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How DSTs are Helping Exchangers Sidestep Market Uncertainty

While some property owners may be waiting to sell until we know more about interest rate cuts, insights from a JTC webinar show how it’s possible to perform a like-kind exchange on schedule with the right strategy.

One of the core benefits of a Section 1031 like-kind exchange is that it allows taxpayers to reinvest the full proceeds from a property sale into another business or investment property. By deferring capital gains taxes, exchangers can afford higher-value replacement property and diversify or upgrade the quality of their real estate portfolios.

But how to best achieve this benefit can be difficult to discern in times like these. First, we had the pandemic, when construction stopped and a shift to remote work made office properties much less valuable. Then we had a supply shortage that caused residential prices to skyrocket. That was followed by an inflation crisis and interest rate hikes.

So should you exchange now or wait for interest rates to go down? And what if you want to sell your property now, but worry about finding a replacement property – what’s the best way to get value from a 1031 exchange in 2024?

JTC recently hosted a webinar where a panel of industry experts discussed the current state of the real estate market and how professionals are approaching the coming months. They also discussed strategies for exchange success in uncertain times, including some methods you may not be familiar with if it’s been a long time since your last exchange.

The realities of the 2024 real estate market

The webinar, “1031 in 2024: Strategies for Real Estate Investing,” featured panelists from diverse corners of the real estate world. James Huang, President at eXp Commercial, discussed recent trends in inflation, pointing out that by some measures, we’re much further along than many may realize.

According to data shared at the webinar, topline and core consumer price inflation excluding shelter costs are already back below the Federal Reserve’s inflation target level. Huang stressed that recent inflation was “mostly because of supply and those that were selling single-family homes,” factors not helped by the Federal Reserve’s ten consecutive rate hikes. Falling home prices could signal the end of the inflation crisis, and therefore the end of rate hikes.

While Huang was confident we’d seen the worst of the inflation issue for the present term, he wasn’t able to be definitive as to when that might lead to interest rate cuts.

“We know that we peaked,” said Huang, “but when are we actually going to cut rates?”

This uncertainty sparked hesitancy in investors, according to Shanaé Mabrie, CES®️, Director – Client Services – Fund Services at JTC.

“Right before the pandemic, business was great. People were buying, people were selling. There was a lot of confidence in the market,” she said. “I think it has shifted the way that people look at the different asset classes that they are seeking to purchase.”

“Sometimes we overreact,” added Huang. “Don’t be afraid of an asset type just because of the fear in the market.” Huang agreed that certain investors are waiting for rate cuts before making their next move. “We do have a lot of money on the sidelines,” he said.

Simon Brower, CEO of Upstream 1031 and an expert on the Delaware Statutory Trust market, said the urge to pull back was common in 2023.

“We had about a 50% pullback in overall transaction volume, which led to reduced equity raise for DSTs,” he said, while noting that this downturn should prove only temporary. “If interest rates do go down, that will serve to increase the liquidity in the market, transaction volume will rebound, and 1031 and DSTs will begin rising again.”

When might interest rate cuts happen? “It is really month by month that we are looking at this,” said Huang, who estimated rate cuts would likely occur in summer and that “best case scenario, we get three.”

How you can pursue a 1031 exchange in 2024

The uncertainty around when rate cuts will occur and how many we’ll see can be difficult for property owners who’d planned on executing like-kind exchanges this year. Should they wait for interest rates to go down, or act now? For some investors, waiting isn’t an option – they want to retire and exchange into less-active investments, and need a solution now.

“Many of the investors I’m working with are in their 60s, 70s, or 80s, and they’re going to sell these properties as much for a lifestyle reason as a financial reason,” said Brower. A failed exchange can be costly, which is why strategy is crucial in a competitive market.

Mabrie walked through some scenarios beyond the simple forward 1031 exchange, including reverse exchanges, simultaneous exchanges, and improvement exchanges, also known as construction exchanges or build-to-suit arrangements. All of these scenarios are less common and more complex than a forward exchange, but offer flexibility in the timeline and the types of properties you can pursue. This flexibility is important in a market where there are fewer replacement property options available.

“A lot of people are looking for triple-net deals, safety deals, leverage deals that can give cash flow,” said Huang. Triple-net leases are an option for exchangers looking for properties with less-active management. But if that type of property proves difficult to find, a DST could offer those investors the cash flow they desire.

Delaware Statutory Trusts as a safe bet in a crowded market

Brower pointed out that while DSTs have been used in 1031 exchanges for decades now, many property owners may be unfamiliar with them.

“A lot of these investors have owned these properties 30 years or more,” he said, making education a crucial part of dealing with these exchangers. Brower walked the audience through the basics of how a DST works and discussed the main advantages of DSTs, one of which is the opportunity to upgrade in quality.

“You’re going to be able to trade up in terms of quality and class of real estate,” said Brower, adding that not only can exchanging into a DST (or multiple DSTs) can provide instant diversification, but there are more options out there than you may realize.

“There’s a DST in pretty much every property type, every location,” said Brower, including “debt-free DSTs as well as leveraged DSTs.” He said one of the things his clients like about DSTs is the speed with which the exchange can be completed.

“The closing and the acquisition of a DST interest really only takes three to five days from the time you decide which DST you want to invest in,” he said. “Most of my investors will actually close on the purchase of their replacement DSTs within their 45-day time frame,” eliminating the need for the 1031 identification process, a method called “identification through acquisition” that Mabrie confirmed is allowed under Section 1031.

While there are positives to a DST, there can be downsides. “When you invest in a DST, you are giving up an element of control,” said Brower. DSTs are less-active investments, but they provide diversification, access to high-class investments, and a reliable replacement property option that can eliminate some of the worries property owners may have about pursuing an exchange in 2024.

JTC works with exchangers to help them exchange into or out of Delaware Statutory Trusts, and provides transparency tools for DSTs to offer their investors greater visibility into the trust’s investments and activity. Now is a great time to learn more about DSTs, and JTC can provide information for those looking to learn more.

The webinar contained many other helpful discussions, including an explanation of the 1031 timeline and rules, a breakdown of factors potentially affecting real estate prices in the coming year, and a full case study of how exchanging into a DST was able to create passive income, diversification, and tax deferral for exchangers. Watch the entire event to learn more about real estate in 2024 and what Delaware Statutory Trusts can offer.

To watch the full webinar recording,

click here

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