforce does not represent the death of the commercial office. Facebook released the results of an employee survey indicating that approximately 50% of their employees planned to utilize WFH options. With a potential half of employees coming into the office and significant additional space required for those that do, the commercial office market may still be in equilibrium.
For the companies that made it through the first round of COVID-19 related shutdowns, the Winter 2020 – 2021 shutdowns may prove to be the nail in the coffin. Small businesses operate with notoriously low reserves, historically preferring to invest in growth. The average American renter also holds alarmingly low reserves. Evictions have been held artificially low for small businesses and renters who are negatively impacted by the pandemic due to moratoriums. Once these moratoriums are lifted, there may be a dramatic shake up in many markets.
The moratoriums are a perfect example of unprecedented government regulation. Are they necessary to preserve a semblance of stability? Perhaps. However, one must ask whether regulation moratoriums are only delaying the inevitable. Coupled with a single-family housing market that remains out of reach for many American renters, all signs point to renters relocating to more affordable markets and renting longer.
You may be asking yourself, what are the trends that real estate investors can get in front of in 2021? While the pandemic has been devasting for many businesses and employees, it has led to greater flexibility for many white-collar workers to work and live where they want.
We expect there to be growth in markets that present high quality of life – friendly neighborhoods, low crime, affordability, nice weather, access to recreation, healthy lifestyles – as tenants revaluate where they want to call home. Markets that are considered highly livable include: Charlotte, Charleston, Austin, Indianapolis, Boise, Sacramento, Phoenix, Grand Rapids, Minneapolis, Las Vegas, Bozeman, Columbus, many cities in Florida, and even Bentonville, AR.
Single family housing starts remain low, in part due to the increase in the cost of building supplies and slowdown of permit processing while municipal agencies work from home. Coupled with all-time low interest rates and indications from the Federal Reserve that they intend to hold rates low through 2023, housing prices may continue to stay high, thus forcing current renters to rent for the years to come.
Economic uncertainty tends to motivate individuals to postpone starting families, as evidenced by a historically low birth rate throughout 2020. The start of a new family is one of the primary motivations for individuals to purchase a home and move beyond renting. If this is not occurring and the cost of home ownership is out of reach, Americans will rent longer, and multifamily demand will grow.
High quality multifamily properties tend to be occupied by tenants who have been less impacted by the pandemic, hence they have maintained high occupancy and rent collection levels throughout 2020. Will tenants who can afford to pay rent move to lower quality and more affordable properties? So far that has not been the case, largely because of how much time is spent at home due to stay at home orders.
Lastly, what property types should investors avoid in 2021? Unfortunately, the negative impacts of the pandemic have not been evenly distributed across our economy and society. Individuals who work within the service sector of our economy and small businesses have been undoubtedly hit the hardest – especially those located in gateway cities where the regulatory response to COVID-19 has been the strongest.
Many service-sector tenants cannot, and will not, be able to pay rent once moratoriums are lifted, leading to a surge in vacancy and corresponding decline in lower quality “Class C & D” multifamily properties’ income. Investing in these properties will not be for the faint of heart. The same challenges exist for commercial property leased to small businesses and hospitality and hospitality companies.
Lastly, with unprecedented levels of debt and steep declines in tax revenue, government leased buildings also face significant uncertainty and present little, by way of upside, to compensate investors for the risk assumed.
While no one has a crystal ball, these trends may help real estate investors make informed decisions about the factors impacting 1031 Exchange replacement properties. Under IRS rules, the broad definition of like-kind property offers the 1031 Exchange investor unique flexibility on the location and asset classes of replacement properties. Investors may exchange one asset class for another or exchange into multiple properties and locations provided IRS rules are strictly followed.
Austin Bowlin, CPA is a Partner at Real Estate Transition Solutions. As a licensed 1031 Exchange Advisor, Austin helps investment property owners navigate and execute 1031 Exchanges and Delaware Statutory Trusts (DSTs) investments. To schedule a free consultation call 888-755-8595.
There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal. Past performance is not a guarantee of future results. Potential cash flow, returns and appreciation are not guaranteed. IRC Section 1031 is a complex tax concept; consult your legal or tax professional regarding the specifics of your particular situation. This is not a solicitation or an offer to sell any securities. DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney.
The information herein has been prepared for educational purposes only and does not constitute an offer to purchase or sell securitized real estate investments. Such offers are only made through the sponsors Private Placement Memorandum (PPM) which is solely available to accredited investors and accredited entities. DST 1031 properties are only available to accredited investors (generally described as having a net worth of over $1 million dollars exclusive of primary residence) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney. There are risks associated with investing in real estate and Delaware Statutory Trust (DST) properties including, but not limited to, loss of entire investment principal, declining market values, tenant vacancies and illiquidity. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. Diversification does not guarantee profits or guarantee protection against losses. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor. This material is not to be interpreted as tax or legal advice. Please speak with your own tax and legal advisors for advice/guidance regarding your particular situation. Securities offered through Aurora Securities, Inc. (ASI), Member: FINRA/SIPC. Advisory services offered through Secure Asset Management, LLC (SAM), a Registered Investment Advisor. ASI and SAM are affiliated companies. Real Estate Transition Solutions (RETS) is
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