The Client's Story
This client was referred to us by their CPA. A Wyoming businessman and rancher, the time had come for he and his wife to sell their eastern Wyoming cattle ranch and transition into retirement. They were interested in using the Section 1031 exchange to defer income tax on the ranch sale and reinvest into commercial real estate that would provide them with monthly income and require no management on their part.
Rolling Up Our Sleeves
Our initial discussions were focused on educating and informing him about the different types of commercial real estate available, and which types of properties would best accomplish their goals. He and his wife decided early on that they would purchase two properties as opposed to a single, larger property, primarily for diversification purposes. We provided them with an overview of the current market, and presented them with suitable properties for their review, outlining the strengths and weaknesses of each. They soon decided on their first property to target for purchase: a brand new medical clinic in Phoenix.
The tenant is headquartered in Mesa, AZ and operates over 40 clinics in Arizona and Nevada. Thorough examination of the tenant’s financial statements showed a company that was very profitable, providing our client comfort with the tenant’s ability to fulfill lease obligations. The lease was a brand-new triple-net lease that held the tenant responsible for all costs and management duties related to the property. One of the property’s strongest attributes was its location. The 1.3-acre property sits on a hard, signalized corner of a busy intersection and is surrounded by dense residential development in a rapidly developing area of the Phoenix market -- a superb location for a walk-in medical clinic. (Testament to the quality of the location, soon after our client closed on the property he was approached by a representative for a national convenience store/gas station chain that wanted the site for a new store.)
We continued searching for a second property while moving forward on the urgent care transaction, and soon presented our client with another strong property. This was a triple-net leased Qdoba Mexican Grill in Oklahoma City. Established in 1995, Qdoba operates over 600 locations across the U.S. Our client’s initial interest in this property was sparked by his familiarity with the market, as he had been to Oklahoma City several times competing in team roping competitions. The property is located on a busy commercial corridor surrounded by brand name national retailers. There was a brand-new 150,000 sq. ft. retail development under construction directly across the street. This was attractive because it would attract even more traffic by this location. Perhaps most appealing was the rental rate in the lease, which was significantly below other similar restaurant rental rates in the immediate area. This situation provides significant potential upside in the event of the current tenant not renewing the lease. In this scenario, another tenant could be found and likely be charged a much higher market-based rate, which would increase net operating income and, ultimately, the value of the property.
We performed thorough due diligence on both properties, examining the lease documents, covenants, conditions and restrictions (CCRs) governing the properties, environmental reports, property inspection reports, market demographics, title commitments, property surveys and more. We vetted the tenants, examining their ability to fulfill the lease terms. Throughout the entire process, we reviewed our findings with our client, their attorney and CPA. We helped our client effectively manage their 1031 exchange to ensure all time limits were complied with, and had suitable back-up properties identified in case the subject properties fell through. As the final step in our due diligence, we conducted site visits with our client, touring both properties and exploring the surrounding areas.
Our client used the Section 1031 exchange to transition from their ranch into two high-quality triple-net leased commercial properties offering long-term, stable income and requiring no management by the landlord. In so doing, they were able to avoid paying a tremendous amount of income tax and now enjoy annual income from the properties totaling over $236,000.
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