Robert S. Smith – July 9, 2019
There is an old saying, “you can run but you can’t hide.” This means you can try to escape what you fear most but ultimately you must face it.
This saying originated in the United States in the 1940s and is attributed to boxing great Joe Louis describing his impending fight with light heavy weight champion Billy Conn.
This may be true in professional sports but fortunately it’s not in the commercial real estate arena. As far back as the 1940s economists Milton Friedman and George Stigler observed that housing laws that favor tenants also reduce the incentive for developers to supply new apartments. Recently New York State approved a permanent extension of rent control in nearly one million apartments and Oregon became the first state ever to enact state-wide rent control.
To add insult to injury, Oregon has made it more difficult for landlords to evict nonpaying tenants. New York condo conversions now face extinction due to a state law requiring 51% of exiting tenants agree to buy their apartments before a building can be converted into a condominium or co-op. In San Francisco, direct conversion of most rental apartments has been illegal since the 1980s.
The road to hell is paved with good intentions. As real estate prices skyrocketed in the zero-interest rate environment created by global central bankers (Jim Grant writes, May 24, 2019, in his Grant’s Interest Rate Observer newsletter that “almost $13 trillion in debt world-wide is priced to yield less than nothing.” He calls this a 4,000-year low in bond yields) bi-coastal local governments have rushed to increase tenant protections.
As a landlord, you can’t hide from this on either coast. However, thanks to the mechanism of 1031 exchange you may be able to run from it without capital gains tax liability. Of course, the next question is where to? Harking back to Arthur Laffer’s commentary in the WSJ “So Long, California. Sayonara, New York.” the Sunbelt. In my opinion the big winners in this regulatory blitz are states like Florida, Tennessee, Texas, Nevada and Utah. These are all states which hold private property sacrosanct and have taken the opposite tack. Measures have been passed to better protect landlords’ rights and create a more positive environment for development.
This is why in the years to come, “millions of people, thousands of businesses and tens of billions of dollars of net income will flee high-tax blue states for low-tax red states.” Arthur B. Laffer & Stephen Moore WSJ 4/24/2018.
Heretofore, it was difficult for small rental property owners to capitalize on a trend like this. You were limited to the local market, what you could see, touch and mange yourself. No one wanted to be the Lone Ranger risking their hard-earned equity in a market thousands of miles away.
If suitable this is where DSTs may be an option. By pooling your money with others and exchanging into institutional quality assets, while not guaranteed, a DST seeks to help mitigate this risk. This may be further enhanced when said properties are selected and run by commercial real estate companies with hundreds of thousands of investors and billions of dollars in real estate transactions under their belt.
Leveraging up on this institutional expertise, managing and selling all types of commercial real estate nationwide is hugely empowering to individual landlords under attack by state and local governments.
Disclaimer:
This material and views are prepared solely by the author and does not necessarily represent the views of the its affiliates. Statements concerning financial market trends are based on current market trend, which will fluctuate. Projections are inherently limited and should not be relied upon as an indicator of future results. Historical figures and performance are not indicative of future results. This is for informational purposes only and does not constitute an offer to buy or sell any investment.
DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only. There are risks associated with investing in Delaware Statutory Trust (DST) and real estate investment properties including, but not limited to, loss of entire principal, declining market value, tenant vacancies and illiquidity. Diversification does not guarantee profits or guarantee protection against losses. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated.
Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor. This information is not meant to be interpreted as tax or legal advice.
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