Using a 1031 as a down payment

[Douglas R.]

Hi, everyone. This is just to get a sanity check on an idea. After paying off the debt owed on a property I will be getting $7.6m in six months and am considering using that in a 1031 Exchange as a down payment on a $25-$30m loan to purchase a portfolio of apartments. I am thinking three apartment buildings (professionally managed Class B/B+, Cap Rates 7+, 95% or more occupancy rate) each located in a solid neighborhood in a separate city in NW Washington (one in Seattle, one in Bellevue, and another in Olympia or Tacoma). I wouldn’t need to derive personal income from these investments, as I would put all profits into servicing the debt more quickly and/or investing back into the buildings. I am somewhat nervous about taking on such a huge amount of debt, though, even if the down payment does afford some cushion. Do you think a little over 25% down payment would be sufficient for a potential $30m portfolio purchase? And does a 1031 allow for such a “down payment” arrangement? Thanks!

[Dave Foster]

@Douglas R., You'll want to use all of your A Team for this.  The best deals this size many times come from private sources.  So talking to numerous commercial realtors can many times shake the trees.

As far as the 1031 goes what you're proposing is really just a garden variety diversification and shouldn't cause any issues.  In fact, because of the slow velocity of assets in this size class you should be able to mitigate some of the time issues of a 1031.  We're doing a $20 mil sale into three  $8 mil NNNs right now and it's not requiring any extra work on the 1031 side than a $200K sale would.  

I'd consider getting under an LOI prior to your sale so you can get due diligence going. It's not uncommon for there to be delays in document transfer, estoppel etc.

One other thought is that rather than trying to eat up your 1031 all at once and find three suitable replacements you may want to negotiate with your bank for a commercial line or commitment to fund your purchases but use only the first purchase to complete the 1031. Then the debt free property becomes the first property of the portfolio and the others are funded with only debt. But the end result is still the same LTV %. Done this way you're only looking for one replacement rather than three immediately. And you can be both more picky and more relaxed in your search.