In 2021, real estate investors faced many challenges when attempting to perform a delayed 1031 exchange. Due to low-interest rates and strong demand, it was relatively easy to list a relinquished property held for investment and obtain a buyer within a short period of time. The sale side of a 1031 exchange was straightforward and relatively easy to accomplish. However, the same variables that made selling an investment property predictable also made identifying and acquiring replacement property challenging.
In that market, real estate investors found it challenging to identify replacement properties because many properties would be under contract shortly after being listed. As a result, some real estate investors chose not to perform a 1031 exchange because of the stress and fast-moving market conditions. Other investors proceeded with a 1031 exchange but received taxable boot if they could not identify and acquire a suitable replacement property. The quick turnover of properties in the market was challenging for 1031 exchange investors.
Fast-forward two years and the situation is drastically different. Interest rates for a 30-year residential mortgage have spiked from a low of 2.65% in January 2021 to 6.15%. As interest rates have increased, demand has slowed, and inventory levels are rising in many real estate markets. Simply put, the real estate market changed from a seller’s market to a buyer’s market. Concerns about the severity of a recession, inflationary pressure, and consumer confidence are all variables that have further put a damper on real estate transactions and sale prices. Today, an increasing number of purchasers are using adjustable-rate mortgages (ARMs) to obtain property at a lower initial interest rate in anticipation of refinancing in the future when interest rates adjust downward.
Generally, falling home prices lead to higher rental rates. As some would-be-buyers are pushed into the pool of renters, this leads to more demand for rentals. Increasing demand without a big change in supply typically leads to higher rental rates. Many investors view the current market as an opportunity to have a choice of replacement properties, and to buy at a favorable price with the anticipation of a steady increase in rental income.
2023 is notably different than last year for 1031 exchange investors. Investors have much more inventory to choose from when identifying and purchasing replacement property. Additionally, many 1031 exchange buyers are asking for concessions from sellers and are receiving financial benefits such as the seller contributing to toward closing costs paying points to help the investor obtain a lower interest rate. The average 30-year residential mortgage rate has been 7% for the last 40 years so historically rates are not considered higher than average. The bottom line is that it is much easier today to complete a 1031 exchange as market conditions have led to a significant increase in inventory and buying opportunities.