The Securitized 1031 Exchange Market: A 10-Year Retrospective

The Securitized 1031 Exchange Market: A 10-Year Retrospective
Posted by on Aug 23, 2017

Various types of buildings in a city scape

More than 10 years ago, the securitized 1031 Exchange market (real estate interests that are packaged and sold as securities and that qualify for 1031 exchange purposes) was dominated by tenant-in-common (TIC) Sponsors. TIC investments grew at a frantic pace from the start of the new millennium, increasing in volume from under $500 million of annual equity raised in 2002 to over $3.6 billion annually by 20061.

What a difference a decade makes.

These days, the securitized 1031 Exchange space is experiencing slower, yet more sustainable growth, according to speakers participating in “State of Securitized 1031 Exchange Industry,” a recent webinar hosted by Mountain Dell Consulting LLC, a 1031 consulting firm in Salt Lake City. The biggest takeaway from the hour-long webinar was that the current state of the industry is stronger than it was before the Great Recession, even if growth is not quite as frenetic. One reason for the strength has been a shift from TIC offerings to Delaware Statutory Trusts (DSTs).

“I like the sustainable growth we’re having. It’s a breath of fresh air,” observed Taylor Garrett, Mountain Dell Consulting’s managing director. “When TIC investments doubled each year, it was too fast. The industry learned a lot from the downturn.”

Back Before the Recession

In 2006, the 1031 market was at its peak. Specifically, $3.6 billion in equity had been raised, with the number of fully subscribed programs at 341, another high. Meanwhile, the number of sponsors stood at 712.

Then came the recession. In the aftermath, investments slowly picked up. By 2016, the total equity raised was $1.4 billion, with the number of fully subscribed programs at 74, with 29 sponsors3.

Equity Raised In The 1031 Market

Though far from the pre-recession peak, speakers weren’t alarmed. Garrett acknowledged that, while the start of 2017 experienced lower equity raises than the year before, “we’ve seen a recent uptick in activity.”

As of Q2 2017, the equity raised for 1031 programs was $901 million, with 26 sponsors in the market. So far, 47 programs are fully subscribed4, and from what the speakers said, more is to come.

And, the offering profile is shifting from TICs to DSTs. The total number of offerings, as of the end of June 2017, was 81. Seventy of those offerings were DSTs, while 10 were TICs5.

“One of the things we’re seeing is a broader acceptance of the DST model by the financial community,” noted Keith Lampi, president and chief operating officer at Inland Private Capital Corp (IPCC). IPCC offers replacement properties for exchange transactions. “More broker-dealers are coming on board to embrace the structure,” Lampi said.

The progression “is changing how we package and bring the product to market,” Lampi said, adding that the structure means a larger pool of investors, lower risk, a decrease in minimum investment costs, more diversification and the pooling of non-contiguous assets into one tidy bundle. In short, DSTs allow “sponsors to increase the asset base and equity raise,” Lampi said. “it encourages investor diversification, compared to the TIC environment.”

Something else that changed over the past decade is the type of preferred investments. Office product made up the bulk in 2007. Ten years later, “Apartments are the dominant type of investment in the asset space,” Garrett pointed out.

Investment Comparison By Asset Type

Decreased Loads, Lower Upfront Costs

Another industry change is that investment loads – upfront fees investors pay to sales intermediaries – decreased over the past decade.

“Pre-recession, we were seeing $.80 on the dollar going into the real estate,” Lampi said. “Today, what we’re closer to $.90 on the dollar actually going into the ground.” The reason? Sponsors are doing more than simply collecting investors and raising money. There is more focus on the back end of an investment and an exit strategy.

One lesson learned from the downturn was that “upfront fees don’t have a meaningful ability to generate cash flow,” Lampi said. There is, however, an important strategy to reducing the upfront loads. “When you go to sell, you have to make sure your property appreciated enough to overcome those upfront fees,” Lampi said.

Looking to the Future

The speakers agreed that 1031 sponsors and investors learned a great deal in the aughts; those lessons have led to better, stronger offerings and products.

“I’m very optimistic,” commented Scott Saunders, senior vice president with Asset Preservation Inc., which is a qualified intermediary that handles tax-deferred exchanges. “I’m optimistic that the growth we’re seeing over the past few years will continue.” Though there has been some noise from Washington DC about possible 1031 curtailment, Saunders doesn’t see that happening. “Investors still require a lot of tax deferral,” he noted. “There are a lot of positive tailwinds driving demand, and a lot of opportunity out there. We’re on a steep growth curve.”

Even better, is that things have calmed down from the unsustainably fast growth of the TIC days. “It’s a night-and-day difference,” Lampi said. “I feel much better about where we are today, than where we were 10 years ago.”

Could securitized 1031 investments be right for you?  As with any major financial investment, it may be worth speaking with a professional and becoming educated on your options to determine if something like this is right for you. At Realized 1031, we’re happy to speak with you and help determine if securitized 1031 investments may fit with your situation and personal investment objectives.


1 Deloitte, Size of the 1031 Marketplace, 2008
2 Mountain Dell Consulting, 1031 DST/TIC Market Equity Update, YE2016
3 Mountain Dell Consulting, 1031 DST/TIC Market Equity Update, YE2016
4 Mountain Dell Consulting, 1031 DST/TIC Market Equity Update, 2Q17
5 Mountain Dell Consulting, 1031 DST/TIC Market Equity Update, 2Q17

 


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Topics: 1031 Exchange, 1031 Exchange Process, Replacement Property Interests