Category Archives: 2016

A Closer Look at Today’s 1031 Exchanges – Part 1

A Closer Look at Today’s 1031 Exchanges – Part 1

August 19, 2016 | by Beth Glavosek | Blue Vault

Editor’s note: Last week, we reported that most 1031s are structured as a Tenants-in-Common (TIC) arrangement. TICs were popular at one time; however, the Delaware Statutory Trust (DST) is a more favored structure today.

As we discussed in a previous blog post, 1031 exchanges can be helpful when selling an investment property in order to avoid a sizable tax burden. 1031s allow taxes on gains to be deferred when the proceeds from the original property are used to purchase “like-kind” property.

There’s reason to believe that the 1031 is growing in popularity. According to Jean-Louis Guinchard, a Senior Managing Principal with San Diego-based Silver Portal Capital, several demographic trends are contributing to renewed interest in 1031s.

“Americans are aging and living longer, and an investment that can provide stable, predictable income can be very attractive,” he explains. “Quite a few people, particularly those in gateway cities such as New York, Los Angeles, San Francisco and Boston, face significant real estate appreciation on properties they purchased long ago. The cost basis in these properties is likely relatively low and the capital gains could be very high. Unless they are willing to pay a substantial tax bill, an option they should consider includes entering into a 1031 exchange, then reinvesting the proceeds from the sale in a Delaware Statutory Trust or DST.”

Guinchard notes that by using a 1031 exchange and reinvesting the proceeds in a DST, these investors could receive certain benefits including, among others: 1) a beneficial interest in a professionally managed and typically a higher quality property than most individuals could acquire on their own; 2) the tax benefit derived from depreciation and other non-cash operating expenses on the improvements; 3) tax deferral on state and federal capital gains and depreciation recapture; 4) geographic, asset class and tenant diversification; 5) monthly or quarterly cash distributions; and 6) the potential for meaningful tax-equivalent yields. Distributions are, essentially, paid to the holders of beneficial interests from the building’s rent after operating expenses and debt repayment and principal amortization are deducted.

The pitfalls of the legacy TIC structure contributed to a dip in 1031s’ popularity. Guinchard maintains that the more investor-friendly structure of a DST from a legitimate and experienced sponsor merits serious consideration for those looking to effectively defer real estate gains.

“TICs had several factors working against them,” he says. “First, many TICs were syndicated to investors by unscrupulous and poorly capitalized sponsors who went out of business or disappeared when the cycle rolled. Secondly, TICs allow for up to 35 investors to participate in the ownership of a property. In order for any material decisions to be made, all 35 owners have to agree unanimously, which poses significant challenges. Lastly, debt placed on most properties was typically fully recourse to the investors, meaning that they were individually responsible for the repayment of their respective interest in the underlying property or properties. This adversely affected investors during the downturn, especially amid falling property values.”

Guinchard maintains that the concept of shared economy – pooling funds to own larger and higher quality properties – is still valid. “A DST eliminates many of the weaknesses of TIC structure. First and foremost, a competent and experienced trustee makes all decisions instead of the holders of the beneficial interests, and unanimous consent among all investors is no longer required. Second, debt is recourse to the DST, not the individual investors,” he says. “Third, restrictions are placed on sponsors to ensure that the beneficial interests of a DST are treated as qualified property for purposes of Internal Revenue Code Section 1031 and a DST. By definition, the trustee may not have the power to accept contributions from other investors after the offering is closed, enter into new leases or renegotiate the current lease, renegotiate the terms of existing loans or borrow any new funds, nor sell the properties and use the proceeds to acquire other properties. Equally as important, the trustee must distribute all cash on a current basis and invest cash held between distributions in high quality instruments. All of this inures to the benefit of the investors.”

In next week’s post, we’ll talk about 1031 suitability, its pros and cons, and the potential benefits to a certain class of investors.

Silver Portal Capital is a leading placement firm in the field of 1031 exchanges. Its clientele includes 1031 product sponsors, accounting firms, tax professionals, and attorneys who work with accredited investors.


August Blog Series on Private Placements

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Dot Your I’s and Cross Your T’s – Get Ready for the Next Generation of Share Classes

Dot Your I’s and Cross Your T’s – Get Ready for the Next Generation of Share Classes

201607_ABC-[Converted] July 13, 2016 - Part Two in a month long series of Share Class blog posts.

This week, we’re taking a closer look at some of the more specialized share classes available through alternative investments.

June’s sales data revealed that sales of nontraded REIT T shares are catching up to A share sales. A shares clocked in at approximately $132.6 million for the month, while T shares weren’t far behind at $125.3 million.

But, just what are T shares, and how do they compete with A shares? By definition, A shares charge a load or sales charge upfront. With nontraded REITs, this means that less money is invested initially “in the ground” than the client may think due to sales charges. In the past, nontraded REITs were criticized because the client only saw the stable share price they paid into the REIT reflected on their statements. This price didn’t necessarily reflect the amount actually invested on behalf of clients into properties.

Once FINRA began requiring that REIT sponsors show how much of an effect the upfront load can have, REIT sponsors introduced the T share. The T share replaces the front-end load with trailing commissions. Clients pay a lower share price upfront, but their distributions going forward will be subject to ongoing distribution fees. The T share is intended to give the client more visibility into how much he or she has invested “in the ground” so that performance can be better measured going forward.

Critics say that T shares are simply spreading the upfront fee out over the course of the investment. Proponents say that the new shares are better for investors over the long haul by making sure more of their money goes into the investment initially, while commissions are taken gradually.

It’s worth noting that FINRA limits dealer manager and distribution fees charged on an ongoing basis to 10% of the gross proceeds of a primary offering. However, share class-specific expenses will still be applied to distributions.

I shares are low-cost institutional shares available to investors who can invest higher upfront capital. They’re available to institutional clients like pension plans, bank trusts, retirement plans, foundations, endowments, and certain financial intermediaries. I shares are also structured so that advisors affiliated with registered investment adviser firms (RIAs) can offer them as a fee-only service. I shares may be an attractive option for individual investors who can take advantage of their availability through their RIA advisor.

In upcoming blog posts, we’ll look at some other share class options and examine their popularity and success among investors.

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Department of Labor (DOL) Fiduciary Rule: Counterintuitive Reaction or True Investor Protection?

by Jared Schneider (Managing Partner) | Blue Vault

One of the hottest topics right now in the alternative investments space is the DOL’s Fiduciary Rule legislation. The rule is designed to redefine what it means to be a fiduciary and how that affects retirement accounts (i.e., IRAs, 401ks, etc.). The rule stipulates that certain investments and commissions for those products are no longer allowed. For example, the rule, as it’s currently worded, would prohibit nontraded REITs, nontraded BDCs, private equity funds, hedge funds, and other alternatives from retirement accounts.

The outcome of the rule, however, contradicts our country’s general desire to encourage public participation in investments. For example, the recently passed JOBS Act was created to encourage entrepreneurship and job creation, and the ability for everyday investors to participate in these endeavors. But now, we have a rule stating that if that investment is part of your retirement account, you cannot invest in those types of opportunities. In the past couple of years, we’ve seen crowdfunding and general solicitation of private offerings become legal, but at the same time regulators were working on a way to discourage investors’ access to those very same investments.

Now, this is not to say there is no fault to be placed on the misconduct of bad brokers and fund sponsors. Additionally, the nontraded product and private fund space has lagged behind the rest of the investment world when it comes to transparency. Commissions and fees have driven up the cost of ownership for these investments, and many investors were unaware of the fees associated with them. Even so, as a whole, these nontraded products have provided very good returns to their investors. Blue Vault, in collaboration with the University of Georgia, has a study1 on the performance of all nontraded REITs that have gone full-cycle or provided liquidity to investors.

If the regulators’ goal is to expose and reduce commissions and fees, then by all means, do that. But rather than prohibiting investors from the ability to invest in alternatives, a much simpler solution would be to limit commissions and provide more transparency in reporting them. When this happened years ago in the mutual fund industry, assets under management grew after commissions came down and many no-load products were introduced. If fees and commissions are simply reduced, there is a strong argument that the masses would embrace and adopt nontraded funds and private funds.

The DOL Fiduciary Rule, while having good intentions of limiting conflicts of interest, has the unintended consequence of limiting access to investments. After all, access to the broadest range of asset classes and investment types should provide the best opportunity to diversify and mitigate risk. That is what a financial advisor wants to help clients accomplish for their portfolios.

1If you are not a Blue Vault Subscriber and would like a sample of the 4th Edition Nontraded REIT Full-Cycle Performance Study, click here.

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