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Simply Multifamily Episode 9: Exchanging from Multifamily into Absolute Net Lease Properties

Updated: Dec 2, 2021

Hear from James Bean, Vice President at SVN-Rich Investment Real Estate Partners and founder of best1031online.com on the process of doing a 1031 tax-deferred exchange from a multifamily property into an Absolute Net Lease property.





Kiran Dhillon, SIG Commercial:

Hi everyone, welcome to our series, “Simply Multifamily.” My name is Kiran Dhillon, I am a Broker-Associate at KW Commercial specializing in multifamily sales. I work with buyers and sellers of apartment and multifamily properties throughout the greater Los Angeles and Inland Empire areas.


The purpose of this series is to highlight issues and introduce strategies that affect and benefit owners of multifamily properties. Today, we're going to be speaking with James Bean Vice President at SVN-Rich Investment Real Estate Partners and founder of best1031online.com. James specializes in representing real estate investors as buyers in the execution of their 1031 exchanges. Welcome James, it's great to have you.


James Bean, SVN-Rich Investment Real Estate:

Great to be here Kiran, thank you for having me.


Kiran Dhillon, SIG Commercial:

Of course. So can you give the listeners a brief background on the services your firm provides for real estate investors?


James Bean, SVN-Rich Investment Real Estate:

Yeah, sure. I help educate investors on the power of the exchange and also help simplify the process by literally holding their hand through every step of the way including representing them in their actual exchange acquisition.


Kiran Dhillon, SIG Commercial:

And by exchange you're referring to the 1031 Tax Deferred Exchange, right?


James Bean, SVN-Rich Investment Real Estate:

Correct. Thank you.


Kiran Dhillon, SIG Commercial:

I'm sure everyone is familiar with that but can you give the listeners a quick snippet of what that is?


James Bean, SVN-Rich Investment Real Estate:

So the 1031 exchange gets its name from the IRS tax code, it's a section of the tax code and what it allows is an investment property owner the ability to reinvest the proceeds from the sale of one of those properties to help them defer the possible capital gains tax on that, whatever gain profit that they made on the sale.


Kiran Dhillon, SIG Commercial:

So I work with multifamily investors and I'm hearing more and more of them being interested in doing a 1031 exchange into a triple net property. Can you give a quick overview of what a triple net property is?


James Bean, SVN-Rich Investment Real Estate:

Absolutely. Well, first of all, the triple net, people don't really understand what that stands for. Each net represents the main operating expenses of a commercial property, an investment property: property taxes, property maintenance, property insurance. In a typical triple net lease, there are landlord responsibility carve-outs, typically they are the roof, the structure and exterior parking lots. You have to be careful though because it all depends on who wrote it, many people have different definitions on what maintenance should be and what the landlord should be responsible for.


The properties that I specialize in are what we refer to as triple nets on steroids. So, they're actually called an Absolute Net Lease or Absolute Net Properties and they're also single tenant net lease properties on absolute net lease forms. The difference is that there are no landlord carve-outs, zero. The tenant is literally responsible for 100% of the property taxes, property maintenance and property insurance, they're responsible for the buildings, real estate, all operating expenses. We like to call them "mailbox money investments," it's kind of like buying a bond backed by real estate.


Kiran Dhillon, SIG Commercial:

And what are some examples of these types of absolute triple net businesses?


James Bean, SVN-Rich Investment Real Estate:

Well, there's more than 15 different uses, I won't go through them all. The most common are the discount stores, drug stores, QSRs also known as the fast food drive through restaurants, those are very popular, probably the most popular. But there's also auto parts stores, banks, gyms, daycare, healthcare, urgent care, emergency care, dialysis centers, dental labs, so the list goes on and on.


Kiran Dhillon, SIG Commercial:

So there are a lot of choices?


James Bean, SVN-Rich Investment Real Estate:

Yes.


Kiran Dhillon, SIG Commercial:

So, my understanding is that what you do is you help multifamily investors, say in California, who want to do a 1031 exchange but they're not interested in buying another multifamily property, so once they've sold that property, you help them find a good replacement triple net property anywhere in the country.


James Bean, SVN-Rich Investment Real Estate:

That is correct. With the SVN platform, we've got 200 plus offices all over the country, so because of that I have built-in broker of record in each state.


Kiran Dhillon, SIG Commercial:

Okay, great. So if there are multifamily investors in California who are thinking about going down this path, what is the timeline for successfully completing that 1031 exchange? When should they start thinking about what their replacement property is and taking steps to achieve that?


James Bean, SVN-Rich Investment Real Estate:

That is probably the most excellent question you could ask and here's why: Anybody who's considering the 1031 exchange, they should start looking at what that looks like and setting a plan long before they even put their down leg, the property that they're going to relinquish, on the market, especially in a market like there is today. This market right now, there is so much velocity and everything is a 5% cap right now because of this velocity. So to the initial answer, yes, the sooner they start thinking about it, making a plan, getting to know all your options, the better. The absolute net lease property as a fee simple purchase for your exchange is only one of your options. You have DSTs, you have tenant-in-commons, you have mineral rights, you have other forms, in fact, billboards, cell towers, there's all kinds of things that you can exchange into. Just so happens that I happen to believe these absolute net lease properties are perfect because they're zero management and they can produce a pretty good yield.


Kiran Dhillon, SIG Commercial:

If we have somebody who sold their multifamily property and let's say they weren't aware of triple net properties beforehand, they closed escrow today and they want to exchange into a triple net, how much time do they have to do that?


James Bean, SVN-Rich Investment Real Estate:

Well, from the time they closed to the time to identify how they're going to effectuate their exchange is 45 days. So the good news is, is that if you started planning beforehand and you closed and you've already got offers out on some of those properties you can still make that happen pretty quickly. In fact, many of my clients close their properties during their identification period.


Kiran Dhillon, SIG Commercial:

Because they got a head start, right?


James Bean, SVN-Rich Investment Real Estate:

Yes.


Kiran Dhillon, SIG Commercial:

So you touched on this a little bit but maybe you can provide a little bit more detail, for someone who's interested in doing this type of an exchange, what is the triple net market like right now? How competitive is it? How long are those escrows?


James Bean, SVN-Rich Investment Real Estate:

So it is as competitive right now as I've ever seen it. In the seven plus years that I have been specifically working in this market doing the exchange transactions, yes, by far and away the most competitive I've ever seen it. I mentioned earlier, about everything is a 5% cap and when I say everything I mean it doesn't matter who the brand is, it doesn't matter where it's located, it doesn't matter how much term is on the lease, I mean, everything is being priced at a 5% cap right now. So to that, it's very important that, again, going back to why you plan so far in advance is that, many people love the thought of mailbox money so if this is the choice you want to make you need to get somebody who knows what they're doing in that property and have the relationships.


And this is one of the reasons why my business right now is just exploding is because I have the relationships with those listing agents that have the inventory that you want to be looking at. Typically, a commercial escrow is 45-60 days, but because this market is so competitive, if you are outside of 30 days, chances are you're not even going to get considered for your offer. A lot of these are selling it all cash and so if you're in an exchange where you need to replace some debt, all the more reason why you need to start planning early so that you can get a pre-qualification to the lender and have everything keyed up. Again, because of this competitive market, if you don't have all your I's dotted and T's crossed before you're going in, you're not going to get the best properties out there.


Kiran Dhillon, SIG Commercial:

And for the clients who are looking to do a 1031 exchange from a California multifamily property to an out-of-state triple net property, what are the most popular geographic areas that you're seeing these clients go to and what types of triple net investments are the most sought after?


James Bean, SVN-Rich Investment Real Estate:

So the most common in my world are the fast food drive-throughs and the main reason for that is because (A) there's so many of them, but (B) because you get more term, which we can talk about more here in a second. Geographically, so that really depends. Obviously, it really depends on the exchanger's goals, short term, long term goals, but also just how it might fit for them. For instance, I'll ask many people, well, where do you like to travel? Let’s say for instance you're a golfer and you like to golf in the Carolinas, then the Carolinas would be a good place to look for a replacement property so that when you go travel to visit your property, you can write that trip off and make it a golf vacation at the same time -- consult your CP on that of course. However, the one thing that is common is that yield increases pretty significantly as you head east and south. Now, for some people they'll be like, you know what? I'd rather be close to it so I can go see it.


And there's actually some leases that specifically say in there that they don't want the landlord to be on the property so obviously, yes, you could go there as a customer, eat, buy food, whatever the use is, but if you go there and mention to an employee or somebody there and say, "Yeah, I'm the owner of this property," that could put you into faulty release, you have to be very careful about that. So, south and east. But, a lot of people for the safety they'll want maybe something more in the southwest, Nevada is very popular right now, Arizona is very popular right now, Texas is very popular. There's other things too, some of those states are income tax free states so that might be another reason, especially if you're planning and your heirs are in income tax free states then that might be a reason to purchase there as well.


Kiran Dhillon, SIG Commercial:

Got it. For most of these clients who are doing these types of exchanges, what is their profile? Where are they in their real estate investment journey?


James Bean, SVN-Rich Investment Real Estate:

Right now most of the people that I'm working with are multifamily owners, and these are multifamily owners that have been in the market for 20 years or more. They remember how it was when it was good and now that they're dealing with California legislature and for a lot of people the pandemic has wrung out everything they had left. I mean, many of our owners were fortunate and didn't have to deal with the pandemic or as tough as it was for some others, but I'm dealing with a couple right now that said, that was it. After the pandemic and everything that that dealt them, they said, that's it, I'm done, let's move on.


Kiran Dhillon, SIG Commercial:

So for clients who are looking to do a triple net exchange, what should they look for in their replacement property?


James Bean, SVN-Rich Investment Real Estate:

That really depends on their income goals and retirement goals, long term, short term investment goals. One of the things that I tell to all my clients with the exchanges is, look, I'm not going to show you a property that I wouldn't sell to a family member, even my own mother. You have to look and you have to dig deep into some of these deals.


For example, a triple net lease with maintenance where the maintenance is shared is one thing but in the investment world, if the landlord has any responsibility, it's technically a double net lease because the maintenance is off the table. The tenant is going to pay the property taxes and the property insurance, but the maintenance is off the table, so you have to really be careful. And again, more times than not, that maintenance is to the landlord, the roof, and the structure. This particular lease we looked at was way beyond the roof and structure and parking lot, it included internal elements like electrical and plumbing and maintenance of the pylon sign and other things like that that make it an entirely different deal.


So structure, then term, I think is one of the most important things. Many of my clients are getting 15, 20 years or more. I've got a client right now that's got a deal in escrow that they're getting a brand new 25 year lease at close of escrow. That's a nice deal because my client is actually going to have some say in how the lease is drawn, which is also something of value.


Then strength of operator, how many units do they have? You have to really be careful with this because a lot of these listing agents they're very careful and strategic in how they put their offering memorandums together and so they tend to make the deal look far greater than it is until you look at, okay, well, who's the actual guarantor.


In a lot of these operators, you'll have a 90 unit operator but they're only guaranteeing your deal based on the entity on who owns the actual one because a lot of these operators will have multiple entities under one umbrella. So they may own 90 units, but that's spread out over five states, they're only going to guarantee you with the entity that resides in that state so it might only be a 20-unit guarantee. So strength of operator.


Fundamentals of the real estate, this goes without saying: location, location, location. You want them to be at a hard corner, a hard civilized corner, you want traffic counts, of course you want to look at the age of the building. I have a woman that we're going to put an offer on a Taco Bell, it's a brand new Taco Bell, new 20 year lease at close of escrow, so just a lot of good safety there.


And of course the demographics, you want to look at populations. Which brings up a point because one of the more popular investments outside of fast food restaurants are the discount stores like Dollar Generals. Dollar Generals are very popular because namely, you're getting the corporate lease, this lease is backed by some 13,000 - 14,000 stores that they have nationwide, very safe. The downside is that their leases are flat for the first initial term, which is 15 years. The other thing is that their business model thrives on rural areas. So I could show you twelve Dollar Generals right now where the three-mile or five-mile radius is less than 2000 people, so very, very rural areas.


Lenders have a big time problem with that. They know it's a Dollar General, they're getting a corporate guarantee, but some lenders are like, look at that population -- just not going to support what our criteria is. Again, when it comes to due diligence, the things you look for in these properties you want, obviously if some people are like, hey, I can see I can get an 8% cap deal and we can sell in three years, then they may be willing to do that. But for the most part people are looking for something safe, something they don't have to worry about anymore. That's one of the more popular reasons for exchanging in the first place is that they want something with less management now, get out of the management business managing their properties.


Kiran Dhillon, SIG Commercial:

So what advice do you have for listeners who are thinking about doing a 1031 exchange from multifamily into a triple net property?


James Bean, SVN-Rich Investment Real Estate:

If you're considering exchange, you really need to start reaching out to some experts sooner rather than later. You can go and visit my website, all my contact information is there, www.best1031online.com. But the point is that people just have no idea of all the options that are available to them and many of them are not entirely clear on the rules. Just to give you a quick example, there are three identification rules, most people don't know that, in fact, I just got a referral from another broker that didn't even know that. The most common is where people will identify three properties, they're only going to buy one but you get to identify three. And they have that rule because they know that business happens, maybe you don't get the one so you want to make sure, all the more reason why you got to be planning and writing offers.


And back to that comment about the market right now, I'm advising all my clients that we need to start writing offers about two weeks before you close escrow on the property that you are selling, that's how primed and teed up you need to be going into your exchange. So that's the greatest advice that I can give them. And make sure you're working with somebody who knows what they're doing, just because they've done a couple exchanges does not mean they know what they're doing, just because they've sold a couple of absolute net lease deals, which is a very small number. You'll be amazed how many agents, brokers don't know the difference, don't even know an absolute net exists because everybody refers to them as the triple nets.


Kiran Dhillon, SIG Commercial:

Well, James thank you so much for sharing your wealth of knowledge regarding 1031 exchanges and triple net properties. If listeners want to reach out to you, have questions or are thinking about doing an exchange, what's the best way for them to get in touch with you?


James Bean, SVN-Rich Investment Real Estate:

The best way to get in touch with me is my office number is (805) 779-1031, or you can reach me through the website, all my contact information is there: www.best1031online.com. My email address is james.bean@svn.com.


Thanks again for having me Kiran, this was so much fun, I'm really appreciative. If nothing else, people get educated, that was the whole purpose of me launching that website was just to give a place to have people to go where they can get clear on what's happening there. So I have a glossary of terms there, all the rules are there to simplify the process, etc., so thank you for that.


Kiran Dhillon, SIG Commercial:

Of course. Thank you so much for talking to us and our listeners about this really important topic and I highly recommend everyone check out the website because there is a lot of really great information there. So thanks again James.


James Bean, SVN-Rich Investment Real Estate:

Thank you.

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