The Client's Story
This client was referred to us by their ranch broker. A former financial executive who became a rancher after inheriting the family ranch in Montana, this gentleman and his wife had decided to sell. For the past couple years, after health reasons prevented him from actively working the ranch himself, he had been leasing out his pasture. Both of his children had moved off the ranch long ago and built their own careers, and weren’t interested in moving back. Thus, the couple decided the time had come to sell the ranch and retire to their home place in western Montana.
Concerned with the country’s economic condition, he wanted to invest solely in real estate -- he wanted “clear title to tangible real property.” They wanted to use the Section 1031 exchange to defer income tax on the ranch sale and reinvest into commercial real estate that would provide them with comfortable monthly income. A sophisticated real estate investor, he wanted a long-term lease with a reasonable return and no management responsibilities.
Rolling Up Our Sleeves
Our goal was to locate the most suitable property available that would accomplish their goals. We presented many properties to them, outlining the strengths and weaknesses of each. Familiar with commercial real estate, he was adept at assessing the options we presented and they ultimately chose four different properties for further investigation. We performed initial due diligence on each of them and completed site visits on three. After thorough analysis by Top Hand and our client, they ultimately decided to purchase a Denny’s restaurant property in South Dakota that offered a brand new 20-year lease guaranteed by the nation’s largest Denny’s franchisee, which operates more than 90 units in eight different states.
The tenant had been operating successfully at this location for many years, a testament to the location's quality. Although the building was 30 years old, in a couple years it was scheduled to undergo a complete renovation, at significant cost to the tenant, to bring it up to Denny's current design standards. This 1.2 acre property is located on a busy commercial corridor in Sioux Falls, and has excellent access, visibility and parking. Sioux Falls is the largest city in South Dakota and possesses strong demographics. Throughout the 20-year lease term, the tenant would be responsible for all costs and management responsibilities associated with the property – this is known as a “triple-net” or “NNN” lease. The long lease provides significant flexibility from a holding period standpoint. Our client could own the property for 5 or 10 years, and then resell it while it still has a significant number of years left on the primary term. This helps ensure that the property will be more marketable to buyers, who typically will pay higher prices for properties with 10 or more years remaining on the lease.
We performed thorough due diligence, examining the lease documents, covenants, conditions and restrictions (CCRs) governing the property, title commitment, property survey, environmental report, market demographics and more. We vetted the tenant, examining its ability to uphold the lease terms. Throughout the due diligence process, we reviewed our findings with our client and their attorney. We effectively managed our client’s 1031 exchange to ensure all time limits were complied with, and had suitable backup properties identified in case the Denny’s deal fell through. As the final step in our due diligence, we conducted a site visit, touring the property and surrounding area.
Our client used the Section 1031 exchange to transition from their ranch into high-quality commercial real estate offering long-term, stable income. In so doing, they were able to avoid paying considerable income taxes and now enjoy income from the property of $98,000 annually, providing a nice supplement to their other retirement income. Guaranteed by a large and experienced Denny’s franchisee, this property is likely to provide passive rent income to our client for many years to come.
We've provided this information for general educational purposes. It is not intended as specific tax or legal advice. Please consult a professional for specific advice regarding your particular situation.
© 2016 Jack Sauther & Diana Sauther