Re: Ray’s insights on these 2 choices - Posted by ray@lcorn
Posted by ray@lcorn on May 27, 2009 at 06:04:03:
I’m tempted to laud you for volunteering to pay your “fair share” of our trillion-dollar deficit by taking the tax hit on $300T, but my mercenary heart just won’t allow it.
Don’t forget that the tax won’t be just the 15% cap gains rate. There will be depreciation recapture at 25%, plus any state tax that’s applicable. Add it all up and then calculate how long it will take and at what return on the remaining principal to replace it. That might change your mind. If the total taxes are a conservative $55,000 you’ve lost 18% of earning power. In a world of average investment returns of 6% or less, that will take 12 years to replace. (Use the 4% you’re settling for on the $500T and it takes 18 years.)
That leads me to the next comment. I don’t like the development deal at all now that the details are known. You’re making a loan that no bank or hard money lender would touch. Land values are a lot like restaurant equipment… they look great on paper, but lose a lot when the auction hammer comes down. As a land-banking, hard money lender friend of mine is fond of saying, his rule of thumb is to take the current market value of the land, cut it in half, then lend half of that. And by the way, he gets six points to do the deal. You are acting as the developer’s banker on very soft terms. Figure in the taxes you are paying as a cost of doing the deal and rather than earning a return, you’re actually paying dearly for the privilege of putting your capital at risk.
The NNN deal I also don’t like. This sounds like a quickie oil-change station? Whatever, the purchase price is three times replacement cost (i.e. $432 PSF); the rent is top-of-market ($36.72 PSF), it’s a specialty building, and the tenant has weak financials. The residual value is maybe 50% of the price. There is no upside and no exit strategy. It will decline in value as each year of the lease ticks by. Deals like this are trading at about 9.5%-10% caps right now, and I think that’s still too much.
However, it does have the advantage of producing income, no tax hit, and there is an exit strategy for about half your capital. Acquire it at a 10% cap rate, use a 45% LTC loan (assuming that meets the debt requirements of your 1031). Then refi with a 75% LTV, 5.5%, 20-year am, pulling out about $400T, which leaves a 15% or so return on the remaining equity.
On the refi pre- or post-1031 issue, it is my understanding that the danger is in the former, not the latter. I would refer you to an acknowledged expert on the subject, Bill Exeter at www.exeterco.com. His online manual states:
Refinancing and Exchanges
A common concern among investors conducting a tax-deferred like-kind exchange is the ability to withdraw equity from the investment property without incurring any income tax liability. Since cash or debt relief constitutes taxable boot, the concern is that pulling cash equity out of a property before, during or after a tax-deferred like-kind exchange transaction would result in the disallowance of the tax-deferred like-kind exchange transaction and full tax liability for the Investor.
It is possible for the Internal Revenue Service to take the position that the refinance transaction has been structured specifically to evade payment of income taxes, collapse the exchange as a â??stepâ?? transaction, and complete disallow the tax-deferred like-kind exchange transaction. The preamble to the Department of the Treasury Regulations contains language stating that refinancing immediately prior to a tax-deferred like-kind exchange transaction will result in the disallowance of the tax-deferred like-kind exchange, so the Investor is best advised to refinance at least six months prior to execution of an exchange, or waiting until the completion of the exchange to refinance.
(Section 1031 Tax-Deferred Exchange Reference Manual; Page No. 59; Â© Copyright 2001-2006 by William L. Exeter. All Rights Reserved. www.exeterco.com; 866-393-8377)
The direct link to the Exetor Co. manual is
So my advice is to keep looking. This is the best buyer’s market we’ve had in years and you can get beter deals than either of these. I think given your described circumstances the NNN CTL (credit tenant lease) deals are going to be most suitable.
Best of dealmaking,