S.E.C. Real Estate Observer

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Editor’s Note: Sarah Hoban, a Chicago-based free-lance writer, wrote this article for the magazine “Success Strategies.” Reprinted with permission.

Numbers drive all commercial real estate transactions. So consider these: 22 properties, 10 states, seven brokers, six principals, eight title companies and closing agents, three lenders, 12 attorneys — and one day.

Jim Brondino, S.E.C., CCIM, and Rod Stewart, S.E.C., CCIM, are members of the Society of Exchange Counselors. Jim is president of Brondino & Associates in Ontario, Calif., and specializes in Internal Revenue Code Section 1031 tax-deferred exchanges. Rod is the president of Rod Stewart Realtors in Wichita, Kansas. Both men are used to complicated deals. But the complexity of a transaction they executed a few years back is one deal they’ll remember for a while.

Brondino represented the owner of 17 rental houses in a subdivision in Katy, Texas. The houses “had been on the market in various manners for a couple of years,” Brondino says, and posed problems for an exchange deal. “We couldn’t figure how to do it. We kept stumbling on ‘We can’t hold 17 escrows because people who buy houses don’t care about your 1031 — they bought a house, they want to move into it.’ So that’s why we toyed with moving them in bulk on an exchange basis for quite a while.”

A 1031 and More

In June 1999, Rod Stewart, S.E.C., a fellow member of the Society of Exchange Counselors, contacted him about a possible transaction. Stewart’s clients wanted to sell a 116-unit apartment complex in Wichita and were willing to consider an exchange with the 17 houses. However, they didn’t want to keep the houses, so Brondino’s client decided to buy them back and “then sell them over a three-year period, because we knew the market was good. And that way, we could sell them piecemeal without tax consequences. That’s how the initial structure came about,” Brondino says.

In the original transaction, Brondino’s client would exchange the houses and two commercial lots in Lake Havasu City, Ariz., for the apartment complex. This transaction structure would be subject to his client buying back the houses with a blanket mortgage and cross collateralizing the buyback with the 116 units he received in the exchange.

“It was basically a no-money-down with a ‘soft’ buyback provision,” Brondino says, but it was cross-collateralized with the 116 units to minimize any concerns about default that Stewart’s clients might have. “We said, ‘you know your units, so we’re going to cross-collateralize the blanket note with [them]. Now we’re at about a 50 percent loan-to-value, and that paper is pretty strong paper in your hands.’ In addition, the two Lake Havasu City lots would be sold for cash prior to closing.”

The mortgage secured by the apartment complex precluded any carry back or second mortgage on the property, which “presented a problem balancing the equities,” Brondino says. To solve this, a first mortgage was created against an appraised value property belonging to his client — 50 percent interest in 41 acres of land in Lebanon, N.H.

Brondino’s client still was obligated to cause the sale of the 17 houses and deal with the two commercial lots. To address this issue, his client formed a Nevada corporation, funded with money borrowed against an industrial property he owned in California. The new corporation would then purchase the two lots, and the sellers of the apartment complex would receive the cash. The corporation also would purchase the 17 houses with a blanket loan and resell them for basically the same acquisition price that was paid — the proceeds from which would go to paying down the blanket mortgage given to the sellers of the apartment complex.

In the meantime, Brondino was marketing the houses individually on the Internet. A buyer from a Florida nonprofit organization was interested in one house; then another buyer made an offer on the remaining 16. Brondino and this buyer negotiated a discount for the bulk purchase, and the buyer agreed to pay for all closing costs. This maneuver also generated some upfront cash for Stewart’s clients. And the Nevada Corporation carried a blanket mortgage from the buyers of the 16 houses, with some cash down, in the same amount as the blanket note executed in favor of the sellers of the apartment complex. There was virtually no equity in the blanket mortgage, but the buyer has an obligation to sell all the homes by the end of 2002. (As of February, nine had been sold.)

Moving Forward

The framework finally was in place, and buyers, sellers, brokers, and lawyers were aligned nationwide. To avoid the added expense of accommodators and to fulfill Section 1031 exchange requirements, the transactions had to close simultaneously. And, of course, that’s when the complications began.

For starters, the lone house sale to the Florida buyer made things a bit more difficult. The buyer “didn’t understand what we were doing, and he was hard to get a hold of. So it just complicated [the transaction] to have that one house languishing,” Brondino says.

The New Hampshire portion of the deal also got a wrench. Brondino retained a New Hampshire attorney whom he’d worked with before to represent the paperwork there. But somehow, “He got crossways with the title company over how the policy was to be written, so there was a conflict there,” Brondino says.

Other frustrating delays, such as office absences and vacations, forced the closing date to be adjusted three times. At last, closing for the entire deal was set for December 11, 1999.

The central closing agent for the transaction was in Wichita. Two hours before closing, she phoned Brondino and told him that she couldn’t verify the funds that his client had lent to the Nevada corporation, which was in turn using them to buy back the Lake Havasu City lots. The lender transferred the funds that were to be wired to the closing agent in Wichita to a company in Tennessee, and the closing agent couldn’t verify that they’d ever been received. But in genuine cliffhanger timing, the closing agent found the transfer and confirmed the funds, and the deal closed — with 20 minutes to spare in the business day.

So who was left with what? Stewart’s clients had “cash and paper, which made them happy,” Brondino says. Brondino’s client had the two buyers for the 17 houses. Subsequently, his client also retired the loan that he’d obtained to fund the Nevada corporation by securing a loan on a piece of industrial property that he owned in California. As of February, the two Lake Havasu City lots owned by the Nevada corporation were in escrow; the funds generated by the sale will be used in further transactions. The New Hampshire property is listed and will retire the first mortgage created against it when it sells.

Creativity Is Key

Brondino “loves to get involved in problem ownership, where it takes some sort of creativity to get [the deal] done — where just selling it on the open market has presented no activity. We’re driven by understanding clients’ needs; that’s the only way you can do this,” he says.

He ranks this transaction among the more complicated he’s experienced. But, he adds, “It reinforced our basic philosophy which is: If you understand what your clients need to have — not necessarily what they want to have — and you establish a working relationship grounded in trust. You can then exercise creativity. Otherwise, you don’t know what you’re trying to accomplish other than the seller of the property saying Ôsell my property.’

“Few brokers ask, ‘If we could sell your property, what are you going to do with the money?’ Many times clients say, ‘We’re going to go buy another piece of property.’ Well, why don’t we just integrate that into the transaction now via an exchange so that you don’t have to pay the taxes — and we can also accelerate the transaction possibilities through creative exchanging,” he says.

Brondino credits a variety of strong business ties for smoothing the path. But he especially stresses the need for close work with clients. “We design transactions predicated on the needs of clients and the clients’ recognition of the needs they were seeking,” he says. “That shared partnership between client and broker allows creativity to unfold — and allows clients to participate in the transaction process to come up with [possibilities]. They become active participants.”