Opportunity Zones Help 1031 Exchange Sales
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CoStar Money: Opportunity Zones Help 1031 Exchange Sales; Hong Kong Unrest Hits US Firms; Tech IPO Troubles Spill Over to Hotels; and More
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Opportunity Zone Program Boosts 1031 Property Exchange Business
Expanding opportunities. The granddaddy of federal tax-advantaged deals, 1031 tax-deferred property exchanges, has continued to run along the exceptionally hot pace it has been on for the last five years. Such sales have been steadily totaling from $8 billion to $10 billion per quarter since the start of 2015, according to CoStar data. That is up from an average of $2.75 billion per quarter in the six years before that.
Now, another tax-cutting scheme – the federal opportunity zone initiative – is opening new prospects for 1031 participants.
A 1031 exchange is a series of transactions that allows investors to sell one property at a gain and reinvest all the proceeds into a similar property. By doing so, they defer paying taxes on any of the gains. The exchange is arranged through a qualified intermediary who sells the property, buys the replacement property, and then transfers that deed over to their client.
In a similar way, the opportunity zone program gives investors the ability to transfer any capital gains proceeds into properties and businesses in more than 8,700 federally qualified opportunity zones. That investment is done through a qualified opportunity fund.
The two tax programs intersect in a few ways. For starters, it has opened new clients and investor groups to 1031 qualified intermediaries, many of which have opportunity zone funds.
"We certainly saw it as an opportunity for both our 1031 exchange clients as well as our other clients that are more high net worth individuals that are often looking at different tax strategies to implement as a way to mitigate their tax liability," said Ricky Novak, co-founding partner at The Strategic Group in Atlanta.
The Strategic Group has launched two opportunity zone funds.
The opportunity zone funds offer a fallback option for 1031 sellers, Novak said. A 1031 purchase has to be concluded within 180 days of a sale. There are times when the second half of the exchange doesn't go through or buyers change their minds. Now in these cases, sellers can still defer their gains by moving into an opportunity zone fund.
Novak added the 1031 investors have benefited in another way as well. It has expanded the number of properties they can target for purchase. That gives buyers more options to choose from in arranging an exchange and boost the volume of deals in those zones.
Qualified intermediaries are also able to expand their options by starting opportunity zone programs. Beyond just facilitating the exchange of existing properties, some are now becoming developers as well.
The opportunity zone program, "gives us access through wealth manager and broker dealers to an army – millions of accredited investors who have get capital gains that they want tax-favorable treatment on," said Louis Rogers, founder and chief executive of Richmond-based Capital Square. "It also pushes Capital Square to be in the development business because those zones are best fulfilled with a new building. We're building apartments for millennials in the inner city in opportunity zones."
Capital Square has one opportunity zone fund launched and two waiting to start. In September, the company purchased land in Richmond, Virginia’s Scott’s Addition opportunity zone to develop a multifamily community named Scott’s Collection II. The ground-up development will include a five-story, Class A multifamily community with 60 units and onsite parking spaces.
The intersection of the two federal tax programs is starting to show up in CoStar data. Sales that are part of 1031 exchanges are up 3% in opportunity zones in the first three quarters of this year over the same time in 2017 before the opportunity zone tax benefit was in place. Such exchanges are down 8% outside of opportunity zones between the two periods.
Protests in Hong Kong Hit Some American Businesses Hard
Rattling sales, property markets. The increasingly violent protests that began this summer in Hong Kong are beginning to affect business around the globe.
The protests had already prompted the US State Department to issue a travel advisory to the Special Administrative Region of the People's Republic of China. Morgan Ortagus, speaking for the State Department, said this week that they are "watching the situation in Hong Kong with grave concern. We condemn violence on all sides."
U.S. retailers and hotel firms are among the first to report the extent to which the protests have hurt their firms. Many are warning it could get worse.
"In Hong Kong, where we have several important retail doors, heavy protest disruption drove the equivalent of 48 full days of store closures during the quarter. These closures, along with significantly lower tourism, drove declines in our Hong Kong business and negatively impacted our total Asia comp by about three points," Ralph Lauren Corp.'s Chief Financial Officer Jane Nielsen reported. "We expect disruptions in Hong Kong to negatively impact revenue by about $10 million in the quarter."
Ralph Lauren Corp. is expecting pressure to accelerate, Nielsen added. "We have seen, like many others, the tourist falloff has accelerated and door closures due to protest. We don't expect it to improve."
Marriott International reported a 27% revenue decline there last quarter and expects it to be as much as 40% in the current quarter.
The Walt Disney Co. reported a $55 million drop in revenue at Hong Kong Disneyland,
"Based on the trends we saw in [fourth quarter] and what we are seeing so far in [first quarter], we expect operating income at Hong Kong Disneyland to decline by about $80 million for Q1," Christine McCarthy, chief financial officer of Walt Disney, reported. "If the current trends continue, we could see a full year decline of approximately $275 million versus fiscal 2019."
The clashes between students and police are just one of three eminent risks to Hong Kong's commercial property markets, researchers at global real estate services firm JLL's office in Hong Kong said. The other two are the ongoing US-China trade wars and a slowing Chinese economy. The three have the potential to temper demand and drag down leasing markets further this year.
Tech IPO Troubles Spill Over to Bay Area Hotels
Unicorn misses. What had been an already bad year for initial public stock offerings by technology companies was made only worse by the ill-fated effort this summer to take WeWork public. Now a string of so-called unicorn launches that haven't lived up to their hype may be taking a toll of San Francisco Bay area hotels.
Unicorns, or upstarts valued at a $1 billion or more, included the likes of rider-sharing services Uber and Lyft, group messaging service Slack and others. Their stumbles in the public markets have prompted others to pause or rethink their financing plans.
The flops seems to have spilled over into weak hotel performance. Host Hotels reported San Francisco among its worst performing markets this past quarter. Park Hotels and Resorts reported its third quarter revenue there declined 1.9% driven by soft demand. Pebblebrook Hotel Trust reported a 4.9% revenue decline there.
STR, a CoStar Group company, tracks hotel supply and demand data. STR's trend report for the Silicon Valley area shows demand down 4% year-to date, occupancy down 5.1% and revenue per available room down 4.2%.
Hotel REITs are signaling that the technology sector troubles were at least one of the triggers to the slowdown.
"Clearly the third quarter for San Francisco was disappointing," John Arabia, president and chief executive of Sunstone Hotel Investors, reported. The big group bookings "that we were all anticipating didn't occur and we lost a little bit of rate compared to our forecast. It's too early to tell if what's going on with technology or unicorns or WeWork or all the rest are having an impact, but we'll continue to monitor."
Read about WeWork's turnaround plans here
Wealthy Foreign Investors Rush to Apply for Citizenship
Time's running out. Wealthy foreigners have been rushing to obtain U.S. citizenship by investing in American commercial real estate development projects. The blitz comes as changes taking place next week will make it more expensive to participate in the U.S. Citizenship and Immigration Service EB-5 Immigrant Investor Program.
The USCIS recently published quarterly application statistics for the third quarter of the fiscal year. USCIS received 1,171 applications, a growth of 27% from the previous quarter and the highest quarterly total since the inception of the EB-5 program in 1990.
Under the EB-5 program, individuals are eligible to apply for conditional lawful permanent residence by investing at least $1 million in eligible new US projects. Starting Nov. 21, that minimum jumps to $1.8 million, the first increase since the program started.
The tally of applications is projected to soar for the fiscal year fourth quarter ending Sept. 30 when figures are released.
"As November [21] draws closer, immigration professionals and attorneys are expecting a drastic shift in the EB-5 landscape once the new regulations come into effect," according to Abbas Hashmi, director global family office business & strategy Hongkun USA, the New York-based subsidiary of Hongkun Group, a global real estate investment, development and management holding company headquartered in Beijing.
Hashmi wrote in a new report that the new regulation would change the entire landscape for the immigrant investor program. The program will now attract investors from more affluent families, he said. So more participants will be focused on what return they'll get on their investment and not just looking for US citizenship.
"It will pinch the number of foreigners applying for a visa," Hashmi wrote. "Considering the upcoming developments, regional centers can no longer sell the prospect of immigration to candidates. The pool of applicants is expected to include more sophisticated investors who are looking for lucrative real estate investment opportunities to funnel their capital."
Developers who can deliver better value and better returns will be the winners, he said.
Dean Foods Retreats as Americans Sour on Dairy Milk
That milk spoiled fast. After posting a profit of $1.66 billion last year, Dean Foods Co., the largest U.S. distributor of dairy products, filed for Chapter 11 bankruptcy protection this week. While "milk" remains a household item in the U.S., people are simply drinking less and less cow milk.
For the past 10 years, overall demand for dairy milk has fallen about 2% year-over-year. Dallas-based Dean Foods has been on twice that pace. It suffered a full year 2018 year-over-year decline in fluid milk volume of 5.8% following a 2017 year-over-year decline of 4.2%, according to the company's bankruptcy filings.
The decline in dairy sales is coming in conjunction with the rise of oat, nut, soy, coconut, hemp, goat and pea alternatives that are taking up more store refrigerator space.
The decline in dairy sales has had Dean Foods trimming its real estate fat. It has reduced its number of refrigerated plants by 21 since 2013 and now stands at 58 across 29 states. Its rent expense last year was $143.4 million, according to company records. It has been spending from $100 million to $120 million a year on those plants on upkeep costs.
Dean Foods is in discussions about a sale of the company to Kansas City-based Dairy Farmers of America, which operates 42 plants of its own across many of the same markets in which Dean operates.