Investors and residents are packing up, leaving town, and saying goodbye forever.
Make no mistake, the “great migration” from city to suburbia and rural areas is underway throughout the country and it stands to have sweeping and permanent impact on the real estate investment landscape. Thank you, COVID-19, social unrest and choking taxation for lighting that firecracker.
To say that 2020 has been difficult for investment property owners and real estate investors would be a whopper of an understatement. Add in a toxic political environment and a closed economy that forced employers to shed more than 30 million workers, and we can confidently say this year is one for the record books.
For investment property owners and especially the mom and pop types who own a rental property or two, this tsunami of unforeseen forces is driving rapid change which is bleeding major metropolitan areas of residents and subsequently, investors.
Tax ‘Till You Drop
The appetite for new dollars in high taxation states apparently knows no bounds. In California, politicians have proposed legislation this year that would raise the top tax rate on millionaires to 54%*. Yes, that is correct. Investment property owners in the state are facing similar financial pain as two measures on the November ballot have sent shockwaves through the investment community statewide.
Proposition 15 repeals the long-standing Proposition 13 tax breaks for commercial and industrial and larger residential properties. Instead of paying annual property taxes based on the purchase value of the real estate, investors who own commercial or residential properties including apartments and more than a couple of single family rentals, will be required to pay taxes based on the current value of those properties.
Proposition 21 caps annual rent increases to 5% on housing that is 15 years or older. In addition, many local communities have proposals that go beyond the statewide measures.
Whether these two measures pass or not, many of our investors are assuming that it is only a matter of time before more anti-real estate investment proposals are passed in CA.
The impact of this never-ending stream of new and more restrictive regulations on investment property owners is causing many of our clients to sell their rental properties and reinvest in more landlord-friendly states like Colorado, Texas, Florida, and Tennessee among others.
Social Unrest Spells Sayonara
Growing civil unrest and crime in urban areas like Seattle, Portland, San Francisco, and New York is causing many long-time residents to pack up and move. As some violent protests and the “defund-the-police” movements continue, cities are at risk of losing waves of middle-and upper-income residents to suburban and rural communities they believe will be safer for their families. At First Guardian Group, we are seeing a significant uptick in sales of rental properties in these affected areas as investors decide to move their equity and, in many cases, their personal residences into more stable and safe markets.
The COVID Effect
According to a recent survey conducted by the recruiting firm, Hired, more than 40% of tech workers in the Bay Area would move to a less expensive area if they were asked to work from home. Facebook has already mandated its employees work from home at least until June 2021. Facebook’s CEO, Mark Zuckerberg recently predicted that 50% of their employees will be working remotely within the next five to 10 years*. In addition, many see a move to less congested communities as a flight to safety and a way to help potentially avoid contracting the virus.
Over the past week I have been hearing radio ads from a firm that assists people who want to leave the Bay area. On a recent visit to San Francisco, I saw more U-Haul trucks in the streets than I have ever seen – mostly folks loading up to leave the city. Until this year, more people wanted to come here rather than leave. That is now rapidly changing.
It is not just the new work-from-home requirements that are fueling the city-to-burb exodus. Unfortunately, the reality for so many residents is simply the fact they have lost their jobs or have had to close their businesses, and without a second round of governmental financial support, they can no longer afford to live in these high cost urban neighborhoods.
Beyond the human devastation of COVID-19, the pandemic has pounded the economy to such a degree that once thriving urban areas may now be forever changed. With businesses closing and residents moving, cities will be hard pressed to replace the lost tax revenue. With diminished coffers, do not be surprised to see state governments impose tax penalties on residents who move and elect to live in other states.
Commercial real estate has endured its share of challenges over the years. Just think back to the economic devastation of the housing bubble collapse and the subsequent Great Recession. But know that next to stocks and bonds, real estate is the third largest asset class in the world, and I am confident investors will continue to participate and the industry will indeed, recover again. From my perspective, I believe we will see a few trends over the next few years:
There will continue to be an acceleration of capital from problem areas to those landlord-friendly submarkets that are gaining population.
Mom and pop type investors who are currently self-managing their rental properties will tend to hire third party management firms to manage remote rental properties as they move equity out of state.
Unless the 1031 exchange is further compromised, the demand for managed real estate that can deliver a steady income (including properties structured as a Delaware Statutory Trust) will continue to grow.
As we measure all we have endured in 2020, it would be easy to suggest this is the hardest moment in time our country has ever experienced. And it may be. But I believe on the other side of this mountain resides a country, an economy, and an indelible spirit which will allow us to recapture the essence of what has made this the greatest nation on earth. Commercial real estate and those who invest in it, will be a key part of the recovery.
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Disclosure: DSTs, like all real estate, have risks, including illiquidity, potential for loss of property value, costs and expenses that could offset the benefits associated with tax deferral, and reduction or elimination of monthly cash flow.
Disclaimer: There is no guarantee that any strategy will be successful or achieve investment objectives. All real estate investments have the potential to lose value during the life of the investments. This material does not constitute an offer to sell nor a solicitation of an offer to buy any security. Such offers can be made only by the confidential Private Placement Memorandum (the “Memorandum”). Please be aware that this material cannot and does not replace the Memorandum and is qualified in its entirety by the Memorandum.
This material is not intended as tax or legal advice so please do speak with your attorney and CPA prior to considering an investment. This material contains information that has been obtained from sources believed to be reliable. However, FGG1031, First Guardian Group, LightPath Capital, Inc., and their representatives do not guarantee the accuracy and validity of the information herein. Investors should perform their own investigations before considering any investment. There are material risks associated with investing in real estate, Delaware Statutory Trust (DST) and 1031 Exchange properties. These include, but are not limited to, tenant vacancies, declining market values, potential loss of entire investment principal.
Past performance is not a guarantee of future results: potential cash flow, potential returns, and potential appreciation are not guaranteed in any way and adverse tax consequences can take effect. The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities. All financed real estate investments have a potential for foreclosure. Delaware Statutory Trust (DST) investments are commonly offered through private placement offerings and are illiquid securities. There is no secondary market for these investments. Like any investment in real estate, if a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions. Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits.
IRC Section 1031, IRC Section 1033, and IRC Section 721 are complex tax codes; therefore, you should consult your tax and legal professional for details regarding your situation.