Data for the Marketplace Apartment Sales Stuck in Mud Alternatives to Outright Sales

Not much oxygen in the real estate marketplace these days.

As the adjacent chart reveals, a paltry 29 Orange County 5-unit+ properties closed escrow in the first quarter of the year, down sharply from 56 transactions in Q1 2022 and 61 in Q1 2021.

And it’s not just Orange Country. Nationwide, sales of apartment buildings were halved from Q1 2022 (4,396) to Q1 2023 (2,139).

Obviously, the spike in interest rates has deeply impacted. Buyers are holding their noses at the 6–6.5% interest rates currently offered for most five-to-ten year fixed rate multifamily loans; those 3.5% rates we’d come to know and love are long gone now (sigh).

Higher borrowing costs exert downward pressure on property values— you’ll note on the opposite page that the nationwide data for apartments shows GRM’s, price per SF and price per unit all down from a year ago and the average cap rate up (a higher cap rate reflects a falling value for apartment cash flow).

However, steeply elevated interest rates thus far have not translated to price declines on sales of Orange County multifamily property—the cap rate on OC apartments has actually fallen from a year ago. Resistance to lower pricing may be rooted in a conviction among sellers that the county merits premium pricing due to its powerhouse diversified economy that generates robust employment, its high-quality overall infrastructure, an affluent citizen base and the clincher, consistently exceptional weather.

Within this boggy, price-agreement challenged market, there are nevertheless OC rental housing owners that desire to sell, but for most, they wish to do so only if capital gains taxes can be deferred.

There are multiple ways to accomplish the tax deferral aspect. Most know about the 1031 tax deferred exchange, where one sells an investment property and then transfers proceeds into one or more “upleg” properties identified within 45 days and closed within 180 days from close of the relinquished property.

Discussed below are two alternative tax deferred transfers with special appeal to owners ready to wave goodbye to property management responsibilities.

Delaware Statutory Trust

The first of these is the Delaware Statutory Trust (DST). This involves selling one’s investment property and using the proceeds to exchange into a fractional share of a DST that acquires a large, “institutional” type property (e.g. a 300-unit apartment); this qualifies under section 1031 as a tax deferred exchange as long as timing and all other standard 1031 requirements are met.

Kelly Clyde, a principal in the San Clemente based investment firm South Coast Advisors, which markets DST’s, breaks down benefits as follows: (1) convenience in finding one’s 1031 upleg investment—there are generally several available DST’s to select from at any given time; (2) regular cash distributions from the underlying property’s cash flow; (3) no management responsibilities; (4) no personal liability on mortgage debt; (5) pass through depreciation to the investor; and (6) when the DST property is eventually sold (typically 4–7 years after original acquisition) the investor’s share of proceeds can be reinvested via another 1031 tax deferred exchange.

According to Clyde, proforma’s on new DST’s generally project annual returns in the 3.5%–4.5% range.

IRC Section 721 Exchanges

Fundamentally different from 1031 exchanges, a 721 transaction does not involve selling one’s property. Rather, the owner contributes a property to a limited partnership that holds other investment properties contributed by other section 721 exchange investors, all of whom become limited partners with an ownership percentage proportionate to their contributed equity; the equity dollar value is mutually agreed to by the partnership manager and the equity contributor at the outset.

Irvine based Advanced Real Estate (Advanced), a longtime AAOC member with a portfolio of 12,000+ southern California apartment units under management, recently established its “X

Fund” to accommodate such section 721 Exchanges.

Paul Julian, a principal in Advanced, summarized why X Fund is expected to attract a sector of multifamily owners:

(1) elimination of management duties; ing to work with them. In other cases, evicted tenants may change bank accounts, ignore collections or declare bankruptcy.

(2) quarterly distributions of cash flow —X fund is currently projecting a 4% annual return; (3) capital gains tax deferral; (4) No need to sell property or go through escrow (5) no loan liability —any debt on the contributed property is immediately assumed, replaced or or paid off by Advanced; (6) pass through of depreciation benefits; and (7) Advanced will complete renovations on partnership properties over a two-tothree year period to reposition the entire portfolio for future exchange into “larger and more efficient apartment communities” to optimize limited partner returns.

When interest rates eventually ease, sluggish markets will regain traction. Be patient, it may take time.

As a landlord, however, you can choose to take back some control over your current dilemma. Here are some “take charge” measures for financial assistance and loss remediation you can act upon today:

• If you’re a non-mortgaged property owner, negotiate a short-term delay or altered payment schedule with your local tax agency.

• Apply for rental assistance from the Emergency Rental Assistance Program in your state. You must do this before attempting any eviction action, and you must provide the court with proof that the application was denied or the tenant failed to participate before an eviction summons will be issued.

• Communicate regularly with your tenants. Offer direct assistance to help them with relief fund applications, negotiate partial payments and payback plans. Foster that personal relationship.

• Remember to follow the law if you choose the eviction process. You cannot lock tenants out, nor turn off utilities, which could lead to criminal charges and fines.

Rental property owners have been at the mercy of a prohibition that could have long-term ramifications for the future of the entire rental market. We need to rally behind them, too.

About the Author:

Daniel Berlind is the Chief Executive Officer and Founder of SNAPPT, a cutting-edge technology company that is disrupting the rental property application process. Prior to founding SNAPPT, Daniel served as the President of Berlind Properties and oversaw the management of their properties from 2011 to 2017. Prior to Berlind Properties, Daniel was a professional baseball player for the Chicago Cubs and Minnesota Twins.

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