The Running Exchange
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Of the many formulas for putting together transactions, the Running Exchange is one of the most powerful, yet least used tools in the bag of the exchangor. The Running Exchange is a catalyst method to begin transactions, and may be utilized by an experienced moderator at your local marketing sessions. It may also be utilized by an individual broker to complete more transactions and gain tremendous control of their marketplace.
Utilizing a commodity or property that has very broad appeal in the market, such as a free and clear property or cash, starts the transaction. For our example we will use a $100,000 CD to begin the transaction.
Step one: With our $100,000 CD, we go out in the market and locate a property we wish to buy. Or, we might attend a marketing session where we would seek offers from the participants who would be interested in making offers for our CD. There are conditions to the transaction being offered. 1.) The taker cannot close on the cash (CD). He is required to utilize the net amount, after fees, to go into the market and locate another property acceptable to him (a 1031 exchange). 2.) He can add to the transaction (boot) to go into a larger property.
As a broker you could go into the market and locate a property you would like to own and make an offer to purchase the property. However, you place the contingency in the contract that the seller must utilize the net amount to locate other property acceptable to him. At first he will not understand, but you now have the ability to explain the benefits of a section 1031 exchange.
Tell him you would be happy to help him locate such a property. This is a very easy way to obtain a controlled client, without having to obtain a listing on his property. Make sure you have all the proper disclosures within your contract with regards your being a “licensed real estate broker working on your own investment account for the purpose of making a profit.”
Let’s assume our first contract to purchase is for a nice, free and clear condo at the lake and the contract is accepted at $100,000. We will assume a six percent commission is fair, so the first transaction will result in a net amount to the owner of the condo of $94,000 and the fee accumulating to the brokerage is $6,000.
Step two: Upon counseling with the owner of the condo, we find he has a note secured by first mortgage on another piece of real estate in the amount of $100,000 and would be willing to add it to a transaction. He also indicates he would like to invest in an apartment house but did not understand that he could exchange his condo without paying tax. You now have a client under your control.
You locate a nice 10-unit apartment complex you feel would give your client the benefits he is seeking. The value of the property is $400,000 and there is an assumable first mortgage in the amount of $150,000. You make an offer of cash in the amount of $94,000 (left from the first transaction), the note in the amount of $100,000, and ask the owner to carry back a second note and trust deed on the apartment building in the amount of $56,000.
In the offer to exchange, the same clause stating the owner cannot accept the proceeds of the transaction and close is inserted. He can and does, however, use the proceeds to locate another property acceptable to him. Of course, you explain the benefits of section 1031 of the IRS code and that you would be happy to help him locate such a property. In counseling you learn he could add cash to a transaction for the right deal – $200,000 is not out of the question.
For our example we will still assume a six percent fee is fair, so the transaction will result in a net amount to the owner of the units: $70,000 is cash, plus $156,000 total value in paper from the two notes. Fees accumulating to brokerage now total $30,000.
Step three: After counseling with the owner of the units and searching the market, we find an office building priced at $1,200,000. It has a $600,000 loan with a due on sale clause. We offer the remaining $70,000 cash plus the $156,000 in paper, subject to obtaining a new loan. Since the bank indicates the maximum loan would be 75%, the client agrees to add the additional $74,000 in cash from his available funds. The seller agrees to a commission in the amount of $72,000.
Final step: As the broker you may now close the transaction if the owner of the office building is willing to accept the sale, and pay his taxes. Being a builder, he agrees. The brokerage fees have now accumulated to $102,000. To close the loop you agree to take the condo as your fee in the transaction. The cash or CD was never actually needed; it was just the catalyst that made the whole transaction possible.
As you see, the “Running Exchange” is an excellent concept to make transactions happen in the market. Most investors and brokers have difficulty visualizing an exchange and tend to think only in terms of two-way transactions. Try it . . . you’ll like it!
Running Exchange Summary:
$100,000 CD
1. Buy: Condo F&C for $100,000. Offer $100,000 CD (cash). Fee $6,000.
Has: $94,000 cash plus can add $100,000 note.
2. Buy: 10 units, $400,000, loan $150,000. Offer cash of $94,000 plus paper of $100,000 and carry back of $56,000. Fee $24,000.
Has: $70,000 cash plus $156,000 in paper and can add cash.
3. Buy: Office building, $1,200,000. Offer cash of $70,000 plus $156,000 paper and cash can add of $74,000, subject to obtaining a new loan. Fee $72,000.
Fees now total $102,000 and the transaction can close if owner of the office building is willing to accept the sale and pay tax. Otherwise just go for another leg until you find an owner willing to close on a sale.
