1031 Exchange Tips for Real Estate Closing Agents

If you work as a closer for real estate transactions and you're notified that one of the parties to the transaction wants to do a 1031 exchange, it’s important for you to make note of that right away in the file and find out who are the people that are helping facilitate this exchange. Here are a few tips for closing agents who encounter 1031 exchanges.

Eleventh Hour Fire Drills

We often get calls from closers at the eleventh hour saying that nobody made arrangements for the 1031 exchange. Everybody involved thought it was someone else's job to do, and now we need to hurry up and get 1031 documents prepared for a closing that's imminent. We can do that, but it's a real fire drill.

Questions to Ask

The better arrangement is to contact the party that intends to do a 1031. Ask them the following questions:

• Is this your relinquished property that you're selling?

• Have you started your process with a qualified intermediary?

How a Qualified Intermediary can Help

If they haven't started with a qualified intermediary, have them contact CPEC 1031 right away. We can get a copy of the purchase agreement and title work from you; we can gather the specific details in particular that we need from the seller; and we can put together the 1031 and the closing instructions that you'll need to know how to prepare the settlement statement and what notices need to be given to the other parties. This allows all of the documentation to be dealt with up front well before the closing occurs so that we have a smooth signing ceremony.

• Start Your Exchange: If you have questions about closing documents related to a 1031 exchange, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Delaware Statutory Trust Ownership Structures

For people that are putting together real estate syndications, the old model that was often used for large-scale syndications was the tenancy-in-common model.

Tenancy-in-Common Model

With a tenancy-in-common model you'd have up to 35 co-owners of a property as tenants-in-common owning a property typically pursuant to a tenancy-in-common agreement. However when the recession occurred it became evident that the tenancy-in-common model wasn’t really doable because decision-making often had to be done by unanimous vote. It can be very hard to get unanimous agreement as to leasing a new tenant, or whether or not to refinance with a particular lender, or whether or not to sell the property.

Delaware Statutory Trust Model

These major decisions often caused log jams that made it very difficult for the owners of the property to work together. So a new model was created based in part on the old Illinois land trust. The new model is called a Delaware Statutory Trust. At the top of the ownership pyramid there is a figurehead owner - the trustee of the trust. But within the trust the beneficial owners are deemed to be the owners of the underlying real estate.

The beauty of it is that once the Delaware Statutory Trust is set up and it owns the property and it's got the property stabilized with the leasing in place, the financing in place, then ordinary investors can take their 1031 funds and invest them into the Delaware Statutory Trust where they receive a beneficial ownership interest in the trust. But for tax purposes they are deemed to own a fractional interest in the underlying real estate.

Institutional Financing

Furthermore the Delaware Statutory Trusts have set up institutional financing that the beneficial owners are not personally liable for. So they get the benefit of institutional debt without the personal liability. So if the property were to be foreclosed they likely would not have any personal liability for deficiency. For older investors that need to offset debt relief - debt that was discharged on their old relinquished property - they are comforted that they are able to defer their gains, take out new debt, but it's not debt that they’re personally liable for.

• Start Your 1031 Exchange: If you have questions about DST ownership structures, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Maximum Leverage? Looking at Loan-to-Value Ratios by Property Type

Note: In this article, we hear from guest contributing blogger Kip Dunkelberger (kdunk@venturemortgage.com), the President and CEO of Venture Mortgage Corporation.  Kip leads this trusted, dynamic commercial real estate mortgage banking firm, and he himself is known as an experienced and resourceful problem solver in the realm of commercial real estate financing.  

Lenders evaluate commercial real estate largely based on the current and potential income generated by the property, the ease of finding replacement tenants (as applicable), and the degree to which the property is stabilized. With that in mind, let’s take a look at several property types and the general LTV ratios you can expect from potential lenders.

Remember that each piece of commercial real estate is a unique entity, and loan-to-value ratios can vary for a number of reasons: the examples below are presented in good faith only as general guidelines.

Multifamily

Multifamily properties have the distinct advantage of having tenants that are relatively easy to replace in the grand scheme of things. A single-tenant industrial building has a very limited, specific market of potential tenants, making it a riskier proposal in the eyes of a lender than a stabilized apartment building with thousands of potential tenants within a 5 mile radius on any given day. Therefore, owners of multifamily commercial real estate enjoy some of the highest LTV ratios in the market, and can push this ratio up to 85% in some cases, though 75 to 80% is more common.

Specialty/Recreational Properties

The income potential for these properties is largely seasonal and can be volatile, which can cause some lenders to be reluctant to lend on this type of commercial real estate at all. That is not to say all hope is lost: there are several lenders who are familiar and comfortable lending on these properties, and a commercial mortgage banker is a good option to assist borrowers in assessing the lay of the land in sourcing capital for these loans. However, because of the potential swings in income and the risk of drastic changes in the operating stability of these properties, borrowers should expect to see a cap of 50% LTV. Some very stable assets with a long history of good operation (and the documents to support such a history) could possibly push the LTV higher, perhaps to 55 or 60%, but that is relatively rare.

Borrowers should also be aware that valuation of these properties tends to be quite conservative, which could further reduce the potential loan size.

Retail (Strip/Center)

The retail sector of commercial real estate has seen some challenges in the past decade, but remains in relatively high esteem in the eyes of most lenders. It should be noted that retail centers are valued more highly (and have the corresponding higher LTV potential) if they contain one or more national, stable tenants (i.e., Walgreens, AutoZone, Caribou Coffee, Toys R Us, and the like) who will increase customer traffic for the lesser-known tenants and are unlikely to abruptly vacate or go out of business. Lenders also like to see leases with many years remaining for each tenant at the time of origination, which assures them that a property that is currently operating well will not lose half its tenants shortly after closing, and the higher the occupancy rate, the better. A stable retail strip center with low vacancy and good tenants can expect about a 70% LTV ratio, with very well-performing properties able to reach closer to 75% LTV.

Triple Net Leased National Single Tenant Retail

Perhaps the holy grail of leases, the true NNN or triple net lease obligates the tenant to be responsible for taxes, insurance, maintenance, capital expenses, and any other operating expenses associated with a subject property. The owner, in essence, only collects rent and pays the debt service to the lender. When combined with a long lease and a national, publicly traded company as the tenant (Wal-Mart, Best Buy, Aldi, Nordstrom, etc.), lenders are quite comfortable with LTVs up to 85% for these properties; in some cases, special loan programs offer the opportunity for a 90% LTV if the tenant has an especially good credit rating.

Here, we’ve looked a just a few of the many property types in commercial real estate and the range of loan-to-value ratios for each. We’ve explored the reasoning behind the LTV spectrum from the lender’s perspective, and we’ve advised that seeking a consultation with an experienced commercial mortgage banker can provide you with advice regarding the best lender for your property type, situation, and objectives. When it comes to commercial real estate financing, remember that tenants and cash flow are keys to a stabilized, well-performing property that makes lenders comfortable with a potential investment and allow borrowers to maximize their leverage. 

If you have questions about obtaining a mortgage or financing for a reverse exchange or any other commercial real estate investment, you are invited to call Kip Dunkelberger at (952) 843-5125, or email him at kdunk@venturemortgage.com.

Find Venture Mortgage online:

www.venturemortgage.com

Giving Written Notice in Your Purchase Agreement

In a 1031 exchange, typically the purchase agreements for the sale of the relinquished property or the purchase of the new replacement property are assigned to the intermediary by the taxpayer that's doing the exchange.

Old English Common Law

Under the Old English common law, an assignment was not considered effective until all of the parties to the contract were given written notice of the assignment. The IRS has adopted this Old English concept and in the context of a 1031 exchange when the seller of a relinquished property assigns their rights in the relinquished property purchase agreement to their intermediary, that necessitates the seller giving notice to the buyer of the relinquished property as well as any assignee, or parties that were assigned rights in that contract.

Well sometimes that's easy to do and sometimes it's hard to do because the buyer that's actually purchasing the property may or may not be affiliated with the original contracting party and it's sometimes difficult to track down all of the parties to the contract and give them written notice.

Replacement Property

The same thing goes on the replacement property. When you contract with the seller of the replacement property and then assign your rights in that purchase agreement to the intermediary, you must give written notice to that seller. There is often less rigmarole and assignments of the replacement property purchase agreement but nevertheless, if there are any other parties in that purchase agreement the treasury regulations require that the taxpayer give those other parties written notice of the assignment to the intermediary.

Making it Happen

So how do you make sure that you get that written notice proved up? You ask those other parties to sign an acknowledgement that they received written notice. How do you make sure that these other parties do that and give you the written proof? You make it a contractual requirement in your purchase agreements that ALL of the other parties will cooperate and will provide you with that requisite acknowledgment at or prior to closing.

For a sample 1031 cooperation clause, check out this link.

• Start Your 1031 Exchange: If you have questions about 1031 purchase agreements and cooperation clauses, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

Text Messages Add New Layer of Risk to Deal-Making in the Modern Age

Note: This is a guest article by Steven Katkov - a business attorney at Cozen O'Connor.

Texting is becoming ubiquitous in this era of 24/7 connectivity, but a recent court decision stands as a strong reminder that those quickly-composed texts can be held up as a “writing” sufficient to seal a multi-million dollar deal.

Recent Ruling

In a decision that comes as a surprise to many observers, the Massachusetts Land Court recently ruled that text messages between two real estate brokers regarding the purchase and sale of a commercial building may constitute a “writing” sufficient to meet the requirements of the Massachusetts Statute of Frauds. In other words, brokers are now on notice that a text message which — either on its own or when read in conjunction with other writings — identifies the subject of the parties’ agreement, shows that they made a contract, states the essential terms of the contract with reasonable certain, and bears some form of a signature may be the legal equivalent of the four corners of a written document bearing the signature of the parties.

The case, St. John’s Holdings, LLC v. Two Electronics, LLC centered on a negotiation for the sale of a commercial building. The brokers for the parties discussed the deal in person and reduced the terms of the agreement to a letter of intent (LOI), which was further discussed and subsequently revised. The brokers continued to negotiate the $3.232 Million deal via email and text message, including discussions of the purchase price, due diligence period, earnest money deposit and closing date. One of final texts between the brokers stated that the seller wanted the buyer to sign the final LOI first. The buyer’s broker obtained the requested signature and then sent a text message to the seller’s broker stating that the LOI was signed and that he had the earnest money check required by its terms. Each of the texts at issue concluded with the sender’s name.

Ultimately, rather than execute its end of the LOI, the seller’s principle accepted a third party’s offer to buy the building. The jilted buyer sued to enforce its rights as a buyer of the building under a binding letter of intent to purchase.

Court Determination

The Massachusetts Land Court considered whether the brokers’ text messages created a binding contract for the purchase of real estate or were evidence only of mere negotiations. The court observed that the parties frequently communicated electronically and that their conduct throughout their course of dealings clearly evince an appreciation that the final exchange of text messages would memorialize the final LOI as an offer and acceptance.

Further, the court found that the typed signature at the end of the text sufficiently portrayed the sender’s intent to authenticate the message. The brokers’ practice of including their names in messages containing material terms, but omitting names from informal discussions, signaled their intention to authenticate their “signed” statements by electronic means, the court reasoned. The court noted that “[t]he communications between SJH and Two Electronics before the text message evidenced a meticulous attention to provisions that would govern the agreement to purchase the [building].” When read in context of the exchanges between the parties, the court concluded that the text messages at issue constituted a binding offer and acceptance.

Lessons Learned

This decision can be seen as a harbinger of surprising weight on text messages. It is generally understood that email may rise to the level of a writing that satisfies the Statute of Frauds and create a binding contract when all essential terms are present in such communications. Now, we are reminded that text messages can be viewed as akin to email or any other writing. Indeed, courts have continually modernized their interpretation of the ancient Statute of Frauds by recognizing that electronic communications have supplanted the traditional four corners of a document in a real estate transaction.

Brokers should take precautions to include qualifying language in all electronic communications that acceptance is subject to final client review and that no agreement can be reached with the use of electronic communication without a statement that “I so contract.” This case may serve as an important reminder to all parties to a negotiation that they would be wise to rely less on the informality of electronic communication and return to more formal, and face-to-face interactions, as they bear down to close a deal.

Of course, this case is just the latest reminder that all parties to a real estate transaction must be very careful with letters of intent. If the parties engage in protracted negotiations leading to a form of LOI that contains the essential terms of a contract to purchase, it is essential to expressly state that it is not intended to be legally binding. Otherwise, the LOI itself can be enforceable against them if the court can find mutual agreement on those terms — even if that agreement is announced with the “ping” of a cell phone rather than in the form of a traditional commercial real estate purchase agreement.