When it is time to sell a property investment, whether it be an office building, industrial building, retail center or land, owners are sensitive to estate planning issues and often times find themselves looking to divest of their property while retaining their property investments. In most instances, property owners spend ample time structuring the method in which they hold title in order to allow for each family member to exchange into their own separate properties. This takes time and expertise in order to ensure it is done in a manner consistent with the IRS 1031 tax code. Look to a qualified exchange accommodator for guidance to comply with all the 1031 exchange requirements.
After the successful disposition of a property, an investor must identify exchange property within 45 days and close escrow within 180 days. If the investor has been able to structure the release of the deposit to on the sale of the property, and after that deposit has been released, an investor can use it to put down as a deposit on exchange property. This is a little known nuance in the 1031 exchange world that can allow for the investor to spend its precious time sourcing and underwriting property.
The first step in locating suitable property is identifying property type. In investor must be comfortable and knowledgeable with the property type as there are vast differences in the ownership and operation of an office building, compared to an apartment complex, Rite Aid, or business park. When thinking about property type, an investor must also think through their decision for a single tenant property versus a multi-tenant property. A single tenant property offers simplicity in management and leasing coupled with the risk of 100% vacancy at the end of the lease term. Multi-tenant properties offer a diversification of cash flow coupled with ongoing re-tenanting, leasing commissions, and renovations.
Let’s say for sake of argument that you decide to invest in a single tenant retail property. What kind of tenant? In the land of single tenant retail property there are bank (Chase, Wells Fargo, Citibank), quick serve restaurants (Del Taco, Starbucks, McDonald’s), sit down restaurants (Denny’s, Coco’s, Hometown Buffet), and health and wellness stores (Rite Aid, Walgreen’s), to name a few. Lease terms often times are 5-20 years in length however the amount of term remaining on the lease when it is available for sale can be less. Banks will scrutinize the lease and provide financing with maturity consistent with the lease expiration.
One must be cognizant of the lease terms as not all triple net leases are created equal. There are leases whereby the tenant pays rent and 100% of the property tax, insurance and maintenance expenses where the landlord’s responsibility is limited. There are also net leases whereby the landlord is responsible for the roof and structure of the building. There are net leases whereby the tenant will not pay for the management expenses associated with operating the property. There are even net leases whereby the landlord pays for any building system repairs over a capped amount.
Lastly, one must think about their exit strategy for such an investment. Let’s build on this example where we purchase a single tenant absolute net retail property leased to Rite Aid for 10 years. When are we going to sell the property? If we sell the property when there is 5 years left on the lease, a buyer an still obtain suitable financing for the property. Who wants to buy a property that only has 2 years left before the tenant is going to move out? We could sell the property once the tenant exercises their option to renew their lease at a new higher rent. Would the property be suitable for a user to come in and buy the property with an SBA loan and move into it? Do we have to renovate the property, market it and provide tenant improvements for a new tenant to sign a new 10-year lease? How will we budget for that? As you can see there is a lot of nuance once you scratch the surface of any property investment.