Today’s reality is that cash is king. So how does one buy apartment complexes with no cash? Many do this through the use of a cash alternative. For multifamily properties to trade 1031 Tax Free Exchanges are a significant provider of equity (cash) driving transactions.
Depending on the market, 1031 Exchanges can represent two-thirds (2/3) of all transactions driving multifamily acquisitions activity. With limited 1031 Exchange activity occurring there are fewer sales/trades in multifamily. This is a simple fact.
The IRS defines a 1031 Exchange as follows: To qualify for Section 1031 of the Internal Revenue Code, the properties exchanged must be held for productive use in a trade or business
Stocks, bonds, and other properties are listed as expressly excluded by Section 1031 of the Internal Revenue Code, though securitized properties are not excluded. The properties exchanged must be “like-kind”, i.e., of the same nature or character, even if they differ in grade or quality. Personal properties of a like class are like-kind properties. Personal property used predominantly in the United States and personal property used predominantly elsewhere are not like-kind properties. (http://en.wikipedia.org/wiki/Internal_Revenue_Code_section_1031)
In 2007 Sam Zell sold Equity Office to Blackrock for over $38 billion dollars. The U.S. recession began soon after. The size and scope of this deal was so large, I believe the entire real estate industry held their breath for a full three minutes at the conclusion of the sale.
And what happens after a large room full of people try to hold their breath for three minutes? There will be a whole lot of gasping going on. This was the height of the market for residential property also. Homes in southern California have fallen in value some 40% since. More in Nevada and Arizona. But before the fall there was greed.
Greed: excessive desire to acquire or possess more (especially more material wealth) than one needs or deserves, avarice: reprehensible acquisitiveness; insatiable desire for wealth (personified as one of the deadly sins) wordnetweb.princeton.edu/perl/webwn
Mr. Zell was not greedy. Mr. Zell was made a bona-fide offer and concluded it was reasonable. He accepted and sold. However, those following in his wake (all too often) thought of themselves as mini-Zell’s, whereas, if Sam can get $300 a square foot certainly I can also. Not true. And as sellers attempted to ratchet prices yet “one more time” buyer’s balked (slowing their step- not wanting to be the last one standing without a chair when the music stopped).
Lenders also took notice as their default rates were beginning to rise based on valuations not supported by “current” operating numbers. As credit tightened prices (and 1031′s) began a gradual decline. The death spiral increased its velocity as Lehman collapsed in the fall of 2008.
In your local market, for deal sizes that fit your profile, identify the number of property’s that are changing hands via 1031. This is another barometer for tracking the level of sales activity (and the number of players) with whom you must compete for deals. Fewer 1031′s means fewer direct competitors for multifamily property’s in your marketplace. Good to know before being in the throes of negotiations.