NestEgg Investing: 1031 Tenants in Common Exchanges

How do you know a 1031 TIC Exchange Firm is Honest?

I got the following questions emailed to me:

are the main questions we should ask of the RSP or real estate provider?

how do we know they  are honest?

how do we know the property is really going to yield 6-7 %?

1) All the questions that I list on how to choose the right 1031 exchange firm (link) are questions you should ask the real estate firm, other investors and folks like your CPA, CFA.  For your CFA, ask if they have any biases, commissions,etc. Often the CFA is recieving a 5% commission to introduce you to a firm

2) How do you know they are honest?  This is a tough one.  Asking prior investors is the best way to tell.  Also, take a look at their fee structure.  If their fee structure is egregious (ie greater than 15% of equity rolled in) it's a sure sign that the firm is trying to make a quick buck.  You can also ask a a lawyer or friend who is a lawyer to take a quick look to see if the ceo of the organization or the organization itself has ever been sued

3) How do you know you will get the promised yield?  Most offerings have a triplenet lease which is a contract guaranteeing the return.  To make sure that the firm lives up to the guarantee, ask if there has ever been a capital call.  Also, look to see how aggressive the loan agreement is.  If it's a variable, interest only loan, you might ask how the firm is going to continue its cash yield commitments when interest rates rise and principal needs to paid back.

To better serve you, we're looking to launch a feedback project on 1031 service providers (find out more link) .  If you think this would be valuable, please post  comment or email us at nesteggemail@gmail.com

Researching a 1031 TIC Exchange Firm Part 3

Continued from previous post (link)

7) Has the firm ever been sued? 

8) Has the firm ever had to make a capital call?  If the firm has had to make a capital call, that means the firm used too much leverage, did not manage the property well enough, or made a similiar mistake.

9) How do I get out?  A life event may force you to have liquidate your ownership share earlier than you intended.  You should get in writing the process for selling down your ownership. In highly leverage buildings (70% debt), often the loan document must be amended and the new buyer approved by the bank.  This will incur significant fees in addition to the decrease in selling price do to your distressed situation.  Some firms won't let you get out at all.  More generally, have a firm layout in black and white exactly the restrictions (both legal and practical) you will face if you need to sell

10) Talk to prior investors: If you do anything at all, talk to private investors about their experience.  If you can find someone not referred by the 1031 firm, all the better.  It will give you confidence that the firm you are working with is legitimate. Please also help others in this regard. If you have performed a 1031 exchange of any kind (traditional, TIC, etc.) and have feedback--good, bad, or indifferent-- on any the firms that you've worked with, please email us with feedback: nesteggemail@gmail.com

Continued at Researching a 1031 Firm Part 4 (link)

Researching a 1031 TIC Exchange Firm Part 2

Continued from previous post (link)

4) Fee Structure:  Have a 1031 syndicator layout on paper their entire fee structure.  Many times they will list the fees as a percentage of assets rather than a percentage of equity.  For example, a large firm quoted us fees of 10% of the asset purchased which sounded reasonable.  However, when you consider that the building was being purchased with 50% debt, the fees equated to 20% of equity exchanged which is higher than the national capital gains tax.

5) Underwriting Leverage:  From what we've seen, 1031 syndicators underwrite their purchases from 0% debt all the way up to 80% debt.  Obviously, the lower the debt, the less risky.  We generally think that around 50% debt makes sense.  With higher debt levels, there's greater chance that firm will not be able to cover debt service and deliver their guaranteed return.  Even worse, they are not able to cover debts service and will make a capital call which requires you to put more money in.

Finally, the greater the debt, the more restrictions the banks will have on the investors.  Thus, they may have restrictive covenants that prevent you to sell down your portion, etc.

Also pay attention to how this debt is structured.  Many firms will use interest only debt in the early years.  They do this to increase their yield to investors at the cost of big principle payments and lower returns (and potentially capital calls) in the future.

6) Debt Available to You:  When you do a 1031 exchange you need to rollover both your equity and your debt.  Most firms will provide loans for you.  This is helpful, as raising debt on your own can be difficult for a fractional ownership of a building.  Be careful about how these loans are secured. Many firms will over non-recourse loans which are secured by ownership in the building itself rather than your personal assets.

Diligence List Continued (Link)

1031 TIC Exchange Firm Due Diligence List

The 1031 industry is in some ways brand new.  As a result, it's pretty difficult to determine which firm you can trust.  To help sort through the wheat from chaff, we've put together a "due diligence list" below to help you more rigorously research firms to work with.  As always, consult your tax and financial advisors.

To better serve you, we're looking to launch a feedback project on 1031 service providers (find out more link) .  If you think this would be valuable, please post  comment or email us at nesteggemail@gmail.com

1) Firm background: Find out how long your 1031 syndicator has been in business, how many transactions they have performed, and how credible the leadership of the firm looks.  Many firms have grown out or are subsidiaries of title or brokerage companies.  So be careful about differentiation between the track record of the 1031 company and the parent company.

2) Offering:  First take a look at what type of offering (Tenants in Common, Tenants in Common Triplenet Leases, UpREIT). Generally, we feel that the UPREIT still has not been approved by the IRS and is thus more risky.  Second, look at the properties themselves:  research the geography, the tenants, and the general quality of the assets.  Finally, how big is their property portfolio.  The bigger usually will indicate a larger and more established firm.  Also, when you go to exchange it's more likely that they will have a property available.

3) Promised Return:  Be careful about exactly what return the firm is promising.  Some firms advertise "cash on cash yields"  which are really returns to your equity.  Others advertise capitalization rates which are returns to equity and debt. 

Diligence List Continued (Link)

Choosing the Right 1031 TIC Syndicator or Exchange Firm

Six months into our research, we do think that the new options available under the loosened 1031 law can very powerful vehicles for personal investors.  We've talked about this in the prior posts, but these new 1031 options allow investors to diversify geographically, to eliminate management (through exchanging into triple net leases), to increase yields (particularly if you are exchanging away from the low cap rate geographies like the Bay Area), and to reduce principal and tenant risk (if you are exchanging into institutional properties). 

That's great in theory, but how does play out where the rubber hits the road?  We're beginning to research actual firms that provide 1031 exchange options and our advice is be careful and really do your homework.  This is a new industry, and while there are some reputable firms, we've certainly found plenty of fly-night operations. 

To help you do your homework, we've created (and will update as we continue to do our research) a diligence list of good questions to answer before working with a 1031 syndicator.  As always, consult your financial and tax advisor.

Firm Due Diligence Checklist Link

Please also help us with this effort.  We're looking to launch a feedback project (find out more link) on 1031 service providers.  If you think this would be valuable, please post  comment or email us at nesteggemail@gmail.com. 

1031 TIC Exchange Triple Net Leases, The Management Free Option

An increasingly popular 1031 exchange option is the triple net lease  (ie. "NNN").  A triple net lease is a long term lease where the tenant pays for all maintenance, taxes, insurance, and utilities.  Usually, these NNN leases are with well know franchises or chain stores such as Walmart, Walgreens, Pizza Hut, and Starbucks. 

The advantages of exchanging your investment property (either individually or through a tenants in common) into a NNN property are:

1) Zero maintenance

2) Zero occupancy risk- high credit tenants sign long term leases

3) Lower principal risk (because of #2)

4) If you purchase through a tenants in common structure, you can buy a larger, and thus higher yielding property

The attached article provides a good overview: article link