Financial Resource

Net Lease Real Estate Investments

Passive real estate for both the investor and the investor’s heirs

By David E. Sobelman, Vice President, Calkain Realty Advisors and Benjamin R. Hanan, Shareholder, Abel Band, Chartered

Experienced, savvy and sophisticated real estate investors typically are inundated with decisions of what to do with their existing assets as they plan their estates.  In many cases, individuals holding various types of real property may want to simplify their portfolios for the next generation for ease of administration and enjoyment.  

Net lease investments (“NLIs”) are one of the most passive forms of real estate investment.  Under an NLI arrangement, the investor purchases the real property subject to a “triple net” lease.  In such case, the tenant is responsible for paying all of the taxes, insurance, and most importantly, the maintenance of the real property.  By divesting of current real estate holdings and purchasing an NLI, the investor can ultimately simplify the investor’s real estate portfolio and have the ability to transfer assets to the investor’s beneficiaries with the comfort of understanding that little to no real estate experience will be required in order to manage the NLI.  Additionally, depending on the type of asset purchased, the investor can assist in providing the investor’s heirs with (a) an income stream that extends into the future; and (b) an appreciating capital asset.

Investors concerned with the potential tax burdens associated with the sale of their existing real estate investments may consider taking advantage of the tax-deferred exchange provisions of Internal Revenue Code Section 1031 in order to effectuate their diversification into NLIs.  Through the implementation of a properly structured tax-deferred exchange, investors can sell maintenance-intensive real property investments, defer the taxable gains on such sales and reinvest the proceeds in an NLI.  Throughout the remainder of the investors’ lives, they can continue to enjoy the income stream and appreciation afforded by an NLI.  Should a particular investor continue to maintain their investment in the NLI until death, the investor’s estate will receive a step-up in basis in the NLI to its fair market value as of the date of the investor’s death, thereby eliminating all of the deferred income tax on such real estate investment.  Thereafter, the investor’s beneficiaries receive the following benefits: (a) a real estate investment; (b) an income stream subject to the terms of the NLI; and (c) an asset in which they possess a relatively high basis such that if they sell the NLI in the future, they can minimize the taxes paid in connection with such sale (or, if properly structured, such taxes can be deferred through a subsequent 1031 exchange).

Case Study:

Situation

For over 40 years a private investor had amassed a portfolio of New York real estate encompassing over 3,800 multifamily units.  Over the four decades, the investor had personally managed and operated the portfolio with a small team of staff and advisors.  Now in his late 60’s and with no heirs willing to undertake the management-intensive nature of the holdings, the investor was looking to gradually simplify his assets while maintaining a level of passive income that could be easier to pass on to heirs.

Problem

The size of the investor’s portfolio made it more challenging to find one single buyer since the assets are valued at approximately 0 million.  Additionally, the sale of the assets, if not properly timed, would have triggered a substantial capital gain that would have drastically affected the net proceeds for the investor.

Solution

Staggering the sale of the assets within the portfolio to allow for much smaller dispositions and encourage an ultimately higher sale price, due to increased competition, would allow the investor the opportunity to use the 1031 tax deferred exchange code in order to find like-kind assets to purchase.  The assets found for the exchange were real property occupied by tenants who signed long-term triple net leases, were priced in the – 10 million range and had a large scope of geographic diversification.  Therefore, the passive income attained from the newly acquired assets coupled with the use of the 1031 tax code allowed the investor the comfort to plan for future generations’ passive income as well as eliminated the immediate capital gains taxes he would have realized.

Authors’ Biographical Information

Benjamin R. Hanan is a Shareholder in the Business & Corporate Counseling, Personal Services & Planning and Employment Law Practice Groups at Abel, Band, Russell, Collier, Pitchford & Gordon, Chartered. Also a Certified Public Accountant, Mr. Hanan focuses his law practice on corporate law and business transactions involving individuals, physician practices, and other entities, including entity formation, operation, business sales, mergers and acquisitions, employment arrangements, buy-sell arrangements, and equity owner agreements. Mr. Hanan also devotes a substantial portion of his practice to estate planning and family wealth transfers.

Mr. Hanan earned his Juris Doctorate degree, with highest honors, from The George Washington University Law School in Washington, D.C. Mr. Hanan attended the University of Texas at Austin, where he earned an undergraduate degree in accounting, with highest honors, and a Masters degree in professional accounting.

David E. Sobelman is Vice President of Calkain Realty Advisors, the private markets division of Calkain Companies.  Mr. Sobelman focuses on single tenant retail, industrial, and office net leased investments. Mr. Sobelman is regularly sought out for his opinion on the national and regional commercial real estate trends and has been highlighted in prestigious periodicals including Retail Traffic, Commercial Property News, Northeast Real Estate Business, Globest.com, and many others.  

Mr. Sobelman earned his Bachelor of Science degree from the University of Florida and is a former Presidential Appointee in The White House.

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