TI RED OF BE I NG A LANDLORD? CONS I DER PASS IVE I NVESTI NG . In 2020, over 6,000 landlords replaced their rentals with roughly $6.4 billion of real estate in syndicated passive 1031 exchange programs. Why are so many landlords exchanging their rentals for passive investments? 1
There are several reasons. Some owners are weary of maintenance hassles, troublesome tenants and looming expenses. Potential legal liability for landlords has never been greater. And the pandemic economy has hit small apartment owners particularly hard, compounded by extended eviction moratoriums. Finally, for many owners, their rentals no longer make financial sense. When property values outpace rental revenue for several years, yield on equity inevitably declines. Below is a simple example of a rental property in 2011 and 2021. RENTAL PROPERTY * Property Value Loan Balance Equity New Operating Income (NOI) Yield on Equity
The NOI increased by 50% over 10 years—not bad. Yet the equity grew by 220% over that time, a function of property values doubling and principal payments reducing the loan balance. Despite enjoying solid appreciation, the yield on equity decreased from 8% to 3.75%. Why should a landlord continue bearing the hassles and liabilities of direct ownership for a meager 3.75% cash flow? This is especially true in markets where unemployment is soaring, taxes are high and more people are moving out of
town than in.
Any positive trends that supported property values over the previous decade may not continue, in such markets, going forward. Enter passive replacement programs. The primary vehicle for securitized passive replacements is the Delaware Statutory Trust (“1031 DST”). 1031 DSTs are the only form of indirect real estate ownership recognized by the IRS as qualifying for a 1031 exchange.
A 1031 DST is simply a business trust, formed
2011 1,000,000 500,000 500,000 40,000 8.00%
2021 2,000,000 400,000 1,600,000 60,000 3.75%
% Change 100% -20% 220% 50% -53%
* Hypothetical example for illustrative purposes only
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