After the Internal Revenue Service extended the deadline for 1031 exchange buyers to commit to deals, there was a spike in net lease transactions in June. When the sales numbers come out for July, there could be even more commitments.
But now that deadline, which was July 15, passes, what happens to 1031 sales, especially as COVID-19 forces shutdowns around the country?
“It could be the case that we still have a strong performance in July, but towards the end of the summer, you’re going to see more of a slowdown,” says Chris Pappas, associate director with Marcus & Millichap’s Net Lease Division. “This exchange capital is going to be placed, and then there’s going to be a lull in the market.”
In anticipation of the deadline, Pappas thinks many sellers who wanted to put their properties on the market did so before July 15. That could hamper supply for the remainder of the year.
“I think that the buyers had to place the money,” Pappas says. “At the same time, I think that sellers recognize that it might be one of their last opportunities, until at least the end of the year, to get a good price for their property. So that caused the supply to match the demand. I think that there was enough supply out there for people to purchase quality assets.”
That was especially true with quick-service restaurants, which saw strong sales in June. “In terms of quick-service restaurants, there were plenty of assets that had leases guaranteed by large franchisees,” Pappas says.
While the passing of the July 15 deadline was only one reason for the lull, it isn’t the only factor. “I think there are several other factors, including the stimulus benefits expiring,” Pappas says. “There is also going to be an expiration of the mortgage moratoriums and eviction moratoriums.”
Political factors could also contribute to the slowdown. “You have the election coming up in November, which I think creates a certain level of uncertainty,” Pappas says. “In 2016, velocity dropped around the president presidential election.”
Longer-term, Pappas is concerned that 1031 net lease investment could be hampered by other factors. If the volume of real estate transactions falls, there will be less exchange capital in the market.
“There’s going to be far less 1031 capital to chase these deals, which means there is probably going to be a reduction in demand because,” Pappas says.
As real estate volume declines and municipalities face financial strain amid the COVID-19 pandemic, Pappas thinks that taxes will eventually rise for landlords, further limiting demand.
“Businesses have been shut down for months and months,” Pappas says. “So the cities and the states aren’t collecting tax revenue. On top of that, if there’s a downward shift in real estate demand in cities because people are moving out, then prices are going to go down.”