COVID

COVID RISKS AND OPPORTUNITIES
The fallout from COVID-19 pandemic started in mid-March and the 10 Year Treasury Yield fell as low as 0.39% as the Federal Reserve slashed rates. The public markets began to deteriorate and publicly traded net lease institutions saw significant declines in their public valuations. The ETF focused on net lease (NYSEArca: NETL) saw a 30.8% decline over the course of the first quarter. Accordingly, many institutional investors have canceled transactions or placed a pause on acquisitions during this time of instability and market volatility.
At the end of the first quarter, the primary interest from net lease investors was from private investors and 1031 exchange buyers. 1031 investors will continue to seek stable cash flows from this asset class while sheltering their capital gain. Additionally, properties targeted by these investors are from the essential businesses that are less impacted by COVID-19; Pharmacies, Convenient stores, Dollar stores and Grocery stores with investment-grade rated tenants. As a result of the market’s bifurcation between essential and non-essential businesses during the Covid-19 pandemic, there will be limited investor interest in properties that fall in the non-essential category until there is further stability.
Net lease transaction volume for 2020 is expected to be significantly lower than in 2019 as a result of the impact of Covid-19. Following the economic stress from Covid-19 some tenants during this time period may experience significant financial stress causing investor concern. Net lease investors will be carefully monitoring tenant health and the greater economic impact of recent events on the economy. As this situation evolves, forecasts from investors will vary widely due to the rapidly changing and unprecedented health crisis.

 

1031 Marketplace

Real estate transactions have always been a challenge to complete, even under normal circumstances. When the time deadlines of a 1031 exchange are added into the mix it is especially important that everything runs smoothly. The number of net lease properties on the market at any given moment, as well as their relative ease of acquisition, have long made them an attractive option for investors in a 1031 exchange. Certainty and ease of closure are key benefits that may give certain net lease properties even more appeal in this new environment.

The pandemic caused by the COVID-19 virus has created some unique issues for those who are trying to close real estate transactions, especially those trying to buy replacement properties to complete their 1031 exchange transaction. There are multiple challenges to purchasing real estate under the current conditions, including restrictions against visiting properties to conduct due diligence, lender issues, as well as general concerns for the financial viability of the tenants.

Given the “pre-packaged” nature of most net lease property transactions they may very well wind up being the safety net many exchangers rely on during these uncertain times.

When the economic outlook is uncertain there is a flight to quality assets. Net lease drug stores, dollar stores, and automotive services are some of the most sought-after properties in the current market.

For the majority of Investment Grade properties listed we obtain all the due diligence items in advance so that they are immediately available for purchase, unlike other property types.”

 

COVID Impact on Real Estate Markets and 1031 Exchanges

1031

An important question for those already involved in a 1031 exchange is “will there be an extension of the 45-day identification period and 180-day period in which to complete their exchange?” The frustrating answer is that despite the legal criteria for an extension having been met, the IRS and Treasury Department have not taken the last necessary step of issuing a notice of extension. While a rumored extension seems likely, investors should take a conservative approach and proceed as if no extension will be granted, with the understanding that they may get lucky.

 

Additionally, there are no details as to the number of additional days that could be added to the 45-day identification period, or the 180-day period in which to close, but historically the Treasury Department has provided the addition of 120-days for each period. It also remains to be seen if the IRS will permit the reopening of the identification period for those taxpayers who are already past their 45 days.

Typically, this is only allowed when an identified replacement property is damaged or otherwise affected, by a natural disaster. Could an argument be made that quarantine mandates have directly “affected” replacement properties, which would allow for the reopening of identifications? It remains to be seen.

The most compelling reason for an extension is the unprecedented voluntary and mandatory quarantine orders in place by various states and cities, which is making it challenging to purchase replacement properties.

Although there is a decent chance an extension will be issued the most conservative approach is for taxpayers to proceed as if no extension will be provided. If an extension is granted, and if the IRS allows exchangers to “reopen” their identifications even if they are past the 45-day period, you might see more of a focus on net lease replacement properties as there is more certainty of closure in these uncertain times.

Even if extensions are approved, there are still challenging times ahead. “Because most net leases indemnify the landlords for things like environmental liabilities and maintenance obligations you can buy one of these properties in this environment and the risks are mitigated by the lease and tenant’s credit.

CRE DEBT 

90% of banks are still closing and originating loans, but there are challenges to obtaining some of the ancillary services, such as surveys and environmental inspections. For example, in certain areas of the country surveyors are not considered ‘essential personnel’ and are not allowed to visit properties.

Net lease properties also provide a much simpler underwriting picture to lenders as compared to more traditional real estate and may continue to gain favor with exchangers dealing with tax deadlines.” Factors that make certain net lease properties easier to underwrite are corporate guaranties, desirable real estate locations, easy access to unit economic information, and lease terms which provide certainty to lenders.

In this environment borrowers than can leverage lenders with access to many different lenders can help make sure  loans get done when needed.

We have seen both buyers and lenders modify terms on purchase and sale agreements and loan documents respectively. Banks and life insurance companies are still well-capitalized and able to lend, but we have observed them quickly tighten, shift lending programs, and adjust their appetite for certain property and product types,” he said. Certain types of net lease properties are among the easiest to finance at the moment.

 

ANCILLARY SERVICES

Technology has helped to ease the burden caused by office closures by allowing buyers and sellers to transact remotely. Investors, brokers, attorneys, qualified intermediaries, lenders, and title companies are all using audio and video conferencing, emails, file-sharing services, and other internet-based technology, to continue closing transactions.

This pandemic has clearly created a number of challenges for the title insurance industry. Title companies that made the investment of time and resources over the years enabled the firm to swiftly implement our business continuity plan, allow staff to work remotely while maintaining the same level of productivity, perform virtual closings and Remote Online Notarizations, when available.

Clients will only transact when they feel confident that they have all the pieces to their transactions in place. Long-term relationships between service providers and their clients have become even more important given the current uncertainty. Getting the attention of lender and title insurance underwriters, to resolve issues unique to a pandemic, are key to getting transactions closed.

 

 

In Summary

Although the real estate market is trying to maintain its momentum, the lower interest rates have caused a refinancing boom, which means that many title companies are working overtime to keep up with that demand.

Despite the challenges brought on by Covid-19 real estate investors can take comfort from the unprecedented steps the government has taken to ease the financial strain on both businesses and private citizens. Historically low interest rates, stimulus checks, and SBA loan programs are providing parties with the financial reasons they need to transact.

These financial reasons, coupled with technology enabling real estate professionals to transact, as well as the ease of underwriting net lease transactions, will mean that many 1031 exchange transactions will go forward despite the challenges.

● 1031 Tax Exchanges will not slow in the near term. People will sell real estate and must still save taxes, retire, pass along generational wealth, etc. However, exchangers will likely look online and remotely, more than ever before, for new properties.

● Foreign investors will continue to flock to U.S. Net Lease real estate. This is not a new trend, as foreign investment in U.S. Net Lease has increased by $8 billion annually for the last five years, and in 2019 it increased by roughly $9 billion, the second-largest year-over-year growth on record. Top buyers historically have been Canada, South Korea, China, Germany, Spain, and Switzerland. U.S. Net Lease properties, especially those with international brand name tenants, will be a safe harbor in this storm.

● Demand for Net Lease real estate is at its highest yet and keeps growing. Net Lease investment increased by 11% in 2019 for a record $78 billion, outpacing the growth of all other commercial real estate sectors. Demand is consistent, but supply is tight. Net Lease is roughly a $7 trillion segment in the U.S. and growing.

● Mortgage rates are astoundingly LOW. Great time to borrow money.