President Joe Biden's election was a warning sign to Josh Eitingon that the 1031 exchange's days may be numbered. And that is pushing him and his clients to look to Sun Belt markets for their next commercial real estate investments.
Eitingon, the co-founder of DXE Properties, said he sees the pressure to sell properties and reinvest the proceeds through the 1031 exchange program mounting over the next 12 to 24 months as the industry waits for Biden to propose his campaign promise of tax reform.
“I think there is some added urgency now more than ever if you were considering a sale,” Eitingon said.
Like-kind exchanges, also called 1031 exchanges, allow real estate investors to sell one asset — in many cases apartment buildings or single-tenant retail properties — and funnel those proceeds into buying similar assets within 180 days. By doing so, investors can avoid paying capital gains taxes.
Tax reform and its effects on 1031 exchanges are part of the growing motivation some investors are expressing when making moves, especially when selling properties in high-cost, high-tax markets along the West Coast and Northeast and into more business-friendly and lower-cost-of-living environments in the Sun Belt.
“Some of them are definitely operating under the guise that 1031 won't be a viable option anymore," Berkadia Director Matt White said.
While 1031 exchange investments nationwide dropped along with the rest of investment sales nationally due to the coronavirus pandemic last year, activity is on the upswing again. Politics is playing a part in that.
The threat of higher taxes in the future prompted by the Biden administration has real estate investors second-guessing expensive markets like New York and San Francisco where taxes are already high, Mag Mile Capital CEO Rushi Shah said.
“When you have $3 [trillion] to $4 trillion in fiscal stimulus … when that type of spending occurs, the taxes you have to be able to fund it at some point will need to go up,” Shah said. “The darling markets of the new paradigm [is] low taxes. The Sun Belt.”
Investors who make use of 1031 exchanges also are being lured to Sun Belt markets for many of the same reasons their institutional brethren have been buying up properties in cities like Atlanta, Phoenix, Dallas and Houston: They tell present-day America's growth story.
The 18-state region stretching from the Southeast to the Southwest now accounts for half of the U.S. population, and it is expected to reach 55% by 2030, according to a 2019 Clarion Partners report, citing a combination of its own and Moody's Analytics' research.
The Sun Belt has long been the fastest-growing part of the country, accounting for 75% of the U.S. population growth over the past 10 years. Over the next decade, Sun Belt states are expected to add another 19 million residents, while non-Sun Belt states will only grow by 3 million, according to Clarion Partners.
“We, in general, have seen the flow of capital moving from Gateway markets to smaller cities. And there's been a significant flow of capital to lower-tax states, like Texas, like Arizona and like Florida,” Marcus & Millichap Senior Vice President of Research John Chang said.