By Christopher Miller, MBA
Specialized wealth management
Occasionally, I refinance a property in my portfolio or get a new loan to buy another – and it reminds me what a horrible experience that is. Gather all your documents and send them – then do it every month until the loan closes, answer the same questions multiple times, and be mindful of meeting loan-to-value guidelines. Your loan broker may check your credit 5 or 6 times and then you will need to explain to lenders why your credit was checked. If you are doing a 1031 exchange, it all needs to be done on a tight deadline. All other participants in the transaction know this, so they will sometimes try to “re-exchange” you (increasing the interest rate), or the seller may refuse to make reasonable concessions. Part-interest properties can help you avoid many of these problems; this month, we’ll discuss how.
What are Partial Interest Properties?
For over 20 years, my real estate advisory practice has focused on helping clients complete 1031 exchanges by buying properties of partial interest. My clients can sell their 8 unit property in Los Angeles and trade in a portion (say 3%) of a 300 unit apartment complex in Dallas or a CVS drugstore in suburban Atlanta. I source these properties through management companies that focus on this part of the real estate industry: they buy these properties, offer partial interests to investors, and then stay to manage the property through their business plan.
Benefits of Partial Ownership
These investments offer many potential benefits to my clients:
- No day-to-day management responsibility. Even investors who hire property managers often spend a lot of time “managing the manager” but are relieved of these tasks with my offers.
- An opportunity to buy outside of California. Many of my clients are worried about California and are willing to move their investments to other states. Partially owned properties are an easy way to do this.
- Diversity. An investor can sell his $2 million property here and buy, perhaps, portions of 4 or 5 part-interest properties. This way, we can buy properties in different metro areas and in different asset classes (like apartments and triple net rentals), to potentially find more growth.
All negotiations have been done
When buying real estate on your own, there is a lot of negotiation with sellers. Your inspection will almost always reveal some negative characteristics of the property, and you will need to approach the seller and ask for concessions – usually in the form of a price reduction. If the seller knows the buyer is making a 1031 exchange (and he does because it has to be written into the sales contract), he may not want to give any concessions at all. After all – if his buyer has 1031 exchange deadlines to meet; what are the chances that he will drop the escrow and start over with another property?
With partially held properties, on the other hand, all the negotiations have already been done in advance. The managers we work with first buy their properties before reselling them to investors. These managers have no 1031 deadlines to meet, and no pressure to act quickly. This gives them more power when negotiating with sellers and the chance to get better deals.
Never ask for another loan again!
With partial interest properties, the manager will purchase the property in advance using temporary mezzanine financing. In some cases, they will buy the property with leverage and also arrange a permanent loan for the property. So when buying a hypothetical $50 million apartment in Dallas, they can take out a $20 million fixed rate loan and then use an additional $30 million in temporary financing to complete the purchase. . The manager will then raise $30 million in equity from investors to repay the temporary loan. Investors will then get a “credit” for their share of the loan: an equity investment of 1% ($300,000) will also “buy” 1% of the loan ($200,000), so the investor now owns 500,000 property $.
Many of my investors need to replace debt as part of their 1031 exchange, or want to go into debt in order to “buy more base” and create more depreciation deductions and tax savings for them- same. Using fractional interest properties could also be a great way for you to achieve these goals.
Off-balance sheet loans
The partial interest properties I offer are structured in such a way that non-recourse loans are not the personal liability of my investors. (The property itself is the only collateral for the loan.) So I call these loans “off balance sheet.” This means that any loans associated with your partial interest investment will have no effect on your ability to obtain additional credit in the future. When you draw up a balance sheet, you count your equity in the property, but not the debt. This way, you are still free to buy “traditional” investment properties yourself while holding partial stakes.
My clients use fractional interest properties to defer (potentially forever) capital gains and accumulated depreciation taxes from the sale of their investment properties. They also enjoy the potential for other benefits such as monthly income, increased capital cost allowances, freedom from management responsibilities, and capital appreciation. Could a partial interest property work for your next 1031 exchange? My office number is (877) 313-1868.
Christopher Miller is managing director of Specialized Wealth Management and specializes in tax-advantaged investments, including 1031 replacement properties. Chris’ real estate experience includes work in commercial valuation, in institutional acquisitions for a national real estate syndicate and as an advisor assisting clients through over four hundred and fifty 1031 exchanges. Chris has been featured as an expert in several industry publications and on television and earned an undergraduate degree in business and an MBA focused on real estate finance from the University of Southern California. Chris began his real estate career in 1998. Call him toll free at (877) 313 – 1868.
Securities Offered by Emerson Equity LLC, Member FINRA/SIPC. Emerson Equity LLC and Specialized Wealth Management are not affiliated. Any investment involves risk. Always discuss potential investments with your tax and/or investment professional before investing. The what-if scenarios here are provided to illustrate mathematical principles only, and do not constitute a promise of performance. There can be no assurance that an investment strategy will achieve its objectives.