By Don Meredith, Author: DST Revolution –1031 Exchange Into Retirement Mode
By now most of you have heard of the Delaware Statutory Trust. They offer an effective 1031 exchange exit strategy into fractional ownership of institutional-grade and professionally managed real estate. What started out as a cottage industry 20 years ago is now a multi-billion-dollar cornerstone of many real-estate portfolios.
So just how did this upper end of professionally managed real estate respond to the pandemic? And how did the different asset classes perform? What was amazing to me was the immediate transparency, communication and detailed notices generated by the DST sponsors. There was and is ongoing communication throughout this pandemic crisis and it has been impressive.
The generation of “flash reports” on properties has been timely; including details and spread sheets of rents collected as a % during that time of the month, those requesting deferred payments, as well as rental and leasing activity via virtual tours.
There was an initial 1031 extension by the IRS:
Two deadlines we always have to remember when rolling over a 1031 exchange investment are the identification window, and the time of sale to investment completion date. 1) The investor has 45 days from the sale date of their property to identify a new investment and 2) 180 days from the sale date of their property to complete the purchase of their new investment.
Investors who had either of their deadlines fall between April 1, 2020 and July 15, 2020 have been granted an extension to July 15th by the IRS. But waiting unnecessarily might not be a good strategy. There is a potential that investors who may have been postponing their exchanges will have to compete for a dwindling supply of eligible replacement properties. Some investors could lose out on their equity reservations as a result of a surge of demand with insufficient resources to quickly complete their transactions. Unable to complete their exchanges by the deadline, investors could be faced with the risk of an unexpected capital gains tax burden.
Pandemic economic impact and DST sponsors observations:
Straight up. Some real estate asset classes have done well and others have been hit harder by the pandemic. Self-storage, multifamily and essential retail (for example, food, drug and low-priced Dollar stores) have fared the best. Other asset classes, including student housing, non-essential retail, and hospitality, have struggled due to state-imposed shutdowns.
Tenants that are unable to use their facilities may not be able to pay their rent. If the shutdown persists, this could possibly lead to defaults on leases. Tenants are already trying to negotiate their existing leases and possibility of loan defaults when there is insufficient income to pay the mortgage. Some lenders are more receptive to modifications than others. Too early to tell what commercial lenders will do.
There are niche asset classes with unique attributes. For example, student housing which has a very short, spring leasing season. Will classes return to “normal” this fall or will an on-line learning model continue for an extended period?
Also, smaller shopping centers with just a few tenants that continue to enjoy strong sales numbers (grocery, pharmacy and the like) are performing well. Centers with restaurants and “non-essential retail” that have been closed under government orders are at risk of significant loss of revenue as tenants may be unable to pay their rent. Many owners are working with tenants and lenders to navigate the economic hardship created by the pandemic. The long-term result may be more on-line commerce in many sectors of the economy.
With 100 years in the distant past (the Spanish Flu). a pandemic was not factored into our economic outlook and/or business models. How could it have been? The unknown and unforeseen represent sound logic for maintaining a diversified portfolio. Even real estate is vulnerable given the right circumstances.
DSTs showing themselves formidable during this COVID crisis:
Self-storage is an asset class that has had almost no change due to the coronavirus crisis. This industry has been one of the fastest growing segments of commercial real estate over the last 40 years. Why is there no rental deferral in self-storage? Because you either pay or come get your stuff! As a matter of fact, in the short term it seems that occupancy for some has actually gone up (with students in transition etc.). Historically, it has proven to be very recession resistant based on performance since 2008.
Senior living space continues to perform well. Consider the senior living rental model and how if held up through all the major events starting with the 1991 recession, right through 9-11-2001, the 2008 Great Recession, and the crisis today. Occupancy and rental income was relatively unaffected through all of those events. This asset class has seen a crossover of from the greatest generation (WWII) who have mostly left us by now, to the leading edge of the baby boomers who are now turning 75 (and at a rate of 8,000 to 10,000 a day).
What about Multifamily Property DSTs as a 1031 exchange? Class A and Class B apartments continue to thrive, but management is now forced to deal with rental deferment requests, especially in vacation destinations which have experienced the highest requests for rent payment deferral.
Keep in mind that vacation destinations have a high percentage of employees working in the hospitality industry, one of the hardest hit by the pandemic. Suffice it to say this has an impact on investor returns at least for the near term. The rents that are deferred are still owed, and will not be waived indefinitely, and there’s always the risk of bad debt.
However, the fundamental need for housing remains. It is a necessity. As hotels and gyms were closed for a time, apartment owners and managers have been renewing leases. And recognize that residential rent payment/default risk is spread over many tenants and not just a few.
Always a word of caution:
Although it’s too early to assess overall trends, initial indications are that multifamily property owners are favoring maintaining occupancies over efforts to turn over units in order to realize higher rents. Whereas earlier projections called for rental increases in 2020 ranging from 3% to 5%, many landlords are now assuming rent growth for the year will be flat and possibly even negative. Also, the effect of any sustained delinquencies and late/waived payments on overall 2020 revenues is unknown.
By Don Meredith, President of Tactical Income Inc.
Author of The DST Revolution –1031 Exchange into retirement mode. 2nd Edition
Securities offered through Lightpath Capital. Inc. Independent of Tactical Income, Inc. Member FINRA/SIPC. 310-260-9187 1453 Third Street Promenade, Suite 315 Los Angeles, CA 90401