Tired of Being a Landlord? Consider Passive Investing.

In 2020, over 6,000 landlords replaced their rentals with roughly $6.4 billion of real estate in syndicated passive 1031 exchange programs.[1] Why are so many landlords exchanging their rentals for passive investments?

There are several reasons. Some owners are weary of maintenance hassles, troublesome tenants and looming expenses. Potential legal liability for landlords has never been greater. And the pandemic economy has hit small apartment owners particularly hard, compounded by extended eviction moratoriums.

Worse, states like California and Oregon recently declared war on landlords. Rent control is now statewide, with some cities imposing even more onerous regulations. Not only are rents capped and tenants protected from eviction after twelve months; some landlords now are prevented from conducting criminal background checks on prospective renters.

Finally, for many owners, their rentals no longer make financial sense. When property values outpace rental revenue for several years, yield on equity inevitably declines. Here is a simple example of a rental property in 2011 and 2021:

RENTAL PROPERTY* 2011 2021 Increase/Decrease
Property Value 1,000,000 2,000,000 100%
Loan Balance 500,000 400,000 -20%
Equity 500,000 1,600,000 220%
Net Operating Income (NOI) 40,000 60,000 50%
Yield on Equity 8.00% 3.75% -53%

* Hypothetical example for illustrative purposes only

The above NOI increased by 50% over 10 years—not bad. Yet the equity grew by 220% over that time, a function of property values doubling and principal payments reducing the loan balance. Despite enjoying solid appreciation, the yield on equity decreased from 8% to 3.75%. Why should a landlord continue bearing the hassles and liabilities of direct ownership for a meager 3.75% cash flow?  This is especially true in markets where unemployment is soaring, taxes are high and more people are moving out of town than in. Any positive trends that supported property values over the previous decade may not continue, in such markets, going forward.

Enter passive replacement programs. The primary vehicle for securitized passive replacements is the Delaware Statutory Trust (“1031 DST”).  1031 DSTs are the only form of indirect real estate ownership recognized by the IRS as qualifying for a 1031 exchange. A 1031 DST is simply a business trust, formed under Delaware state law, for the purpose of owning and operating investment real estate on behalf of accredited investors. All of the stakeholders own a pro rata beneficial interest in the underlying property of the trust. They each receive their share of any distributable income and any net appreciation upon sale.

The basic attributes of DSTs are:

  • Passive investing—no participation in acquisition, operation or disposition of properties
  • Institutional management
  • Built-in, non-recourse, no-application financing
  • Constantly changing menu of investment property options
  • Flexible investment amounts
  • Customizable investment property portfolios
  • Digital investing–no escrow, no notary

With 1031 DSTs, individual owners have the opportunity to diversify their equity across multiple states, various property types and even thousands of tenants—with only a few hundred thousand dollars. Multifamily is the most popular type of DST, but options include self-storage, industrial, senior living, retail and healthcare.

For rental owners with debt, replacing their loan in a 1031 exchange can be challenging. Indeed, some landlords would rather keep their property than obtain a new loan. 1031 DSTs solve this problem by offering built-in debt. Investors are not a party to the loan agreement and do not have to qualify for the loan—it was already in place when the DST acquired the property.  Yet 1031 DST investors are able to claim their pro rata share of the loan for purposes of a 1031 exchange.

After the DST trust manager sells the property (typically in 6 – 8 years), the investors may either pocket the proceeds and pay the taxes, or conduct another 1031 exchange.  Since the IRS approved 1031 DSTs in 2004, most people whose investments went “full cycle” have elected to roll their equity into another 1031 DST.

Of course, like any real estate investment, there are risks. DST sponsors do not guarantee income or performance. Investors can fail to comply with 1031 rules and timelines. Macro-economic or local market conditions can impact rental revenue and expenses. Floods, hurricanes, tornados…and pandemics can cause physical or economic damage in excess of insurance coverage. And fees are higher than direct real estate ownership, including acquisition fees, asset management fees and dispositions fees.

For more information about passive replacement investments, please call 1031 Capital Solutions at 1-800-445-5908 or visit our website, 1031capitalsolutions.com.

There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal. Past performance is not a guarantee of future results. Potential cash flow, returns and appreciation are not guaranteed. IRC Section 1031 is a complex tax concept; consult your legal or tax professional regarding the specifics of your particular situation. This is not a solicitation or an offer to sell any securities. DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and attorney. Because investor situations and objectives vary, this information is not intended to indicate suitability for any particular investor.

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services offered through Concorde Asset Management, LLC (CAM). 1031 Capital Solutions is independent of CIS and CAM.

[1] Mountain Dell Consulting, LLC. Assumes average equity investment of $500,000 and average program LTV of 50%. Total equity invested in 2020 was $3.192 billion.

This information is for educational purposes only and does not constitute direct investment advice or a direct offer to buy or sell an investment, and is not to be interpreted as tax or legal advice. Please speak with your own tax and legal advisors for advice/guidance regarding your particular situation. Because investor situations and objectives vary, this information is not intended to indicate suitability for any particular investor. The views of this material are those solely of the author and do not necessarily represent the views of their affiliates.

Investing in real estate and 1031 exchange replacement properties may involve significant risks. These risks include, but are not limited to, lack of liquidity, limited transferability, conflicts of interest, loss of entire investment principal, declining market values, tenant vacancies, and real estate fluctuations based upon a number of factors, which may include changes in interest rates, laws, operating expenses, insurance costs and tenant turnover. Investors should also understand all fees associated with a particular investment and how those fees could affect the overall performance of the investment.

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services offered through Concorde Asset Management, LLC (CAM), an SEC registered investment adviser. Insurance products offered through Concorde Insurance Agency, Inc. (CIA). 1031 Capital Solutions is independent of CIS, CAM and CIA.