There was much anticipation, during the previous administration, that the long-standing Section 1031 tax deferred exchange provision would see changes. There were several proposals, from elimination (of what some referenced §1031 a loophole), to limiting the exchange dollar limits, to other strategies, none of which came to fruition. 

January 27, 2024

By Al DiNicola, AIF®
DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC, Member of FINRA/SIPC

We have previously written about the reasons why. Advisors, CPAs, real estate professionals and most importantly the individual investors feel comfortable the program will stay intact, at least we are hopeful.

In Part 1 we commented on real estate prediction, interest rate changes, financing, inventory supply, asset classes and short-term rental in certain areas. (See   Part 1 – 2025 CRE Trends). We will address a few other areas and amplify. 

Can you Refinance? There continues to be concerns regarding the ability of investors (especially large investors) to refinance maturing lower rate loans to higher interest rates. We have heard of the projected number of loans maturing over the next two years. The estimates range from $700M to $2 Trillion depending on the source and interpretation of the data. No matter what the dollar amount will be, the individual investor will be focused on how to reposition their asset either through refinancing or reselling.

A lot of that will be determined by the banks that are holding the loans. Some analysts have often used the phrase “extend and pretend” but some banks may potentially use some of the same strategies. In banking, the term “extend and pretend” refers to a practice where banks or lenders extend the terms of a loan (i.e., by lengthening the repayment period or restructuring it) instead of addressing underlying issues, such as the borrower’s inability to repay. This is often done to avoid recognizing a loan as non-performing or impaired on the bank’s balance sheet, which could require the bank to set aside additional reserves or take a loss. 

There may be an increase in the volume of activity simply based on the fact that there are maturing loans, and some investors want to get out from under the loans. The challenge many investors will face when doing a §1031 exchange is that the loans that are being paid off need to be replaced in order to have a valid §1031 exchange unless the investor can provide fresh cash in place of a mortgage. Delaware Statutory Trusts (DSTs) may assist certain investors with debt being replaced with non-recourse loans.

Interest Rates and Transaction Volume

A reduction in a few basis points in interest rates is expected to boost 1031 transaction volume. This may push an upward trend in residential and commercial exchanges. Investors evaluating making moves may focus on tax deferral as well as NOI or distributions being paid.

Seller Financing

Traditional financing challenges will lead to more seller-financed transactions. This may become problematic with sellers leveraging §1031 Exchanges. We will follow up with another article on the benefits and drawbacks of seller financing.

Shifts in Asset Classes

Multifamily, industrial, self-storage, and certain necessary retail properties are expected to see robust activity as investors use §1031 Exchanges to defer taxes. Certain investors may move from one asset class to another.  Investors utilizing DST may have an advantage in selecting several asset types and geographic locations as replacement properties.  This diversification spreads the risk of real estate over a greater number of properties.  For example, an investor selling a residential rental property for $500,000 may acquire 3-5 different DSTs (typically $100,000 minimum in a DST) and assemble a portfolio of real estate rather than one property. If the relinquished $500,000 property has debt, the DSTs provide non-recourse debt which may be viewed by investors as favorable.

Shift to Passive Investments

Investor demographics continue to suggest a move away from active management. An increase in management-intensive properties being exchanged for passive investment types like NNN (Triple Net Lease) and DSTs is expected.

Geographical Shifts

Local regulations may restrict the rental of certain real estate.  New policies and zoning regulation may change the number of rentals per year or per month (as in the case of Airbnb investors) that will prompt investors to move their investments to more landlord-friendly areas.

The need for more housing

In many locations there is a movement for permitting Additional Dwelling Units (ADU). The need for residential units in many locations has prompted municipalities to seek alternatives such as permitting ADU to be added to existing properties.  A single-family home may have enough room to build a smaller home or garage/carriage home on the same property. Hence the name additional dwelling unit (on the same property).  The increase in unit counts may prompt investors to look at §1031 opportunities. There may also be a combination of mixing commercial with residential offerings known as Mixed-use.  This diversification may appeal to a variety of investors, especially those seeking §1031 Exchanges.

Location, Location

The migration of people and to certain extent investment dollars are moving to the southern smile states (as they are known). These are known as retirement-friendly areas. Rumors of warmer weather (although maybe not in the southeast in January 2025), lower cost of living, favorable tax conditions, and areas friendly to retirees, continue to be in demand for investors.

2025 may be a fluid year with opportunities for investors. Potential legislative changes, market dynamics, interest rates, net operating income and other strategies are trends we will continue to monitor. The DST strategy as well as Opportunity Zones should continue to be of interest to advisors as well as investors. Another trend to watch is the IRA to ROTH conversion strategy.

NAMCOA® is a SEC registered investment advisory firm that provides comprehensive portfolio management, financial planning, and fiduciary decision-making services on behalf of retirement plan sponsors. Our Difference is summarized by our fiduciary approach which enables us to better meet portfolio and retirement plan objectives, resulting in stronger risk adjusted returns for investors and peace of mind for Clients. We also focus on alternative real estate investment. Many real estate investors are seeking tax deferred solutions utilizing §1031 exchanges or Opportunity Zones.

DSTs are not for all investors.  The acquisition of a DST is for accredited investors only.  Contact your investment adviser for additional details on how a DST may be a solution to your 1031 Exchange and suited for your investment future. For more information on how to properly set up an IRC 1031Tax Deferred Exchange or if you are an accredited investor and would like additional information on a DST contact Al DiNicola at 239-691-8098 or email adinicola@namcoa.com.

This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus.  Investing in securities, real estate, or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor.   NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission). Our corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 8215 SW Tualatin- Sherwood Rd, Suite 200, Tualatin, OR 97062.  MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.

Thank you.