1031 Strategies For HNW Investors & Advisors, With Justin White

In an era of high inflation and possible tax hikes, it’s important for HNW investors and their advisors to focus on “triple net returns,” and especially proven ways to mitigate capital gains tax liability.

Justin White, managing director at Centennial Advisers, joins the show to discuss smart strategies that HNW investors should employ when completing a 1031 exchange, plus some other tax-advantaged strategies to consider.

Watch On YouTube

Episode Highlights

  • Four tips for High Net Worth investors to consider when considering a 1031 exchange.
  • Why advisors are increasingly willing to facilitate 1031 exchanges with the assistance of other expert professionals.
  • The types of replacement properties that are currently popular with 1031 exchange clients.
  • Several reasons why Centennial’s clients tend to benefit from completing a 1031 exchange (even aside from the tax benefits).
  • The effect of higher interest rates on the commercial real estate market (and one sector that’s still as hot as it’s ever been).
  • A comparison between the 1031 exchange program and the Opportunity Zones tax program, and when it makes sense to take advantage of each.

About The Alternative Investment Podcast

The Alternative Investment Podcast covers new trends in the alternate investment landscape. Hosts Jimmy Atkinson and Andy Hagans discuss tax-advantaged investment strategies to help you grow your wealth.

Listen Now

Show Transcript

Andy: Welcome to “The Alternative Investment Podcast.” I’m your host, Andy Hagans, and today we’re talking about best practices for completing 1031 exchanges, especially for high net worth investors and their advisors. And joining me today, I have Justin White of Centennial Advisers, to offer his insights and expertise. Justin, welcome to the show.

Justin: Thanks, Andy. It’s fun to be here.

Andy: And so, I wanna launch right in. I think most of our listeners and viewers are familiar with the 1031 exchange program. I think a lot of them have completed 1031 exchanges. But I wanna talk about, you know, who’s the ideal user of the 1031 exchange program? I mean, is it the case that virtually every commercial real estate or investment real estate transaction should be completed with a 1031 exchange? Or are there certain types of transactions where it’s really more appropriate than others?

Justin: Well, I think it depends who you talk to. If you talk to commercial real estate brokers, they’ll probably tell you that every transaction should be a 1031 exchange. And in most cases, I think they’re actually probably right. I mean, since the mid-’70s, millions and millions of 1031 exchanges have been completed. And, to me, the biggest reason that they get completed is that ultimately, there’s a lot of financial benefits for the investor to utilize the 1031 exchange, not only to make more money in the years ahead, but in addition to the financial benefits, there’s a lot of non-financial benefits that come with a 1031 exchange, whether it be somebody getting a newer property, somebody getting a property that might be, you know, less management-intensive than what they were experiencing in their younger years. Or it might just be something that’s closer to home, or maybe in a red state versus a blue state.

When you look at kind of the financial benefits of it, in most cases, and the non-financial benefits that you can layer on top of it, it’s pretty good to consider a 1031 exchange. And with, you know, like I said, millions of transactions being done now, when you work with people that really know how to do this stuff, the best practices to make it easy, and to make sure that your clients, you know, their backs aren’t up against the wall and they aren’t paying taxes, we got a lot of experience doing that after all these years, and have found a pretty good way to make it a win-win scenario for just about everybody who does one.

Andy: So, let’s talk about some of those best practices, or maybe… You know what? Let me flip that question. Let’s talk about the mistakes people make. I mean, if you’re a high net worth investor with investment properties, and, you know, you decide you wanna exit one or more of those properties and complete a 1031 exchange, where do investors go wrong?

Justin: That’s a great question. And I’ll start maybe even a little bit before that. And some places where they go wrong is that they stop looking at their investment property as an investment. They get attached to it, because it’s easy. They get attached to it because it’s making more money than it did 5 or 10 years ago, and they stop looking at how is their money performing, and could it perform better? So I think that’s number one on where people can make some mistakes.

Number two is probably in the professional you select to execute the process. You know, we at Centennial talk a lot about what we call the simultaneous exchange, which is working not only the sale of your down-leg property, but the acquisition of your up-leg property simultaneously, and structuring the sale of your down leg the right way. Anybody can say they can do a 1031 exchange, but really knowing the mechanics and the nuance, and how to negotiate the sale property, in order to get the best terms possible, I think picking the right person is critical.

Number three is that they start looking as soon as they start selling. Oftentimes we hear the bad story from 15 or 20 years ago, or get the occasional call today, where somebody says, you know, I was working with a friend of mine, and now I’ve closed my down leg, and now I’ve got 30 days to find something. That’s just starting later than you need to. It’s not too late, but it’s later than you need to. And there’s lots of things that you can do, based on when you start looking, to really condense those timeframes of how long you go from the day you close your down leg to the day, you, you know, close on your up leg.

And at Centennial, we’re typically under 30 days from disposition date to acquisition date, and it goes back to, you know, kind of how you structure it and when you start looking. I think the fourth thing is, the mistake that people make is the fear that they’re not gonna find something. We’ve done hundreds if not thousands of these, and there’s professionals all across the country that do these. There’s been millions of successful ones. People find stuff. The criteria that they’re looking for, there’s usually multiple properties that come available over a 3, 6, 9-month window that you have to do that shopping from when you start.

And so they’re afraid that they’re not gonna find something, when in reality, everybody finds something unless they’re trying not to, I guess is probably the right way to put it. I think in, you know, hundreds of exchanges over the course of my 20-plus years, I’ve had one time where the client intended to do an exchange, and they elected not to after we sold their down leg.

And the only reason that they elected not to is that we were actually flying back from Florida, after doing a tour of a single-tenant property in Florida that they liked, that they were ready to buy. And we were messing around with numbers. I was sitting next to, it was a couple, and sitting next to ’em, and we were just talking about what it was gonna look like. And as we did the numbers, we realized that in their scenario, they could actually pay the taxes, and then put the after-tax money into a deal that they had recently purchased, and then, you know, paid off some of the debt, and they actually would make more money with just the one property than they would the two.

And so it made sense for them not to do it. But it wasn’t for a lack of available buildings that fit their criteria that prevented them from doing it. It was just smarter for them not to. Which maybe leads a little bit to your first question, is there are times where it may make sense to not do the 1031 exchange. And certainly, with the addition of Opportunity Zones as a alternative investment out there, there’s maybe a couple more reasons where the gain, you know, the size of the gain, and what they would pay in taxes, that a cash-out and into the Opportunity Zone might be a better play for somebody who has development experience or whatever, than just doing a traditional exchange. But for the most part, it starts with taking a look at what somebody’s numbers are, how are they doing, and do they wanna do better?

Andy: Yeah, absolutely. And especially, you know, when you consider that with DSTs, they’ve gotten more popular in recent years. And so with 1031s, an investor can even swap back and forth between an actively-managed property, then they can go into a passive fund. So, could you talk a little bit about your client base? I mean, how many of them are wanting to exchange into something that’s entirely passive, versus who wanna maintain that more direct, hands-on approach?

Justin: You know, that’s a great question. I would say most of our clients, 75% of them, are planning or trying to figure out a way to be more passive with their investments. Certainly there, we still have a lot of people that are in wealth accumulation, and they wanna go from a 10,000 square foot building to a 20,000, and then do two more trades, and get up to a hundred thousand square foot building. And they’re looking to build wealth. But for a lot of the main street private client we work with, they’re looking to make things easier. They might have owned a building that they operated the business out of for 20 years, or they’ve owned a series of apartment buildings for 20 or 30 years, and they’re ready to make things easier.

And so we see a lot of people considering, you know, the transition to a less management-intensive asset. And for, you know, a good portion of our clients, that’s usually them acquiring a… You know, using the 1031 exchange to acquire a property that they own as the same entity that they sold, without any partners, that they’re gonna make things easier. But what we do a lot of, especially with DSTs, is the people that really want passive, and they wanna acquire, you know, a grade-A sort of quality property, where they’ve got nothing to do, they utilize DSTs. Or, we work in conjunction with somebody who might be looking…or in conjunction with DST sponsors, for somebody who’s not sure whether they wanna continue to own one property themselves and make the decisions and deal with the management, or maybe they wanna just be totally hands-off.

And so, when you combine an investor’s ability to go buy a property on their own that might lessen their management responsibilities, and make them more money, plus the variety of DST assets that are available that provide them less management and the opportunity to make more money, it’s really, really hard to not find something that works and makes your situation better.

Andy: Sure. So, what kind of DSTs are popular right now, especially, you know, among the higher end of the market, with folks who have more capital to place? I mean, is it mainly, like, institutional-grade multifamily, or, you know, triple-net or, you know, what type of assets do you see there being a lot of interest in right now?

Justin: Well, I think that whether it’s DSTs or it’s the individual investor acquiring a property, there is plenty of product available for everybody, depending on what it is. We certainly see the super high-end, A+ institutional-quality asset, on the DST side, available to an investor who, you know, might have $500,000 or just a couple million dollars coming out of an exchange, that they can use to acquire just, you know, the best property. I use South Coast Plaza in Orange county as kind of always my example of what you can acquire on the DST side.

But whether it’s retail, or single-tenant net lease, or multi-family stuff, there’s a variety of product out there that really can satisfy every investor’s, you know, risk and return scenario. Sometimes what we see is we see people, you know, like, wanting to diversify a little bit, and get money in multiple different markets across multiple product types, so they’ve got, you know, a little bit of portfolio resiliency, at least more so than they might have had with the manufacturing facility that housed their business for 20 years, or the 25-unit apartment building that they’ve owned for 15 or 20 years.

Andy: Sure. Sure. And so, does Centennial mostly work with individual investors? Or, you know, more and more, I talk with RIAs or wealth managers who are getting a little bit more actively involved with real estate, and, you know, the alternatives that their clients own, so, are you finding that there are more financial advisors and RIAs who are willing to work with you, or who are coming to you to facilitate?

Justin: You know, I think in the 20-plus years I’ve been doing this, yes. You know, when I started, it was, you know, let’s call it two, maybe competing interests, but more and more, I think both real estate people like ourselves and the financial advisors are starting to see that by working together, we can really provide more solutions and better performance for our clients. So, while still in our business, most of our relationship is with the individual investor.

I’ve found that when we have been working collaboratively with the financial advisor that we’re able to deliver a much better performance for the client. You know, we’re able to… When you’re talking to your financial advisor, you’re getting, you know, just like if you’re only talking to your real estate professional, you don’t get the whole look at your portfolio, and how it all plays together, and how it can work together to your benefit. So that when we do get involved with financial advisors and we’re able to bring our own expertise to the table for the benefit of the client, I’ve found that the client gets much better results, and that ultimate end goal, whether it be a certain lifestyle or a certain monthly income, we’re able to get there a lot faster when we collaborate and work together with a financial advisor than if the client is maybe keeping us apart, or doesn’t see the benefit in us collaborating and all being on their team.

Andy: Yeah, absolutely. I mean, from the investor’s point of view, you know, my RIA or advisor has that kind of big-picture planning, you know, life goals type of perspective, but at the same time, with a real estate transaction, I’d want an advisor who has experience in the weeds, you know, with this particular type of transaction. So, you know, I think it makes sense, the idea of, you know, multiple professionals working together. And, you know, you see that with family offices. But it’s an unfortunate fact that there’s a lot of advisors, or frankly, even family offices are not using 1031s or some of these tax programs to their full potential.

You know, and I understand the perspective that we don’t want the tail to wag the dog, right. So, you don’t wanna complete a 1031 exchange just to say you did. You know, “Hey, I saved on taxes,” but, you know, “I transacted into an asset that I don’t even like,” or whatever the case may be. You know, how much weight do you put on that, or do you think that an investor should put on that, you know, where they’re trying to optimize, to take advantage of the tax program, versus, “You know what? I’m gonna go after the asset that I want, and let the chips fall where they may in terms of the tax consequences.”

Justin: You know, after doing this for so many years, and being a part of so many exchanges, I almost think that in a weird way, the tax benefit is secondary to the other benefits that the investor can receive. We do a lot of taking a look at exactly where the property is today. How much equity have they built up in the property? How much cash flow are they getting? Let’s factor in any debt that they’ve got, and then what they might be utilizing in depreciation and kind of what their after-tax return is.

And it’s my experience that when somebody’s owned a building a long time, they’ve got, you know, very small amount of debt, and they’ve got very little depreciation, that usually, they can do a lot better from a financial standpoint. And then when you couple that with the reason why somebody brought the property 5, 10, 15, 20 years ago, their goals and objectives at that time might be different than they are today.

If their goals and objectives are different, and they wanna do X, Y, and Z, and they can make more money, and the tax benefits are that you’re allowed to move that money back and, you know, trade it amongst different, you know, like-kind property, it only makes sense to do it. I mean, every one of us will sell a stock and, you know, will sell Apple and buy Tesla because we think it’s the right move. It’s the real estate equivalent that, a lot of times, people just don’t utilize it to better match up with what they wanna do and what they think is a better return. Because it is a, you know, bricks and sticks, and a bunch of dirt, people get sometimes a little too entrenched in that asset, versus it’s just like a stock. It’s a tool to grow my wealth, to grow my future generation’s wealth, to, you know, lead me into a successful retirement.

And so, I think that those things are usually what we look at. People shouldn’t do an exchange just to check off that box that they did it. But if somebody’s owned it a while, they’ve got very little debt, they’ve got very little depreciation left, they can make more money by utilizing the exchange, and align with, you know, their current goals better. Usually.

Andy: So it sounds like a lot of the value you create is just in fighting inertia. Inertia that is a drag on investor returns?

Justin: Yeah. I mean, you know, real estate’s a really good investment. So, you know, most people make more money on their property today than when they bought it. For most people, it’s pretty easy. The tenant’s in there, the tenant uses it. They don’t complain too much. It’s pretty easy. So, it’s easy, and they’re making more money today than they usually ever have before on that property. That inertia makes it really hard for sometimes people to act. But if they look at it, you know, over the course of 5, 10, 15, 20 years, in a lot of cases, it’s millions of dollars that they leave on the table because of that satisfaction with their current property.

And the line that I always, you know, try to remind people is, whenever you bought this building that made you so much, has made you all this money, you are more experienced and better at investing in real estate today than you were when you bought it. You should expect to be able to do even better on the next one. And they usually do.

Andy: Yeah. And, you know, something that Jimmy, my co-host and I, we’ve talked about before on the show quite a bit, is just how crucial the section 1031 exchange program is in facilitating real estate transactions. And really not only the cottage industry, or it’s not a cottage industry, but that kind of micro, or whatever, that specific industry built around 1031 exchanges, but also just how that transaction volume, you know, helps the entire real estate industry, with all of the actors involved, and just creates more economic activity, allocates capital more efficiently, which I think, you know, that’s probably the way an economist would describe the exact thing that you were saying, is that you don’t need to get attached to an asset if you have a more efficient way of generating wealth.

But, you know, I thought it was real interesting. I think it was about a year ago, there was some discussion in Washington around the Biden administration about possibly nibbling around the edges of the 1031 exchange program, possibly, you know, limiting the types of transactions that would receive the benefit or the dollar amount of the benefit. Do you think there’s a real risk that the 1031 exchange program would be not necessarily eliminated, but, you know, scoped in, or reduced significantly in the next few years?

Justin: I would say I really hope not. And I think the biggest reason is, you know, and I’ll give a couple examples. Like, we do a fair amount of transactions with families that have owned a multi-family asset for a really long time. And, you know, the mom and dad may be in their 60s, 70s or 80s, and they’ve continued to own this property, and you show ’em what they can do in an exchange, where they can make more money, not have to deal with the toilets, and really enjoy retirement. Those are really fun 1031 exchanges to be a part of. Because you get to really positively contribute to somebody enjoying all the success that they’ve built up and created through that building.

So I hope that we don’t get rid of 1031 exchanges, probably for that reason alone, is in how it really… It’s a tool that makes a lot of people’s lives a lot better. Do I think it’s possible? I’ve always tried to convince myself that there’s absolutely no way they could get rid of it, because A, the amount of jobs that it creates, how it makes people’s lives better. Those two things, I look at and go, [inaudible 00:21:16] a really positive tool that we have, you know, within the tax code and within real estate.

Now, that being said, we’ve heard it a couple times, potentially, that they could get rid of it, rein it in, you know, change the limit. If it’s above X, then it’s gonna get taxed. I don’t know. I mean, there’s so many things that I think would never happen that sometimes do, that I guess it’s possible. But I think that a lot of people really benefit from it. And I think that when you look at the jobs that it creates, in addition to the wealth that it also creates, it’s kind of a win-win on, let’s call it all sides of the aisle, similar to Opportunity Zones. I think the thing that people say about Opportunity Zones all the time is that it was the one thing during the Trump administration that both sides of the aisle could agree on

Andy: Bipartisan. Yeah.

Justin: Yeah. And the 1031, to some degree, creates a lot of jobs, it makes people’s lives better. And that should be something that both sides of the aisle can always agree on. You know, we saw all those proposals that were coming out about and, you know, eliminating 1031 was one of the big ones. Well, it didn’t happen. So maybe that’s the best indicator, right, that, you know, well, it got mentioned, and it was talked about, and it was proposed as a possibility. When they really looked at it, it wasn’t worth doing. Although I…but I will say that there were people that we did transactions with last year because they were worried that it could possibly happen. And they wanted to make sure they got the benefit of it before they missed out on it. Yeah.

Andy: Yeah. You know, it’s interesting. I think you’re right that sometimes that kind of talk can scare people into action, I guess in a good way. But, you know, I, personally, I guess my take, my 2 cents is I don’t see it happening anytime soon with the economy where it is. And now we’re starting to see real estate transaction volume, I mean, especially in residential, that volume is really starting to decrease, right. And it feels like kind of the wind came out of the sails all of a sudden in the larger economy. But, you know, the residential’s one thing. I wanted to ask you, you’re a little more on the ground, you know, with commercial investment real estate. Are you seeing that inventory build up? You know, are you seeing buyers and sellers get a little bit more, you know, nervous? I guess nervous is the word I would use.

Justin: We’re certainly seeing things change. In the early part of this year, financing for commercial assets was, you know, for some multi-family product, in the high 2s. But usually, there was a three in front of most things, regardless of product, regardless of location. And, you know, it very quickly moved up to 4s and even into the 5s. And we’ve seen a little bit of stabilization lately. So interest rates always have a significant impact in what’s happening in the real estate market. On the residential side, it just makes everybody’s payment get bigger, and people get scared and nervous. Or maybe aren’t as aggressive as they were before.

And so we’re starting to see some of that in the commercial side. I would say the big difference between the commercial and the residential markets is that while interest rates are going up, there’s still opportunity for people. There are… You know, in 2010 and ’11, or ’09, ’10 and ’11, when, you know, we’d seen the correction, and the real estate market was bad, and we were in a recession and all that stuff, there were still a lot of people that actually did 1031 exchanges because they had opportunity. They had built up a huge amount of equity, they were sitting on these large positions of equity that they could redeploy into an asset that had gone down in price significantly, and they did exchanges to get newer buildings, to get into better areas, to make things easier, and to ultimately make a lot more money over the next 10 years. So, we’ll see some of that. There is going to be, with interest rates changing, there is going… Buyers and sellers are gonna have to kind of agree where the market is at again. And sometimes, you know, half of that equation is slow to react, or is hopeful that things haven’t changed. But as you’re…

Andy: You’re talking about sellers who are living in La-la Land, essentially?

Justin: Well, they’re hopeful. I mean, like, it’s human nature and it’s normal to wanna be hopeful and, you know, the price that maybe you could have got in January is not the price you could get today. But, you know, after you realize that, then you gotta step back and go, “Okay, well, can I still do better? Am I still in a better position to continue this transaction?” Which…

Andy: Well, let me dig into that. I’m sorry to interrupt, but, you know, the dynamic of a 1031 exchange is so interesting, because I have to sell, but then right away, I’m buying. And so, you know, depending where the market is, I sell low and I buy low, or I sell high and I buy high. Right? I mean, I’m sure individual investors don’t necessarily think of it that way, but on a macro level, you know, those things seem like they would kind of even out. So is it even… You know, I guess, which part of that equation helps or hurts the market more? Is it the cheap replacement properties that just got cheaper? Or is it the fact that I’m, you know, able to get less for the one that I’m selling?

Justin: Well, I think you’re very realistic with other people’s money. And you’re absolutely right. I mean, you’re buying in the same market that you are selling, in almost every case. And actually, you would say today that maybe you’re even winning, because you’re selling at X, and tomorrow you might be buying it a little bit lower.

Andy: Sure.

Justin: So you actually could be getting a little arbitrage in the market today. But yes, when you are just buying and selling in, let’s just call it the same market, so nobody’s really losing. I think it’s more the perception of what people have lost in value, or it’s the perception of uncertainty in the short term that makes people concerned or worried, and they take a step back. Now, you know, my experience of being in this now for 20 years and seeing all parts of the cycle is that a lot of investors do really well in times like this. Because while everybody else is waiting to see what is happening, or sitting on the sidelines, there are opportunities.

And in investment, you know, the industrial marketplace in most of the markets we work is going crazy right now, and still is, because of the demand. You know, vacancy rates are the lowest we’ve seen in industrial. [inaudible 00:28:36] would, you know, lead you to believe that rents are gonna continue to go up. So, rents are gonna continue to go up. Interest rates probably gonna continue to go up for a little bit, too.

Andy: Why, or do you think there’s underlying factors? Like, what underlying factors are causing industrial to be so tight right now? And you think that’s gonna continue?

Justin: I think it’s gonna continue until, let’s call it, the demand for space meets the need. Which, you know, in some markets, you know, they’re building millions of square footage of industrial, for logistics, for, you know, all that sort of stuff. You know, it’s like the residential side and on the multifamily side, there are markets that are very construction-constrained, because of cost and legislation, where rents are continuing to go through the roof, even in markets that have rent control. But, as we’ve seen, you know, in other cycles in other times, if there’s too much stock floods the market, you know, there’ll be some markets where we see that change, and others will be tremendously resilient.

So, I think that the neat part about commercial real estate is that within products and geographies, there’s a lot of things happening that have a lot of different influence and factors on what, you know, it might make sense to trade an apartment building into an industrial building, or it might be smart to trade a retail property into an industrial building three states away. Like there’s a lot of play, and there’s a lot of things that you can kind of factor in in this analysis to help people, you know, outperform the market.

Andy: Yeah. How many clients are actually doing that, you know, who are buying a property three states away? I mean, are those just triple-net properties? Or, you know, how hands-off can I be as a direct investor for my replacement property?

Justin: We are seeing a lot of money move a lot of different locations. For example, we’ve got a good strong presence in Southern California, and we’re seeing a lot of people move to red states, whether that’s single-tenant net lease property, multi-family. We’ve seen a lot of people move money into places like Boise, Provo, Colorado Springs, over the last, you know, three to five years. So, those markets that, you know, have been really strong, with really great growth, we’re seeing people move money there.

And you can still be passive. You gotta go out… You know, our process when somebody wants to go buy a somewhat management-intensive, let’s just call it a multi-family property or a multi-tenant commercial building out of state, is, obviously, we’re gonna go look at the property, we’re gonna spend, you know, a day just checking out the building and all that stuff. But then, you know, we set up four or five interviews with management companies, to go conduct the interviews with them, to figure out, okay, who’s really the right fit for what you wanna do management-wise, so that it can be as passive as you want it to be?

You’re still always gonna have to manage the manager, whether that’s the building… You know, whether you own the building next door to where your office is, or it’s a thousand miles away, you still gotta manage ’em to some degree. But how much you do it is really a choice. And we help people figure that out, from, you know, the person that has a vacation home 90 miles away, that’s there a lot, they need a certain level of management support. Somebody who maybe never wants to go there is getting a different level of management support, or they’re buying a net lease deal.

But we’re seeing a lot of money move across state lines. People more and more are taking advantage of the ability to put their money in different states that, whether it’s legislatively, tax-wise, whatever it is, to line up better, or just demographic growth, line up better with what they wanna do.

Andy: Yeah. And I think, you know, the lockdowns of 2020, 2021, and some of the disruptions that caused with, you know, rent payments, rent collections, things of that nature, I think maybe it accelerated that process a little bit. You know, I see a lot of investors… You know, what was the euphemism I heard the other day, that, the Smile States, you know, just the Sunbelt, or whatever you call it, there’s so much capital is moving there. I mean, along with residents, right?

There’s a lot of new residents in those states, but still, it almost makes me wonder… I had a guest on the show, he said it made him wonder if there’s a trade on the other side, you know? Any time that kind of trade gets so crowded on the one side, you almost wonder if there’s an opportunity on the other side, you know, to, I don’t know, build multifamily in Chicago or San Francisco or something.

Justin: We get asked that all the time, because, you know, as you were just describing, there was a lot of things that happened in Southern California, or in California in general, that maybe didn’t match up with what a lot of people felt should have happened during COVID, whatever it may be. And there was a lot of capital and a lot of people that moved outside the state. And that made sense for those people, and there’s probably really good investments for them. But, you know, I can certainly see, and we work with a lot of people that, although there’s been now rent control in Southern California, and there’s been all these changes, that it still makes sense for the right person to come in and buy a multi-family, you know, building in Southern California.

So I think that that’s kind of the great part about the real estate business. And, you know, to your point of what we’re talking about, why the 1031 exchange is so valuable is there’s not just 31 flavors out there. There’s thousands of different flavors of investment, that you can match up exactly what you want right now with a building, and you can utilize the 1031 exchange to facilitate getting there.

Andy: Yeah. And all the way to the point where you can go entirely passive with a DST, right. I mean, I guess even in that case, you have to select the manager. You don’t have to manage the manager, necessarily. But, so, it sounds like you could be totally hands-on, you can look for a triple-net or, you know, some sort of asset where you hire a management company and be mostly passive, or you can essentially go entirely passive. But I wanted to ask you about interest rates, because, I mean, it seems to me there’d be so many folks who, you know, they’d own an asset, with a fixed interest rate, that’s extremely low, and, you know, maybe they were smart enough to refinance it in the last couple years.

And so now, if I’m anticipating or thinking about doing a 1031 exchange out of that property, I’d be selecting a replacement property that’s probably going to have debt that’s significantly more expensive. Now, I’m guessing that that’s not gonna be, like, the deciding factor. It’s not gonna be the… What is it? The straw that breaks the camel’s back. But it still is a headwind. Do you see a lot of investors who are turned off, just, you know, by the higher interest rates right now?

Justin: Well, I think it’s something that you factor in, right? You said that it’s probably not the straw that breaks the camel’s back, but when we’re looking at properties and analyzing whether an exchange makes sense, certainly what is… How much is the debt gonna cost, and how does that affect the cash flow, plays into that equation. You know, one of the nice parts about the debt is that you can fix it for the period you want, and then if it gets really good, you know, between now and then, you can always, you know, recast it out, pay the prepay, whatever it may be, and it still is profitable.

And, you know, even if somebody is paying a little bit higher, you know, for debt today, they are locking it in. Whereas if they’re getting a building that has built-in rent escalations, or they’re buying a product that, you know, has really great forecasted rent growth, that rent growth is gonna, you know, continue to grow while your debt payment is locked in at a certain number.

So, yes, we’re seeing people go, “Well, I had this loan, and now I’m gonna have, you know, 150 or 200 basis points higher.” We try to remind them, well, let’s look at the whole picture. Because with those interest rates being higher, maybe the prices come down a little bit, and, how much money are you gonna make at the end of the day? If you still end up making more money, and you get some non-financial benefits that you’re really interested in, more time, easier building, you know, whatever it may be, or maybe you get a building that’s 30 minutes from where your kids live, and every vacation now to see your grandkids becomes, you know, an inspection of your property, then when you put all those things together, are you still doing better if you do it today with where rates are at, is, I think, really the ultimate question that has to be asked, not just, “What are rates, and what is my payment gonna be with a higher rate? And I don’t like that.”

Kind of, you know, we were talking earlier about how, you know, the price going down of maybe somebody’s building, and you made the point, well, you’re buying and selling in the same market. So, while sometimes people focus on just what the price is, the reality is if they’re making a lot more money, that’s the number that’s most important, not necessarily… The price today is part of the process of getting them ultimately to making more money and being happier. The price is just a part of it. Just like the debts, just one little component.

Andy: Absolutely. I mean, it’s all about that net income and, you know, the net present value of all future cash flows from that asset, right? So you have to put it in financial terms. And I mean, I totally agree, if I’m looking at interest rates, I wanna look at cap rates as well. And so if interest rates go up, but then cap rates go up, you know, you can look at a financial model. It may end up being a better deal at the end of the day. What’s frustrating is when interest rates go up, and then the cap rates don’t go up, or at least in the residential market, you know, not necessarily cap rates, but, you know, the interest rates go up and the asset prices haven’t necessarily adjusted yet. So I think what some people are waiting for, capitulation, and I’m guessing, you know, in some markets it’s probably not too far away.

I think we’re right in that, you know, in between time, where a lot of people are crossing their fingers and say, “Well, let’s give it another month, let’s give it another six weeks and see what happens.” But I know we’re running short on time, but I wanted to go back to one thing that you mentioned earlier in the show, that I thought was really interesting. You mentioned that, you know, for some investors who are looking into a 1031 that a QOF or an Opportunity Zone fund might be a better option for that investor.

And for our listeners, you may recall that Jimmy and I did a webinar recently about this very topic, comparing and contrasting Opportunity Zones versus 1031s and DSTs. And, you know, a big thing for me is, as an investor, you know, the Opportunity Zones program can take any type of capital gain, right? Any type of capital gain will be eligible to roll over into a Qualified Opportunity Fund. Whereas, with the 1031 exchange, you know, I have to have real estate. I have to have a capital gain with real estate. One other factor is, with a 1031, I can roll over that entire amount of the sale proceeds, so that’s the capital gain as well as, you know, the principal that I receive back. Whereas, with the QOF, I’m limited to just the amount of the capital gain.

So, I mean, you know, on the surface level, there’s a lot of similarities between the Opportunity Zones tax incentive and the 1031 exchange program, but there’s also a lot of differences. So, you’ve mentioned that Centennial Advisers works with some investors, helping them set up individual QOFs. And so I wanted to ask, you know, when you’re working with a client, when… I guess, what questions do you even ask to figure out is this client gonna maybe be a better fit for a QOF versus a 1031 exchange? And what are the major factors that you’re looking at to arrive at that decision?

Justin: Well, I think when we’ve got somebody who has real estate, or their gain is coming from real estate, it’s usually, you know, how much is the gain, is kind of number one, because one of the… We’ve worked with… Some of our Opportunities Zone clients, their gain’s not coming from real estate. So they can get their, they get their principal out, which they kinda like, and now they just have to deploy the gain to get the deferral, and then all the future benefits that go along with it. But when we’re looking at somebody’s real estate asset and we’re trying to figure out what’s best, it really comes down to how much tax are they gonna have to pay today, versus what are all the benefits of the tax deferral, and how much money they can make on basically not paying that tax until 2027, and maybe cross our fingers we get two more years if we get some tweaks on the legislation.

And then, how much they can make on the gain redeployed into the asset, without having to pay any tax on all that gain, if they hold it 10 years. So, it’s how much gain they’ve got, how long they plan on keeping the equity in an asset, whether that’s an exchange asset or the opportunity fund. I would say those are kind of the biggest things we look at when we’re trying to figure out numbers-wise which one makes the most sense. So, in some, I’m not gonna call it unique, because it’s happened, you know, more than once, but in some circumstances, it makes more sense to pay the, or to sell the asset and put it into an Opportunity Zone Fund than doing the exchange. And we look at all those numbers, and partner with, you know, oftentimes their financial advisor, tax attorney, the whole bit, to put all that analysis together and offer the insight that helps ’em make, you know, kind of the right decision on it.

Andy: Yeah. And, you know, speaking with RIAs and wealth managers and family offices who are more familiar with alternatives, which unfortunately is not a high enough number, but I think more and more advisors are kind of understanding that these programs are complementary, and, you know, you never wanna let the tail wag the dog, as we’ve already covered today. But, I mean, you can imagine a scenario where a client has some real estate assets, and are using 1031 exchanges to exchange and swap those other assets, maybe the sale of a business or the sale of mutual funds, and deploying those gains into QOFs. You know, so there really is a lot of tax-advantaged opportunity right now, I think. But you have to be enterprising, and kind of go look for it.

Justin: Yeah. I would say, you know, in our experience, especially on the Opportunity Zone stuff, is that the financial advisors that get it, and really understand it, are almost 100% behind the idea of using Opportunity Zones to defer some of that tax, especially on the sale of a business or something like that. That, when you factor all those tax benefits that the Opportunity Zone can provide, it is… I mean, we’ve had nothing but unanimous support from financial advisors, accountants, attorneys, basically everybody’s, let’s call it board of directors, or important people that help them make decisions, all get on board with the Opportunity Zone thing. And I’m sure you guys see more of it in the space that you’re in and the conversations you have, but the Opportunity Zone thing, to me, has been an underutilized tool for the last five years, relative to the benefits that it provides people.

Andy: Absolutely. I mean, it is finally, you know, I think the word’s starting to finally get out and spread. And our partners at OpportunityDb, they actually host three events every year, Oz Pitch Day, where they have a lot of QOFs present. And those are very, very popular events, but still, I agree that as much as the word has spread, when you actually explain what the program does, like, if I sit down with a financial advisor, you know, who maybe knows a little bit about the program, but I kind of walk them through the benefits, it’s such a no-brainer in so many situations.

But I know we’re running short on time, and Centennial Advisers helps clients with 1031 exchanges, with DSTs, even with some individual Qualified Opportunity Funds, you offer all sorts of services. So, Justin, where can our listeners and viewers go to learn more about Centennial Advisers?

Justin: Well, our web address is centennialadvisers.com. We spell “advisers” with an E, versus an O, which gets some people confused. But I’ll give everybody our number, too. Our main office number is 562-269-4844. And if you’ve got some questions or you’re looking for somebody to help you figure out what is the best thing to do, that’s really what we try to do for all of our clients. You know, as I started, most of our clients are, you know, let’s call it $1 to $50 million main street investors, that own their real estate as part of something they do, but it’s not what they do all day every day.

And we like to be that person that can help you figure out what is the best thing to do with it, whether it is an exchange, whether it’s holding tight and just improving operations, and making suggestions there. If we can be any assistance to any of the people on the call, or clients of some of the advisors you work with, Andy, we’re happy to help in any way we can.

Andy: Awesome. Well, for all of our listeners and viewers, if you want links to everything we talked about on today’s episode, you can access our show notes at altsdb.com/podcast. And we’ll also include links to Centennial Advisers, Advisors with an E, and everything we’ve talked about. And also, don’t forget to subscribe to our show on YouTube and your favorite podcast listening platform, so that you receive our new episodes as we release them. Justin, thanks again for coming on the show today.

Justin: Thanks, Andy. I had a great time. Thank you.