Owners of investment real estate consider 1031 Exchanges for many reasons. Two of the most common reasons are capitalizing on new opportunities or reducing the risk associated with the current property. The next two articles will compare the potential opportunities and risk mitigation characteristics present in Fee Simple and Delaware Statutory Trust (“DST”) replacement properties.
Our discussion begins with the opportunities unique to Fee Simple property. Fee Simple property means outright ownership of property; property owned either directly as an individual or through a legal entity such as an LLC or Partnership. Chances are that this is how most readers own their current properties and there is merit behind this approach.
There are two opportunities unique to Fee Simple replacement property. The first is the ability to perform value-add work on the property. Value-add work encompasses not only the physical property itself through remodel, renovation or development efforts, but also the management of the property through expense control and improving the overall tenant profile. It goes without saying that executing a value-add strategy is generally involved and hands on, however it has the potential to produce strong returns when done correctly and the market is receptive.
The second opportunity unique to Fee Simple replacement property is the ability to directly control the financing of the property. Owners who want to continue to grow their real estate portfolio often leverage their properties to fund additional acquisitions. Refinancing a property is also a potential opportunity to receive tax-free liquidity that can generally be used at the owner’s discretion. I believe financing flexibility is one of the strongest features of Fee Simple property, however it should be noted that it is not without its risks as most debt will be recourse, meaning the owner is personally liable for the debt were the property to underperform.
Delaware Statutory Trusts (DSTs) present their own set of opportunities that may be attractive to investors considering an exchange. The first opportunity lies in the ability to access many of the nation’s top property management firms. The size and experience of these managers enables them to drive market rents, the means to “accelerate” revenue offsetting depreciation through cost segmentation, and professional bookkeeping on behalf of their investors. The second opportunity, higher potential cash flow, is particularly relevant to current owners in the Puget Sound region as property appreciation has generally outpaced rent growth, leading to a lower than desired Return on Equity. Last of all, due to the fact that DST ownership can easy be divided and assigned to beneficiaries, they present a unique ability to facilitate seamless estate planning, while still realizing the step up in tax basis consistent with all real estate.
Both property types have inherent opportunities and risks that should be considered when evaluating replacement property options. Determining which property type is suitable for an owner considering an exchange depends on the investor’s individual situation, as well as their financial and lifestyle objectives. If you are contemplating the transition of one, or all, of your properties, do not hesitate to reach out to us at 206-686-2211 to discuss the various options.
Austin Bowlin, CPA – Partner at Real Estate Transition Solutions, provides exit strategy analysis, execution, income and equity replacement options for investment property owners. If you have questions relating to your investment property ownership, you can email him at firstname.lastname@example.org or call (206) 686-2201.
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 Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services through Concorde Asset Management, LLC (CAM), an SEC registered investment adviser. Real Estate Transition Solutions is independent of CIS and CAM.