Part two of our discussion about the complexities of real estate investing and the potential pitfalls that investors must navigate, particularly in the context of a 1031 Exchange. Industry experts David and Tom Moore, the 1031 Exchange Bros, and guests Steve Mark from Emerson Equity and Bob Smith from Peregrine Private Capital explore the realities of investment properties and the essential knowledge every investor should have before entering into the real estate investment world.
The Reality of Property Management
When it comes to managing rental properties, many investors have experienced the stark contrast between the ideal and the actual. David recalls attending numerous rental housing association meetings early in his career, where he would witness landlords proudly presenting their units in a slideshow format—before and after their tenants moved in. The transformations were often shocking, and it left him wondering why anyone would willingly enter this line of work.
“I wouldn’t go in there without a hazmat suit!” David exclaimed, reflecting on the state of some properties. It’s a common sentiment among property managers: the condition of units can be staggering, with issues ranging from bizarre layouts—like a washing machine in the kitchen—to outright destruction left behind by tenants. Bob shared a harrowing story of a contractor discovering a unit completely overrun by cockroaches, underscoring the sometimes nightmarish reality of property management.
These experiences lead to the critical question: why do people choose to invest in real estate when the management side can be so challenging? The answer often lies in the long-term benefits and the potential for substantial returns, but it’s important for new investors to understand the risks involved.
Understanding the 1031 Exchange
The 1031 Exchange is a powerful tool for real estate investors, allowing them to defer capital gains taxes when they sell an investment property and reinvest the proceeds into a like-kind property. However, it’s not without its complexities and risks. As David and Tom discussed, many investors start with single-family homes or small apartment buildings, often transitioning to larger assets as they gain experience.
“At some point, they get tired or can’t deal with all this stuff,” Tom noted, emphasizing that many investors eventually seek alternatives to traditional property management. This is where the Delaware Statutory Trust (DST) comes into play—an investment vehicle that can provide a more hands-off approach while still allowing for significant tax benefits.
The Appeal of DSTs
One of the key advantages of investing in a DST is the lack of direct management responsibilities. Steve highlighted that DSTs often come with a variety of asset classes, such as mini-storage and senior living facilities, which can provide a more stable investment compared to traditional rental properties. “You’ve got a bunch of tenants effectively,” he explained, noting that these investments typically avoid the headaches associated with managing problematic tenants.
Moreover, DSTs can offer unique opportunities that individual investors might not have access to. “The sponsor is most likely negotiated an off-market transaction,” Steve pointed out, meaning that DST investors often benefit from better purchase prices than they would find in the open market. This is a crucial point for investors to consider, as it can significantly impact their overall returns.
Comparing DSTs to Traditional Investments
Many investors may wonder why they should consider a DST over traditional properties, especially when they could pursue a triple net lease property. However, there are several advantages to opting for a DST:
- Nonrecourse Loans: Unlike traditional investments where investors often have to personally guarantee loans, DSTs typically come with nonrecourse loans, reducing personal financial risk.
- Professional Management: DSTs are managed by experienced sponsors who handle tenant relations, property maintenance, and any issues that may arise, freeing investors from daily management tasks.
- Potential for Better Returns: As mentioned earlier, DSTs often feature off-market transactions, giving investors access to properties at better prices than they might find on the open market.
- Flexibility: DSTs often have a variety of tenants across multiple properties, which can provide a buffer against the risk of vacancies.
The Risks of Traditional Real Estate Investments
Despite the allure of traditional real estate investments, they come with inherent risks that investors must be aware of. Bob discussed the potential for properties to go dark—meaning they become vacant—and the challenges that come with finding new tenants. “Do you want to deal with it going dark if you own the property?” he asked, emphasizing the stress and complexity of managing such situations.
Additionally, investors must consider the time constraints of a 1031 Exchange. After selling a property, they have only 45 days to identify a replacement property, which can lead to rushed and potentially poor investment decisions. Bob pointed out that sellers often take advantage of this time pressure, making it crucial for investors to be well-prepared and informed.
Common Missteps in Real Estate Investing
As David and Tom shared, many investors fall into common traps when navigating the real estate landscape. One significant issue is the tendency to overly focus on multifamily properties simply because they’re familiar. While multifamily investments can be lucrative, they are not always the best option. Bob emphasized the importance of diversifying into other asset classes, such as self-storage or senior living, which have historically provided strong returns.
“Many investors are cross-shopping between DSTs and traditional properties,” Bob noted. “They’re often working with commercial real estate brokers who are incentivized to sell them a multifamily property.” This can lead to missed opportunities in other asset classes that may perform better over time.
The Importance of Education and Awareness
Ultimately, education is key to successful real estate investing. David and Tom, alongside Steve and Bob, encourage potential investors to explore their options and expand their horizons. “You might decide not to do a DST and buy a property,” David stated, recognizing that every investor’s situation is unique. “But it’s essential to understand what’s available and what might work best for you.”
As the conversation wrapped up, David invited anyone with questions about real estate investing or the 1031 Exchange to reach out. “We’re happy to address those questions or concerns going forward,” he said, reinforcing the importance of having a support system in place when navigating the complexities of real estate investment. For more information regarding DSTs, feel free to contact Bob or Steve.
Investing in real estate through a 1031 Exchange can offer substantial benefits, but it’s crucial for investors to be aware of the potential pitfalls. From the challenges of property management to the complexities of financing, understanding the landscape is essential for making informed decisions. By considering alternative investment vehicles like DSTs and seeking guidance from experienced professionals, investors can better position themselves for success.
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The Guys With All The Answers…
David and Thomas Moore, the co-founders of Equity Advantage & IRA Advantage
Whether working through a 1031 Exchange with Equity Advantage, acquiring real estate with an IRA through IRA Advantage or listing investment property through our Post 1031 property listing site, we are here to help Investors get where they want to be. Call them today! 503-635-1031.
