CRE Market Update 2025 and 1031 Exchange Trends ~ Part 2

There was much antic­i­pa­tion, dur­ing the pre­vi­ous admin­is­tra­tion, that the long-stand­ing Sec­tion 1031 tax deferred exchange pro­vi­sion would see changes.

By Al DiNi­co­la, AIF®
Jan­u­ary 27, 2024
DST 1031 Spe­cial­ist
NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC
Secu­ri­ties offered through MSC-BD, LLC, Mem­ber of FINRA/SIPC

There were sev­er­al pro­pos­als, from elim­i­na­tion (of what some ref­er­enced §1031 a loop­hole), to lim­it­ing the exchange dol­lar lim­its, to oth­er strate­gies, none of which came to fruition.  We have pre­vi­ous­ly writ­ten about the rea­sons why. Advi­sors, CPAs, real estate pro­fes­sion­als and most impor­tant­ly the indi­vid­ual investors feel com­fort­able the pro­gram will stay intact, at least we are hope­ful.

In Part 1 we com­ment­ed on real estate pre­dic­tion, inter­est rate changes, financ­ing, inven­to­ry sup­ply, asset class­es and short-term rental in cer­tain areas. (See   Part 1 — 2025 CRE Trends). We will address a few oth­er areas and ampli­fy. 

Can you Refi­nance? There con­tin­ues to be con­cerns regard­ing the abil­i­ty of investors (espe­cial­ly large investors) to refi­nance matur­ing low­er rate loans to high­er inter­est rates. We have heard of the pro­ject­ed num­ber of loans matur­ing over the next two years. The esti­mates range from $700M to $2 Tril­lion depend­ing on the source and inter­pre­ta­tion of the data. No mat­ter what the dol­lar amount will be, the indi­vid­ual investor will be focused on how to repo­si­tion their asset either through refi­nanc­ing or reselling.

A lot of that will be deter­mined by the banks that are hold­ing the loans. Some ana­lysts have often used the phrase “extend and pre­tend” but some banks may poten­tial­ly use some of the same strate­gies. In bank­ing, the term “extend and pre­tend” refers to a prac­tice where banks or lenders extend the terms of a loan (i.e., by length­en­ing the repay­ment peri­od or restruc­tur­ing it) instead of address­ing under­ly­ing issues, such as the bor­row­er’s inabil­i­ty to repay. This is often done to avoid rec­og­niz­ing a loan as non-per­form­ing or impaired on the bank’s bal­ance sheet, which could require the bank to set aside addi­tion­al reserves or take a loss. 

There may be an increase in the vol­ume of activ­i­ty sim­ply based on the fact that there are matur­ing loans, and some investors want to get out from under the loans. The chal­lenge many investors will face when doing a §1031 exchange is that the loans that are being paid off need to be replaced in order to have a valid §1031 exchange unless the investor can pro­vide fresh cash in place of a mort­gage. Delaware Statu­to­ry Trusts (DSTs) may assist cer­tain investors with debt being replaced with non-recourse loans.

Inter­est Rates and Trans­ac­tion Vol­ume

A reduc­tion in a few basis points in inter­est rates is expect­ed to boost 1031 trans­ac­tion vol­ume. This may push an upward trend in res­i­den­tial and com­mer­cial exchanges. Investors eval­u­at­ing mak­ing moves may focus on tax defer­ral as well as NOI or dis­tri­b­u­tions being paid.

Sell­er Financ­ing

Tra­di­tion­al financ­ing chal­lenges will lead to more sell­er-financed trans­ac­tions. This may become prob­lem­at­ic with sell­ers lever­ag­ing §1031 Exchanges. We will fol­low up with anoth­er arti­cle on the ben­e­fits and draw­backs of sell­er financ­ing.

Shifts in Asset Class­es

Mul­ti­fam­i­ly, indus­tri­al, self-stor­age, and cer­tain nec­es­sary retail prop­er­ties are expect­ed to see robust activ­i­ty as investors use §1031 Exchanges to defer tax­es. Cer­tain investors may move from one asset class to anoth­er.  Investors uti­liz­ing DST may have an advan­tage in select­ing sev­er­al asset types and geo­graph­ic loca­tions as replace­ment prop­er­ties.  This diver­si­fi­ca­tion spreads the risk of real estate over a greater num­ber of prop­er­ties.  For exam­ple, an investor sell­ing a res­i­den­tial rental prop­er­ty for $500,000 may acquire 3–5 dif­fer­ent DSTs (typ­i­cal­ly $100,000 min­i­mum in a DST) and assem­ble a port­fo­lio of real estate rather than one prop­er­ty. If the relin­quished $500,000 prop­er­ty has debt, the DSTs pro­vide non-recourse debt which may be viewed by investors as favor­able.

Shift to Pas­sive Invest­ments

Investor demo­graph­ics con­tin­ue to sug­gest a move away from active man­age­ment. An increase in man­age­ment-inten­sive prop­er­ties being exchanged for pas­sive invest­ment types like NNN (Triple Net Lease) and DSTs is expect­ed.

Geo­graph­i­cal Shifts

Local reg­u­la­tions may restrict the rental of cer­tain real estate.  New poli­cies and zon­ing reg­u­la­tion may change the num­ber of rentals per year or per month (as in the case of Airbnb investors) that will prompt investors to move their invest­ments to more land­lord-friend­ly areas.

The need for more hous­ing

In many loca­tions there is a move­ment for per­mit­ting Addi­tion­al Dwelling Units (ADU). The need for res­i­den­tial units in many loca­tions has prompt­ed munic­i­pal­i­ties to seek alter­na­tives such as per­mit­ting ADU to be added to exist­ing prop­er­ties.  A sin­gle-fam­i­ly home may have enough room to build a small­er home or garage/carriage home on the same prop­er­ty. Hence the name addi­tion­al dwelling unit (on the same prop­er­ty).  The increase in unit counts may prompt investors to look at §1031 oppor­tu­ni­ties. There may also be a com­bi­na­tion of mix­ing com­mer­cial with res­i­den­tial offer­ings known as Mixed-use.  This diver­si­fi­ca­tion may appeal to a vari­ety of investors, espe­cial­ly those seek­ing §1031 Exchanges.

Loca­tion, Loca­tion

The migra­tion of peo­ple and to cer­tain extent invest­ment dol­lars are mov­ing to the south­ern smile states (as they are known). These are known as retire­ment-friend­ly areas. Rumors of warmer weath­er (although maybe not in the south­east in Jan­u­ary 2025), low­er cost of liv­ing, favor­able tax con­di­tions, and areas friend­ly to retirees, con­tin­ue to be in demand for investors.

2025 may be a flu­id year with oppor­tu­ni­ties for investors. Poten­tial leg­isla­tive changes, mar­ket dynam­ics, inter­est rates, net oper­at­ing income and oth­er strate­gies are trends we will con­tin­ue to mon­i­tor. The DST strat­e­gy as well as Oppor­tu­ni­ty Zones should con­tin­ue to be of inter­est to advi­sors as well as investors. Anoth­er trend to watch is the IRA to ROTH con­ver­sion strat­e­gy.

NAMCOA® is a SEC reg­is­tered invest­ment advi­so­ry firm that pro­vides com­pre­hen­sive port­fo­lio man­age­ment, finan­cial plan­ning, and fidu­cia­ry deci­sion-mak­ing ser­vices on behalf of retire­ment plan spon­sors. Our Dif­fer­ence is sum­ma­rized by our fidu­cia­ry approach which enables us to bet­ter meet port­fo­lio and retire­ment plan objec­tives, result­ing in stronger risk adjust­ed returns for investors and peace of mind for Clients. We also focus on alter­na­tive real estate invest­ment. Many real estate investors are seek­ing tax deferred solu­tions uti­liz­ing §1031 exchanges or Oppor­tu­ni­ty Zones.

DSTs are not for all investors.  The acqui­si­tion of a DST is for accred­it­ed investors only.  Con­tact your invest­ment advis­er for addi­tion­al details on how a DST may be a solu­tion to your 1031 Exchange and suit­ed for your invest­ment future. For more infor­ma­tion on how to prop­er­ly set up an IRC 1031Tax Deferred Exchange or if you are an accred­it­ed investor and would like addi­tion­al infor­ma­tion on a DST con­tact Al DiNi­co­la at 239–691-8098 or email adinicola@namcoa.com.

This is not an offer to pur­chase or solic­i­ta­tion to pur­chase any secu­ri­ty, as such be made only through an offer­ing mem­o­ran­dum or prospec­tus.  Invest­ing in secu­ri­ties, real estate, or any invest­ment, whether pub­lic or pri­vate, involves risk, includ­ing but not lim­it­ed to the poten­tial of los­ing some or all of your invest­ment dol­lars when you invest in secu­ri­ties. You should review any planned finan­cial trans­ac­tions that may have tax or legal impli­ca­tions with your per­son­al tax or legal advi­sor.   NAMCOA, LLC is a Reg­is­tered Invest­ment Advi­sor, reg­u­lat­ed by SEC (Secu­ri­ties and Exchange Com­mis­sion). Our cor­po­rate office is locat­ed at 999 Van­der­bilt Beach Road, Suite 200, Naples Flori­da 34108. Secu­ri­ties Offered through MSC-BD, LLC, Mem­ber of FINRA/SIPC. 8215 SW Tualatin- Sher­wood Rd, Suite 200, Tualatin, OR 97062.  MSC-BD, LLC and NAMCOA are inde­pen­dent­ly owned and are not affil­i­at­ed.

Thank you.