Hospitality investors have opportunity to cash in on debt market age existing equity and create additional income through positive leverage.
Take the example of the investor who sells a property for $2.5 million and nets $1.4 million in cash and then reinvests in a $6.4 million property with a cap rate of 12 percent and a new mortgage at 8.5 percent on $5 million. The investor would earn 12 percent on his $1.4 million or $168,000. The investor also would generate additional income of 3.5 percent on $5 million — the difference between the cap rate on the property and the interest rate on the loan. That amount is $175,000.
The current debt market provides opportunities for hospitality investors. Experienced hospitality investors generally obtain preferential rates and terms from lenders, which allows the investor to earn a rate of return on equity provided by lenders. Since hospitality investments are often highly leveraged, this helps investors generate additional cash flow.
By leveraging their equity, aggressive hospitality investors also can take advantage of an appreciating market. A 10 percent increase in value on a $2.5 million property is $250,000 while the same 10 percent increase on a $6.4 million property is $640,000. The investor needs to factor in the risk that the same leverage can go against him in a declining market.
Buying bigger assets also provides hospitality investors with traditional real estate tax benefits from increased depreciation expense — to the extent the 1031 investor buys an asset greater in value than the relinquished asset. These tax benefits increase after tax yields.
A 1031 transaction provides hospitality owners with opportunities and challenges. For hospitality owners seeking to generate more income from their existing equity, a 1031 transaction is a way to complete a tax free exchange of equity into a higher quality hospitality property. Higher quality assets generate more revenue and creates more potential for long term gain.
A 1031 transaction also is a way to leverage equity and take advantage of favorable treatment from lenders because of hospitality ownership experience. Experienced and established hospitality owners can borrow at very favorable rates and create positive leverage in the present debt market. The challenges lie in selling a property, finding a property and obtaining financing within the time limitations of a 1031 transaction. (You can reach Randy Bendel at 1-877-4 TM 1031, or to discuss your specific needs. TM 1031 Exchange assists investors in planning and executing successful real estate investment strategies. Visit us at www.tm1031exchange.com.)
Originally published in the Santa Monica Daily Press print edition on August 30, 2006. Read the original PDF.