Archives for August 2021

In a recent Green Street report, sources say that “while prior administrations have suggested ending 1031 exchanges, chances are better now that it will happen.”

Congressional deal-making, as well as posturing overtures by the Biden Administration, has created increased focus on 1031 exchanges and what they mean to real estate owners and how they play the “long game” and “short game” for their holdings.

A recent August 25 report put out by Green Street offered commentary on small commercial property sales. One major factor influencing this market is the potential elimination of Section 1031 of the IRS code, which allows investors to defer capital-gains taxes on the sale of one property by reinvesting the proceeds in a similar property within 180 days.

Biden has proposed ending 1031 exchanges to help fund his proposed child care and family-leave legislation. There also are ongoing talks over increasing capital-gains taxes, which would hurt institutional owners more but would still cut into private-capital profits.

The Democrat-led initiatives continue to be discussed during what has become a tumultuous time lately for the Administration as America awaits to see their outcomes.

Kevin Aussef, CBRE’s global chief operating officer for capital markets, noted that while prior administrations have suggested ending 1031 exchanges, chances are better now that it will happen. “The threat is real,” he said. “One of the differentiators this time is the amount of stimulus that has been pumped into the economy, and, not surprisingly, policymakers are looking for revenue to offset the debt that has been created.”

Marcus & Millichap’s John Chang said that sales activity is currently higher than it would be as many investors are positioning themselves for the risk of the government cutting 1031 exchanges and raising capital-gains taxes. “We are talking about the government, and it doesn’t always have to make sense to everybody to become policy,” he said.

Issue’s Impact Would be on Generational Wealth

The exchanges are an important tool for the private-capital marketplace, largely the domain of wealthy individuals, family offices and local and regional real estate firms seeking to generate strong cashflow and to create generational wealth.

Those investors use the tax-deferred exchanges to realize equity gains while keeping taxes low. “Some owners are choosing to sell now before doing so would incur taxes; and others are waiting to see what happens with the tax code, said executive managing director Sean Fulp, who leads Newmark’s private-capital group. “We definitely have owners and investors that have opted not to go to market,” even after selecting Newmark to shop their property, he added.

Chang said the short game says, ‘I’m thinking of taking chips off the table and I’m going to sell now to take advantage of the tax rates today.’ There’s the long game that says, ‘I’ll wait, and the way things have gone in recent years, maybe taxes change again, and I can sell later.’ ”

If wealthy individuals lose the favorable tax treatment, they are less likely to sell properties moving forward, brokers agree, according to Green Street. Whereas institutional investors typically focus on a net return over a specific holding period, private capital can hold assets indefinitely. Owners whose cost of capital increases because of harsher tax treatment likely will hold properties longer.

Aussef noted part of the issue is “the misnomer that 1031 is a loophole and a tax-avoidance strategy,” he said. Rather, he argued that deferring taxes leads to higher dealflow, which spurs economic activity.

“If capital is not redeployed, it becomes more expensive,” Aussef added. “The reason we’re seeing liquidity in the market on all fronts is the wall of capital that comes in and recycles the market every three to five to seven years. If you lock investors into their properties … you’re going to have a higher cost of capital.”

Source: “Does Administration Look to Jeopardize Benefits of 1031 Exchanges?“

Conditions are fueling volatility in home, rent, materials prices as the transitory vs. persistent debate is waged.

Inflation has wreaked havoc on consumer prices and apartment materials are no different. While government officials and others insist the spikes are “transitory,” John Burns Real Estate Consulting sees that as code for “don’t worry” and lays out the case for transitory vs. persistent.

“Transitory” inflation could mean one of three scenarios:

1. Prices rise and plunge
2. Prices rise and stay where they are
3. Prices rise and continue to rise, but more slowly

A sharp and permanent increase in home prices and costs is certainly worth worrying about, John Burns Real Estate Consulting authors Alex Thomas and Eaint Zaw suggest.

“Inflation fears incentivize consumers to lock in payments sooner rather than later, especially if they’re confident they can stay and make payments long-term,” they write.

The Federal Reserve and other members who back a transitory condition “are correct in that some of the drivers of high headline inflation prints over the last several months will resolve themselves over the short- to medium-term (six to 18 months),” Thomas and Zaw write.

‘Goods’ Hit with a Double Shock

Goods have seen two simultaneous shocks to its system created by COVID and associated stimulus.

COVID-related restrictions made goods more difficult to manufacture and transport. The result was supply shortages that allowed manufacturers to raise prices.

However, supply does eventually catch up with demand and manufacturers ramp up to full production. A most common example was the volatility experienced in lumber futures. After soaring in the summer, they have fallen considerably and have wiped out their 2021 gains.

Consumers’ Pocketbooks Loaded

Three rounds of government stimulus in the past two years padded consumer bank accounts and juiced demand (and therefore prices) for goods and services across the economy. Demand will eventually subside as savings are spent.

“Consumers, businesses, and those who expect inflation to be “persistent” are baking inflation expectations into today’s decisions,” the report states.

Of the 210 clients John Burns Real Estate Consulting polled last month, 70 percent believe that the recent rampant price appreciation will not result in a fall from today’s prices during the next five years. Thomas and Zaw expect wages to increase as the supply of workers dwindles from heavy retirements.

“A flood of money into the economy has created buying power that will last years,” Thomas and Zaw write.

Banks have $3.9 trillion in reserves (2x pre-COVID) and “the velocity of money is at an all-time low; money must be spent to show up as inflation, and we have not yet felt the full impact on prices.”

What Consumers Are Expecting

Consumers actually anticipate double-digit increases in rent, gas, and medical care over the next year.

“Demand and supply will eventually meet each other, meaning that inflation will technically be transitory,” the authors write. “However, substantial wage increases are already occurring, which will raise the cost of many goods permanently.”

Plan on the following until the next recession hits, the John Burns Consulting’s report states:

Declining material costs: Commodity prices that are less dependent on labor will eventually fall as supply catches up with demand.

Rising labor costs: Prices for goods that are labor intensive will likely increase and remain high until the next recession.

Rising revenues: Some rent and home price increases will be permanent since home buyers will have more money, but that doesn’t mean home prices can go to the moon.

Questionable land prices: While land is a commodity, residential home prices are a function of the following formula: estimated future revenue – estimated future costs – normal profit margin = land value.

With revenues likely to increase in areas where they haven’t grown too much already, and costs likely to decrease, land values should do well in most areas.

Source: “When ‘Transitory’ Inflation Really Means ‘Don’t Worry‘”

However, the rapid rent growth the sector has experienced this summer may be waning

A rise in household formation and the prohibitively high cost of homeownership in many US metros has pushed apartment rents up 11% in the first half of the year, according to a new report from Apartment List. The increase is more than double the rate of inflation and triples the rent growth the firm measured in the years leading up to the pandemic.

Rents have rebounded to pre-pandemic prices in 87 of the largest 100 US cities, and are up 30% since March in cities like Boise, Bend, Ore., and Spokane. That growth is being partially driven by household formation, which is at a historic peak, and major disruptions in apartment construction starts (which have in turn led to record lows in builder confidence). And in many US metros, the supply of available homes to purchase, combined with sky-high prices, are putting homeownership out of reach for many renters. Home inventory dropped by 48% year-over-year in March 2021, while the Case-Shiller home price index is up nearly 8% through May of this year.

“As supply shrinks and prices soar, more and more relatively high-income households are unable to find for-sale housing that meets their needs and preferences. These households therefore remain in the rental market, where they put additional pressure on affordability,” the Apartment List report states. “Post-pandemic apartment hunters are searching with higher incomes and higher budgets, especially when moving to a new part of the country. These are the renters who, if not for prohibitively high prices, might otherwise buy homes and take some pressure off the rental market.”

What’s more, it appears that more renters are searching for new pads: this summer, search volume among apartment hunters clocked in at 10% higher than in previous summers. And those renters are increasingly “higher-urgency,” meaning they’re looking for leases that start within 30 days of their search.

“This urgency could be a result of several factors, including the expiration of year-long leases signed during the pandemic, moving back towards job centers now that offices and in-person activities are reopening, or moving away from job centers to take advantage of long-term flexible work arrangements,” the report states. “Whatever the reason, a larger and more-urgent pool of renters means a more-competitive market that drives up prices.”

And finally, vacancy rates are at historic lows. While rents are up 11% this year so far, vacancies have decreased by 36%. But Apartment List analysts also suggest the rapid rent growth the sector has experienced this summer may be waning. Online search volume is slowing heading into fall, and vacancy rates appear to be hitting bottom.

But “a brief cooling period this winter is unlikely to reverse much of the dramatic price gains we are witnessing this summer,” the report notes. “Prices going into 2022 will assuredly be higher than they were going into 2021.”

Source: “What’s Behind Apartment Rents’ Meteoric Rise And Will It Last“

NIC’s Beth Burnham Mace returns to the podcast to discuss the results from the latest WMRE / NIC Seniors Housing Survey.

Beth Burnham Mace, chief economist and director of outreach at the National Investment Center for Seniors Housing & Care (NIC) returns to the Common Area podcast to discuss the current state of the seniors housing industry and what that means for potential investors.

The seniors housing sector is continuing to deal with the lingering effects from the COVID-19 pandemic, including lower occupancies and higher expenses, which are squeezing net operating incomes and weighing on transaction activity. Yet the 2021 WMRE / NIC Seniors Housing Survey shows growing confidence in the sector’s outlook, including improving fundamentals and a rise in investment activity over the next 12 months.

David and Beth discuss:

• An outlook for the seniors housing industry for 2021 and 2022
• How COVID-19 continues to affect seniors housing operations and fundamentals
• What factors are affecting the overall trajectory for the sector
• How REITs and other players have remained active investors in the sector and remain bullish about it’s long-term prospects
• And more

Tune in now to hear the discussion.

Source: “WMRE’s Common Area: What’s Ahead for Seniors Housing Investment“