Equity Marketing
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Chris Dischinger, S.E.C.
2011 President
It is probably fair to say that the first human commerce involved two primitive human beings arranging to trade one vital necessity for another (food for clothing, perhaps?). These early humans had no concept about currencies, banks, a federal reserve, or the idea of flat money. Had the original cave man asked his neighbor to accept a piece of paper for that night’s dinner and all the paper said was that the receiving party would receive some value in the future, the neighbor would have probably considered clubbing this charlatan to death.
Today we see that many people are again questioning the value of paper currency and what true value it will have in the future. We have recently seen a huge run up in the value of gold and silver precisely because many people fear what the true value of a dollar bill might be in the future. The other interesting occurrence today is the historic rate of return on the greenback. Today we are experiencing a rate of return on a 10-year treasury bill at slightly north of 2%. This rate of return of a long term instrument is not even equal to the rate of inflation. This means that an investor in the 10-year treasury is expecting to lose money on this investment, and they simply hope to preserve most of their capital.
Despite all the gloom and doom that has been associated with real estate the last four years, good investment real estate (read: NOT speculative vacation condos) continues to provide an excellent return (6-10% cap rates), a good hedge against inflation, strong tax advantages, possible appreciation and a tangible asset. (Once all these benefits are factored in most investors are looking at real returns on equity in the teens.) Real estate most certainly can go down in value, however much like gold or silver it has a value beyond a promise to pay. Real estate provides for basic human needs such as shelter, a place for commerce or land to grow food. Real estate is also limited in supply. The government cannot decide tomorrow to turn on the printing press and increase the supply of real estate in the United States by 10%.
OK, so these are some basic tenets on the value of real estate that have been around for centuries—what is the point, you ask? The point is that in an environment where cash may actually have less value than real estate, we should begin seeing more direct exchanges of real estate. I can certainly see a time when an owner of real estate may not be willing to do an exchange that does not result in ending up with the replacement real estate at closing (who would want to give up an 8% return for a 2% return?).
The Society of Exchange Counselors is a group of real estate professionals whose members are well versed in the ability to take a client from one real estate investment to another without the risk of getting stuck with cash.
Equity marketing is a process that we embrace that allows the client to either trade equity for equity or, at the very least, brings together several parties to a transaction at one time, thus reducing the chance our clients will get stuck with cash and possibly a onerous tax bill. The Society of Exchange Counselors meets six times a year in a forum that promotes transactions such as these and we pledge to provide service, counsel and experience in all that we do. Equity marketing and creative techniques also allow the client some control over financing by allowing two parties to trade equity for equity, structure tax deferred transactions, and limit the risks of finding suitable replacement properties.
Let’s look at an example of how this might work with two parties with different goals:
Party A is a young aggressive real estate investor who acquired a vacant property, found a NNN tenant, built out the property and signed a long-term lease. The property is valued a 7% cap and has a 10-year lease.
Property value $1,000,000
Property loan $ 400,000
Equity $ 600,000
Party B is an older operator of apartments who no longer wants to hassle with the day-to-day operations. The property is also valued at a 7% cap.
Property value: $2,000,000
Property loan: $1,000,000
Equity: $1,000,000
They arrange an exchange where Party A can take created equity and leverage into a more valuable property, can increase their depreciation, has the opportunity to raise rents with inflation, and take on a property that is easier to finance in today’s market. Party B reduces management (NNN) and fluctuating rent, can either take some cash or diversify into another asset, could reduce debt, and pays only a portion of the taxes on their gain. Both parties achieve their respective goals and by closing simultaneously, reduce the reinvestment risk. In this case Party B could insist that Party A allows them to carryback a second mortgage which would qualify for installment sales treatment, thereby eliminating any taxes at closing.
If you stop and let your mind wander for a minute you can understand the infinite possibilities of how such transactions can be structured. It’s these benefits that the buyers and sellers of real estate are truly seeking, not the dollar bills that normally accompany real estate transactions.
Creatively yours,
Chris
