1031 Exchange

A brief overview of the Section 1031 exchange rules:

1.  The exchange must involve “like-kind” properties. All properties must be held for a productive purpose in business or trade, as an investment.

2. Within 45 days from the day of selling the relinquished property, one or more replacement properties must be selected. In the case of multiple properties, one of the following rules must be satisfied:

  • Three Property Rule – Up to three properties are selected regardless of market value. Not all of them have to be purchased.
  • 200% Rule – Any number of properties are selected as long as the aggregate Fair Market Value (FMV) of all replacement properties does not exceed 200% of the aggregate FMV of all of the relinquished properties as of the initial transfer date. Not all of the selected properties have to be purchased.
  • 95% Rule – Any number of properties are selected as long as 95% of the aggregate FMV of the selected properties is purchased.

3. The identified replacement property must be acquired by the taxpayer within 180 days.

4. At the close of the relinquished property sale, the proceeds are sent to an intermediary, who holds the funds until the transaction for the replacement property is ready to close.

5. If the investor is trading down, the resulting “boot” –  in the form of net cash received, debt reduction, excess borrowing to finance the replacement property or sale proceeds being applied toward non-transaction costs at closing – may be subject to taxation.

Commercial Property Tax in Iowa

In Iowa, farms are taxed based on production as opposed to land value and residential property is taxed at approximately half its assessed value, according to a report in The Republic. Commercial property, however, is taxed at 100 percent of its assessed value.

Republicans in the state legislature, backed by Gov. Terry Branstad, favor a plan to reduce the commercial property tax rate to 60 percent of the property’s assessed value. Democrats believe that the reduction should apply only to the first portion of the commercial property value. Their intention is to reduce the burden on Iowa businesses, which tend to be smaller while continuing to collect revenue from larger businesses that tend to be from out of state.

The two sides have not yet reached a compromise.

To Buy or to Lease

David G. Hunt provides some factors for firms to consider in deciding between purchasing and leasing commercial property:

1. The availability of capital: Firms should evaluate their capital requirements now and in the near future. Real estate should not take a disproportionate portion of their cash reserves.

2. Opportunity cost: Firms should compare the returns derived from placing capital into real estate versus investing it in other areas of the business.

3. Anticipated growth: A purchase may not make sense if the company plans to sell and relocated within a short time (e.g. less than five years). The upfront expenses of a purchase would remain unamortized and may make the purchase unprofitable.

4. Cash flow analysis: A firm should calculate inflows and outflows during the desired holding period, discounting all funds to its present value and considering market appreciation. The resulting scenarios may assist in deciding between a purchase and a lease.

Mission Bay Development Slows

The global enterprise software company salesforce.com is withdrawing plans to establish its headquarters in San Francisco’s Mission Bay district, according to a report in the Wall Street Journal. Salesforce.com purchased 14 acres in Mission Bay for $278 million in 2010. It has now decided to move its 3,000 San Francisco-based employees to 50 Fremont – a downtown building that has since become available. Of the 4.4 million square feet of potential office space, salesforce.com had about 1.9 million.

The development of Mission Bay will continue, however, the loss of this project will change the timeline, according to those interviewed for the report. The salesforce.com project will likely be replaced by smaller ones that will eventually fill the unused space. Pier 70, an old shipyard just south of Mission Bay that is expected to be converted into office space, may also witness a reduction in demand and in the speed of its development because of the salesforce.com withdrawal.

The University of California, San Francisco (UCSF) has a research center at Mission Bay and will soon add a hospital. Many biotech companies have also moved to this former rail yard area.

 

Accuracy in Cap Rates

A 2008 paper by Eric Reenstierna argues for the establishment of a standard method of capitalization derivation and he promotes the Appraisal Institute as the organization best suited to set such standards.

Inconsistency in the calculation of net income is the primary source of inaccuracy in cap rate calculations. Commercial real estate practitioners do not always include the same factors in their calculation of cap rates. For example, a broker’s net operating expense (NOE) data for a multi-family unit may not take into account (or sufficiently take into account) vacancy deductions, replacement reserves or management costs.  In the case of a net-leased property, a seller may leave out a vacancy factor (useful for accuracy in the event the tenant defaults), management costs that are not reimbursed by the tenant, administrative costs such as annual accounting or credits for expense reimbursements. The result can be inaccurate cap rates that – when used to appraise a property – will differ from the value derived using comparable sales data. If there is a step rate increase in a long-term lease, an appropriate method may be to take an average that takes into account the step increase and weights the different rates appropriately as opposed to using solely the present rent rate or the future rate.

Reenstierna also discusses the use of survey data to determine capitalization rates. Appraisers turn to survey data to supplement cap rate data derived directly from transactions or they use it as an alternative when no direct data is available. In a price-based survey, he explains that the higher end of the response spectrum is most likely closest to the true market price of a property and in a cap rate survey, it is the lowest cap rate that will determine the market rate as that respondent will likely outbid the others. In the latter type of survey, knowledge of whether or not the respondents have actually made acquisitions at their response rate is important to the accuracy of the survey.

The author compares his proposal for an Appraisal Institute-led standardization of cap rate calculations to the BOMA Standard Method for Measuring Floor Area in Office Buildings to stress the value of having such standards and how it will benefit all those involved in this industry.

Government Purchase

The US General Services Administration (GSA) has acquired Columbia Plaza in the Foggy Bottom district of Washington, according to a report from GlobeSt.com. The government purchased the 511,500sf class C office building from a partnership between Normandy Real Estate Partners and Westbrook Partners for $99.8 million. The State Department has occupied the 15-story building since 1992. The government decided to purchase rather than renew the lease in order to save money, according to the GSA.

Transactions such as this contribute to boosting confidence in the DC commercial real estate market where concern about a possible government downsizing keeps some investors from buying into the market until at least after the presidential elections.

Investment in Brazil

Forbes reports that New York-based real estate investment firm GTIS Partners (Golden Tree InSite Partners) has brought in a total of $810.2 million from 24 institutional investors to put toward real estate projects in São Paulo and Rio de Janeiro states. The GTIS Brazil Real Estate Fund II closed on February 24 and it includes many of the same investors that bought into GTIS Brazil Real Estate Fund I, which raised $510 million in 2008-2009.

This latest fund has spent about 30 percent of its commitments on a warehouse and residential project in São Paulo and on one new office building (pictured below). GTIS is also planning to build about 400,000sf of Class A office space near Rio’s port at an expected cost of $150 million and more projects are in the planning phase. According to Tom Shapiro, president and founder of GTIS, the firm is offering its investors cap rates beyond 16 percent.

Brazil’s major cities lack the volume of Class A office space that we see in Europe, North America and Asia, according to the report. The country is growing and developing rapidly and vacancy rates are low. As more business expands or moves into Brazil, there is likely to be increasing demand for higher quality commercial property.

New CRE Search Engine

42Floors is a new free search engine for commercial property. It compiles data from multiple sources (brokerages, landlords, craigslist etc…) and provides the public with direct access to these listings so that their first point of contact does not necessarily have to be a broker. Furthermore, the company will provide photos of both the inside and outside of profiled buildings.

For brokers, 42Floors currently offers a free listing service. If there is an interest in the property, the company will – depending on the nature of the inquiry – refer the client to a tenant rep or to the listing agent. 42Floors also assists in scheduling the appointments for viewings. For the time being, there is no referral fee associated with the service.

42Floors launched today and offers coverage in the San Francisco Bay Area. The company intends to expand in subsequent years to other tech-savvy markets.

Distressed and Stressed Commercial Properties

Mike Donnelly writes in The Washington Post that distressed commercial real estate in the United States totaled $166.9 billion in January 2012 – down $4.7 billion since October 2011. Divided by sector the numbers are:

  • Office: $41 billion (decrease of $829 million or two percent).
  • Multi-family: $35.2 Billion (decrease of $0.3 billion or 0.9 percent).
  • Land/other properties: $29.5 billion (decrease of $0.3 billion or 1 percent).
  • Retail: $27.9 billion (decrease of $0.7 billion or 2.4 percent).
  • Hospitality: $21.1 billion (decrease of $3.1 billion or 12.8 percent).
  • Industrial: $12 billion (increase of $435 million or 3.8 percent).

Stressed properties are those properties that have characteristics of concern in the short term such as maturing loans, bankrupt tenants, financially troubled owners or under-performance.

LA – Orange County has the highest volume of stressed real estate at $4.5 billion followed by Manhattan with $4 billion.

3001 Washington

Commercial Property Executive reports that research and analysis firm CNA has preleased 173,000sf at 3001 Washington in Arlington VA. Construction is yet to commence on the 200,000sf office building. The ten-story, LEED-certified structure will be one block away from the Clarendon Metro station and adjacent to 3003 Washington – another project that will bring 70,000sf of office space to Arlington.

Upon completion in 2014, CNA will transfer its 600 employees from Alexandria to the new Arlington building. The article states that with the vacancy rate for class A office having dropped from 7 percent in Q4 2010 to 4 percent in Q4 2011, it is likely that the newly vacant space in Alexandria will be absorbed within a couple of years.