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1031 exchange transactions seem to be picking up speed

Local Cohen Financial office completed one recently in Oregon.

November 22, 2013
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1031 exchange transactions often involve single retail properties and are a way for investors to leverage their capital gains into more real estate. Courtesy Sperry Van Ness

The Grand Rapids office of Cohen Financial extended its reach to arrange financing for a deal that involved a building in Cottage Grove, Ore.

Cathy Bronkema, a partner and managing director of the local Cohen Financial office, secured a $4.15 million loan from an unspecified national bank so Walgreens could buy the property about 20 miles south of Eugene. The loan has a 10-year term with a 30-year amortization schedule and an undisclosed fixed rate.

But, perhaps what is most interesting about this transaction is it was a 1031 exchange, a tax-deferred sale based on Section 1031 of the Internal Revenue Service code that seems to be growing in popularity.

“The market continues to be flush with 1031 exchange transactions, and I am seeing the 1031 exchange buyers heavily focused on either credit tenant or multifamily properties,” said Bronkema in a statement.

The Sperry Van Ness National Single Tenant Group, which consists of its chairman Peter Colvin and his partner Dave DeMaagd, recently told the Business Journal that it had completed several sales through the 1031 exchange process. Those, like the Cohen deal, were also retail property transactions.

A properly structured 1031 exchange allows an investor to sell a property and reinvest those proceeds in a new property, and then defer all capital gains taxes.

Asset Preservation Inc. offers an example of how an exchange can work. Say an investor has a $200,000 capital gain from a recent transaction, which amounts to about $70,000 in combined federal and state taxes. After the transaction, this same investor only has $130,000 left to invest in another property.

With that amount at hand and assuming a 25 percent down payment and a 75 percent loan-to-value ratio, that investor normally would only be able to buy a property priced at $520,000. But if the 1031 exchange route is chosen, the investor would be able to reinvest the entire $200,000 of equity from the previous sale into an acquisition that is priced at $800,000, based on the same down payment percentage and loan-to-value ratio.

In short, an exchange protects an investor from capital gain taxes and boosts the growth of a portfolio while increasing the return on an investment. However, to pull it off successfully, an investor has to have in-depth knowledge of the 1031 exchange, which only applies to “like kind” properties.

There are primarily two rules that have to be followed to complete a 1031 exchange. 

One, the total purchase price of the replacement, or like kind, property must be equal to or greater than the total net sales price of the sold property. Two, all the equity received from the sold property must be used to acquire the new, or like kind, property.

“As more 1031 money continues to enter the market, the cap rates continue to contract on the credit tenant deals, such as Walgreens and CVS. Therefore, we are faced with the challenge of identifying the best assets that can accommodate a 1031 exchange and finding financing terms and structures that make sense on the lower cap rates,” said Bronkema.

“In light of the current market demand, I am committed to working with 1031 investors to maximize their cash flow and investment needs,” she added.

In a related matter, Standard & Poor’s raised Cohen Financial’s commercial Special Servicers rating to “above average” for third-party loan servicing and special servicing business. The credit rating agency also hiked the company’s commercial Primary Servicer to above average.

“By improving our Special Servicer rating, S&P is validating the challenging work and the high-touch solutions Cohen Financial offers our institutional clients,” said Tim Mazzetti, partner and executive vice president of Cohen Financial, from his office in Chicago.

“These funds look to us to maximize their returns and to deliver strong investment return results, which we have clearly achieved.”

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