Investment Analysis

Best Buys

Structured sales can provide profitable advantages for purchasers.

In the increasingly competitive commercial real estate marketplace, buyers and sellers continue to seek advantages in the negotiation process. Until recently, structured sales were a concept that resonated primarily with sellers. Yet commercial real estate buyers may be surprised to learn that structured sales have distinct advantages for them as well. Consultants and other real estate professionals who understand the fundamentals of structured sales for buyers can offer their clients creative strategies for maximizing their investments.

A structured sale is a cash sale for the buyer, while the seller receives guaranteed payments over a specified time period. Instead of the seller taking constructive receipt at the time of sale, the buyer assigns its future obligation to a highly rated insurance carrier to pay future periodic payment obligations to the seller, avoiding constructive receipt. The seller only recognizes gains, income, and return of basis as each payment is received. In essence, such a transaction can be characterized as a front end-loaded installment sale with a substitute obligor. 

Advantages for Buyers
The most appealing benefit for buyers is the ability to obtain more property with less money. Because the assignment company purchases an annuity to fund the future obligation, a fixed interest rate makes up the difference to equal the agreed-upon amount.

A second advantage is that buyers can make an offer higher than the asking price. In many cases, real estate investors are willing to pay above the asking price because the land or real estate they are seeking is highly desirable and the market is very competitive. Utilizing a structured sale, a buyer could fund a sale at asking price but turn that figure into a much greater number over a five-, 10-, or 15-year period, while helping to solve some other potential problems of capital gains tax efficiency, cash flow planning, and reinvestment options for the seller. By using structured sales, buyers may be able to get more for their money or put forth more attractive offers in a highly competitive market.

What types of investors benefit the most from structured sale transactions? The structured sale process uses a single premium annuity, or fixed-income vehicle, to fund a future payment obligation, a concept most appealing to baby boomers and retirees. In addition, mature investors may be resistant to 1031 exchange options due to their changing risk tolerance and lack of available replacement product in the current market. Furthermore, some of these candidates already may be considering reinvesting commercial real estate sale proceeds into the fixed-income marketplace. Other prospective sellers are those who have non-performing land assets that can be turned into income streams. Still others are those who want a multifaceted approach to exit strategies related to their real estate positions.

Brokers and buyers can maximize their opportunities by offering sellers options. For instance, a buyer could present a seller with an asking price offer but agree to have it payable over five or 10 years. The buyer receives a discount and has some room for negotiation, and the broker has some much-needed leverage with the seller to help make a sale.

Structured Sales at Work
Consider this example of how buyers can utilize structured sales. John is a real estate investor interested in a commercial property that has an asking price of $2.2 million. The seller is 70 years old and has owned the property for more than 30 years. There is no mortgage and the original cost basis was $200,000, saddling the owner with a $2 million capital gain upon sale. The seller is not interested in a 1031 exchange and wants to create an income stream from the proceeds to support his lifestyle.

How can a purchaser propose an attractive offer to the seller? A buyer can offer the full asking price of $2.2 million, but give the seller three scenarios with a five-year, 10-year, or 20-year payout. After the buyer and seller have agreed upon an amount the stream of income will equal over time, a structured-sale broker can run calculations for the buyer to understand how much he would need today to fund the sellers’ time frame.

In this example, John could fund a $2.2 million obligation with a five-year payout for $2,048,315, or a discount of $151,685. In a 10-year scenario, John can fund the same obligation with $1,824,045, or a discount of $375,955. Lastly, the 20-year scenario could be funded with $1,448,217, or a discount of $715,783.

Structured sales can be powerful discount tools for buyers who position the concept as a value proposition to sellers. For commercial real estate professionals to receive potential commissions from structured sales, they must hold a state life and health insurance license. However, technicalities for buyers and sellers are minimal — they only nweed to add a few lines to their purchase agreement to reflect the structured sale. The remainder of the transaction generally is managed by a structured-sale broker to ensure the assignment, escrow, and application processes are managed properly.

David A. Adkins, CTFA

David A. Adkins, CTFA, is principal of North Haven Group in Cleveland. Contact him at (216) 854-6455 or dadkins@northhavengrp.com.IRS Provides 1031 Updateby Ricky B. Novak, JD, in-house counsel for Real Estate Exchange Services in AtlantaIn July, the Internal Revenue Service issued new private-letter rulings regarding related-party Section 1031 exchanges. Specifically, PLR 200728008 allowed an exchanger to sell relinquished properties via a qualified intermediary to a related party. In the outlined transaction, the IRS ruled that gain was not triggered, despite the representation that the related party intended to sell the relinquished properties within two years. PLR 200728008 reinforces the notion that a taxpayer can indeed qualify for tax deferral when selling relinquished property via a qualified intermediary to a related party, which was previously articulated in PLR 200712013, PLR 200706001, and PLR 200709036.Commercial Investment Real Estate’s July/August 2007 Investment Analysis column, “Navigating the Maze,” explains how commercial real estate developers can apply related-party 1031 strategies. In relation to the holding-company strategy discussed in the July/August column, the new PLRs would allow an investment company and development company to be related parties. This is of interest to developers, as there would be no holding period applied to the relinquished property once it is acquired by the related development company, thus allowing it to develop and sell without restrictions.

Recommended

What’s Ahead in M&A

Spring 2022

In a frenzied environment of corporate mergers and acquisitions, commercial real estate will face tough decisions in the long and short terms. 

Read More

From Fairways to Forklifts

Winter 2022

Considering the growing demand for industrial real estate, golf courses are popular targets for conversion to warehouse and distribution centers. 

Read More

Big Data, Major Demand

Fall 2021

 Considering the continued growth of big tech, data centers will be a CRE sector to monitor. 

Read More

Demystifying Defeasance

Summer 2021

Securitized debt can seem daunting, but it’s possible to sell or refinance assets. 

Read More