The current investment property real estate market and 1031 exchange surge is reminiscent of the housing market in 2006. Is it that long ago that we don’t remember the housing market depression caused by the mortgage backed securities or mortgage derivatives and related string of Wall Street bail outs, foreclosures and short sales? Word from Investment Realtors is that we are in a Seller’s market where multiple Purchase and Sale Agreements are received within days of listing properties. But is that really true? Multiple clients report that their properties are not selling, but that could be that location continues to be a critical component in the number of days a property is on the market.
The Surge
According to the S&P/Case-Shiller Home Price Index (CSHPI), the top 20 metros rose at an annual rate that is three times the historical average in April to 12.05 percent. The CSHPI tracks the leading indicators of U.S. residential real estate prices nationally and in 20 metropolitan regions.
| 1 Year | 3 Years | 5 Years |
|
| 1 Year | 3 Years | 5 Years |
Atlanta | 20.81% | -1.16% | -3.76% | Miami | 12.96% | 3.25% | -4.45% | |
Boston | 8.14% | 1.20% | 0.06% | Minneapolis | 14.82% | 2.04% | -1.87% | |
Charlotte | 7.28% | 1.09% | -1.88% | New York | 3.24% | -1.17% | -3.49% | |
Chicago | 9.35% | -1.90% | -5.45% | Phoenix | 21.52% | 6.37% | -3.87% | |
Cleveland | 4.79% | -0.98% | -1.47% | Portland | 12.91% | 0.54% | -3.20% | |
Dallas | 7.40% | 1.90% | 0.75% | San Diego | 14.71% | 2.56% | -0.73% | |
Denver | 9.91% | 2.74% | 1.48% | San Francisco | 23.95% | 4.92% | -0.39% | |
Detroit | 19.76% | 6.22% | -2.82% | Seattle | 11.37% | 0.89% | -3.66% | |
Las Vegas | 22.26% | 2.60% | -7.69% | Tampa | 11.32% | 1.20% | -4.46% | |
Los Angeles | 18.75% | 3.88% | -0.99% |
| Washington DC | 7.25% | 2.65% | -0.72% |
So what is driving the surge in both the home price index and 1031 exchanges? The Joint Committee on Taxation estimates that 1031 exchanges will defer taxes of $4.1 billion in 2014 and $3.7 billion in 2013, up from $3.2 billion in 2012.
Clearly the higher capital gain tax rates effective January 1, 2013 have pushed tax deferral strategies to a higher consciousness amongst investors and their financial counsel. Capital gains rates rose from 15 percent to 23.8 percent for taxpayers with the highest adjusted gross income. Combine the higher capital gains rates with low interest rates and those who need the leverage may benefit from the investment purchases.
Those investors with deep pockets are searching for attractive gains. The National Association of Realtors suggests that nearly one quarter of homes purchased in 2011 and 2012 were by investors who did not intend to make the homes their primary residences. Americans place a strong value on owning property, thinking that real estate prices will not go down; however, we know from the real estate depression in 2008 – 2011 that was not and is not the case for many investors caught when the investment music stopped.
Interest Rates and Inflation
What concerns me is that interest rates and inflation must go up, given the low interest rates are the result of a Federal Reserve (Fed) monetary policy responsible for pumping $80 billion per month, or $17 trillion, into the economy without a strong recovery. Once the Fed slows down the printing press or those who are buying our debt stop, interest rates and inflation will increase unless Washington continues to delay the inevitable hard landing similar to the one the city of Detroit announced last week. Once interest rates increase, the U.S. government will be paying more of every dollar to pay back creditors. Goods and services will cost more; inflation will reduce the dollar’s purchasing power. Many are of the opinion that the housing recovery will continue due to pent up demand from years of lower than normal annual housing starts. We have excess human and manufacturing capacity that with greater demand will generate government revenues to soften the transition from a stagnant economy.
We would be in a better place if the economy was growing without dependence upon massive government spending. Perhaps the underlying economy is better than it appears. I firmly believe that what the government reduces in services will be replaced by private organizations who value them. If more Americans were gainfully employed, demand for investment and primary residences would increase steadily.
This year’s increase in real property 1031 exchanges is a byproduct of the housing surge. Time must pass with improving economic conditions for new investors to hold for appreciation. As always, time, interest rates, employment gains and ultimately consumer demand will determine whether the housing market will continue its surge.
Will rising interest and mortgage rates let the hot air out of the rising housing market? What do you think? How is the homebuilding industry and regional banking industry performing? They are the leading indicators of a healthy economy.
Download a brief review of what questions to ask a Qualified Intermediary to find the right accommodator when considering a 1031 exchange.
