For property owners considering taking advantage of today’s busy real estate investment market, Heartland Real Estate Business (HREB) has interviewed three companies specializing in 1031 exchanges to give you an insider’s opinion of the market. The professionals we spoke to were: Suzanne Goldstein Baker, vice president and division manager, and Thomas Dunck, vice president and Midwest regional manager, with Chicago-based Investment Property Exchange Services (IPX 1031); B. Wyckliffe Pattishall Jr., president and CEO of the Chicago Deferred Exchange Corporation; and Richard Kaplan, president of Chicago-based Syndicated Equities.

HREB: Describe the current climate for 1031 exchanges. Is it a buyers or sellers market?

Baker & Dunck: Continued low interest rates have spurred both selling and buying activity, driving up sales prices for sellers, and making more expensive properties more affordable for buyers. In addition, the flight of capital from equities to hard assets, including real property in particular, also has the effect of increasing the number of exchanges that are currently underway.

Pattishall: In this interest rate environment, it is an extremely tight market. Properties are moving quickly, though perhaps not at top dollar. While real estate has benefited from the downturn in the equity market, investors still remain cautious.

Kaplan: This is as much of a sellers market as we’ve seen in the last 5 years.

HREB: In the current market climate, what are the benefits for a property owner doing a 1031 exchange?

Baker & Dunck: The benefit of Section 1031 to an owner of investment real property has not really changed as a result of the current market climate. The ability to defer the recognition of realized gains remains particularly attractive and is a powerful and unique planning tool for restructuring or repositioning a real estate investment portfolio. This tool is unavailable for other types of investment portfolios.

Today’s real estate valuations are high, resulting in higher built-in gains. At the same time, the stock market and other forms of investment are volatile and performing poorly. In this market climate, property owners have great incentive to do 1031 exchanges since they can sell high, avoid recognition of the generous gain on the property transferred and retain a real estate investment that is better performing and more stable than other investment options.

Pattishall: In any market climate, a 1031 exchange is a valuable tool to defer tax. We have seen many customers benefit from the reverse exchange Revenue Procedure that the Internal Revenue Service issued in 2000. As taxpayers find property today that is desirable, they can arrange for that property to be acquired by an accommodation titleholder and then review their portfolios of properties and sell less desirable property within 180 days.

Kaplan: Short of having the inside track on some amazing opportunity, I can’t think of an investment that could overcome the benefits of a trade. If the trade candidate sells, he pays 20 percent capital gains and has to find something that makes up for the tax hit and returns an annual 7 to 8 percent cash on cash return with write-offs against that return. Where’s he going to find that?

Right now the strength of the market allows sellers to capitalize on appreciated equity in their holdings. Of course, the active market has also driven up prices of replacement properties, but this is offset by today’s historically low interest rates. The key to success in this market is for the 1031 investor to develop a strategy and use the right team to implement it.

HREB: What types of buyers are seeking exchanges? What types of sellers are seeking exchanges?

Baker & Dunck: Businesses are divesting excess real estate, often seeking passive real estate to invest in for the short term. Individuals who want to capture recent market appreciation are also good candidates for initiating exchanges. We have both corporate and individual buyers seeking replacement properties needed to complete their exchanges. However, with the issuance of Rev. Proc. 2000-37, which gave us guidance for structuring safe harbor “parking” arrangements, we also have a number of portfolio owners that are seeking new properties to enhance their portfolios before deciding on the relinquished property that will be matched up in the exchange.

Pattishall: Individual taxpayers to Fortune 50 companies utilize Section 1031. The Treasury regulations create clear, workable safe harbors for all taxpayers. The questions an investor needs to answer before entering into a 1031 exchange are: Do I have gain that can be deferred on the sale of my old property? Do I intend to acquire other property? Do the economics of the transaction make sense? If the answers are yes, you should do an exchange.

Kaplan: The smart ones are seeking exchanges. The timing and requirements of both buyers and sellers will dictate who is active. Sellers may want to lock in appreciated value on older properties. Buyers should consider the low interest rates, but a buyer or seller needs to look at his or her overall investment strategy and determine what makes sense.

HREB: What is the most common property your clients seek for an exchange?

Baker & Dunck: Lately, we have received many inquiries about more passive forms of real estate investment: triple net lease properties and fractional share interests in tenant in common properties, without any specific category restrictions (i.e. commercial, industrial, multifamily, etc.). We still represent a significant number of exchangers that remain committed to the same use as their relinquished property, or are seeking a geographic relocation for their investment property to a warmer, more vacation-oriented type of investment.

Pattishall: Our customers purchase all different types of property — office, industrial, multifamily and triple net leased properties. An exchange is an individualized transaction — every investor has a different objective.

Kaplan: Most of our clients are looking for properties with investment-grade credit and little or no management responsibility. They are trading properties with uncertain cash flow from small, non-credit tenants for properties with long-term commitments from investment-grade tenants. They like single-tenant properties that project long-term, ongoing returns on their investment in the form of consistent forward income.

We also see many clients moving from properties with personally guaranteed loans to properties with non-recourse lending. For example, the client may trade out of a strip mall into one of our multi-owner properties with non-recourse debt. Our multi-owner opportunities have been very attractive to both large and small trade investors. We’ve recently completed transactions involving a significant downtown Chicago parking/retail facility and several multi-owner drugstores, and we are about to close on a 450,000-square-foot enclosed shopping mall in Michigan. These kinds of opportunities sell out very quickly for us.

HREB: How do you identify target properties for exchanges? Do you have a list or catalog? Is it challenging to update this or to know what is coming down the pipeline? Do you have developers/brokers you work with for certain property types?

Baker & Dunck: We maintain a referral network of commercial realtors, triple net lease sponsors, tenant in common (“TIC”) sponsors, and CapHarbor, a clearinghouse service that matches 1031 exchangers and their real estate agents with sellers of replacement properties nationwide. As a qualified intermediary we do not actually offer any specific properties; our purpose in referring exchangers to these network contacts is to assist in the exchange’s successful completion through the acquisition of a qualifying replacement property.

Pattishall: We refer our customers to a number of suppliers of replacement properties, both brokerage firms and syndicators selling tenancy in common interests. In 2002, we found that a majority of our customers completed their exchanges within a very short time frame. By the time they came to us, they already had replacement property under contract.

Kaplan: Unfortunately there aren’t any easy ways to identify prime properties. Finding good deals is always a challenge. We attract sellers and buyers by knowing whom to stay in touch with and having a reputation for professionalism and fair dealing. Syndicated Equities Corporation has four full-time investment strategists who maintain nationwide relationships with preferred developers for national credit tenants. We’ve also developed relationships with attorneys, bankers, accountants and intermediaries around the country, particularly out of our Chicago and Miami offices. The information we gather from all these sources is entered hourly into a live database unique to Syndicated Equities. We also cooperate with a few reliable brokers specializing in net-lease product. And, of course, our investors represent a valuable resource for product, to buy or to sell. We are their first resource when they’re ready to make a trade.

HREB: Have investors fleeing the stock market for NNN properties affected the 1031 supply pipeline?

Baker & Dunck: There is certainly a great demand for NNN properties and a limited supply. As the number of providers of these kinds of investment vehicles expands, which we are seeing in the marketplace, a careful due diligence into the offered investment and the investment sponsor become particularly important.

Pattishall: As quickly as investors flee the stock market, new companies sprout up to meet the demand. We haven’t seen a single transaction fail because a customer was unable to buy the replacement property they wanted. There is a lot of product available.

Kaplan: We’ve met a significant new investor group in the last couple of years as the stock markets have faltered and as corporate accounting shenanigans have come to light. These folks are diversifying into real estate –– an investment that they can understand, see and touch. And these investors are not necessarily 1031 trade candidates. Through our multi-owner opportunities, we assist investors with $100,000 or with millions. They can own an undivided fractional interest in property leased to investment-grade national tenants. They get cash on cash returns that outperform stocks these days. And much of that cash return is sheltered by depreciation and taxes. Naturally, as more people seek quality real estate investments, demand for prime product increases and supply tightens. But we know where to look for the right product, so we’re managing to meet our clients’ needs.

HREB: What do you expect the market to be like in 2003?

Baker & Dunck: We ended 2002 with a very strong level of activity, as IPX1031 completed over 12,000 exchanges, more than 350 of which were reverse exchanges. We expect to see significant growth in exchange transactions in the coming year. The current interest rate levels, which are forecasted to remain low for at least the early part of the year, will fuel the overall velocity of commercial real estate transactions, but the growing understanding and appreciation among real estate investors of the benefits that can be realized from structuring an exchange will keep the growth curve moving up, even if the interest rates move up to pre-2000 levels.

Kaplan: We expect more of the same; a tight, active market with buyers and sellers looking for quality product. We anticipate that interest rates will remain low while investor interest remains high. The bright side of the supply picture is the number of investment-grade corporations continuing to grow, and we hope to capture our share of those opportunities.


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