Real estate has historically been a sound investment, but also one that requires a watchful eye on tax laws, business asset valuations and market conditions. Take your eye off the ball and you risk significant financial loss.
With ongoing uncertainty around certain real estate sectors, it’s not an easy environment to be a real estate investor. Now may be the time to consider strategic decisions about your property. To help you preserve and build wealth with these assets, here are three questions to ponder.
The American Tax Relief Act of 2012 lowered the federal gift and estate tax rate to a maximum of 40% and increased the exemption, which for 2024 is set at $13.6 million per individual. Sunsetting cuts are set to expire at the end of 2025. The result? The exemption amount will fall to roughly $7 million, and the maximum gift and estate tax rate will increase to 45%.
When wealth preservation is paramount, consider moving your assets from your family name into a trust before the cuts expire. Transferring assets may be a wise wealth management strategy to help avoid probate and minimize future estate taxes for your heirs.
Be aware that the IRS rules for the transfer of real estate are complex and require many steps. One critical requirement? You must have a property valuation from a qualified appraiser before you make a transfer. This valuation should be completed in compliance with IRS internal reporting memo 4.48.6 guidelines.
Here’s why: the IRS may call for a reassessment for property tax purposes when your property changes hands. If you undervalue your property, it may invite heightened IRS audit risk and potential penalties and assessments. Overvalue and your heirs could overpay in taxes.
Talk to your estate planning advisor about transferring your real estate holdings. If that’s the savviest strategy, contact your real estate lawyer and bring in a qualified appraiser for a property valuation, which is the first step toward transferring your property into a trust.
The sooner you engage in the estate planning process, the better. As the gift and estate tax sunset approaches, both qualified appraisers and lawyers that specialize in gift and estate tax work will likely have less availability. And with interest rates set to fall in the coming quarters, asset values could increase, reducing the estate planning benefit.
If you own office space that has been adversely impacted by economic conditions in recent years, you may be looking for new ways to maximize its value. Perhaps you should convert it into a hotel or a mixed-use property. Transform it into residential rentals. Perhaps not. The answer lies in knowing as precisely as possible what your property is worth today and, potentially, its value upon conversion/repositioning.
One real-life example: a newly constructed office building in downtown Phoenix that was finished just as the 2007/2008 fiscal crisis hit. It was competing with other new office properties with more desirable locations. The top four floors were pre-leased for office use; the lower 20-plus floors were vacant, in shell condition.
The owners commissioned a feasibility study based on converting the first 20 floors into an upscale hotel and retaining as office space the top four levels, which were encumbered by a 10-year lease, plus options, to a single tenant. The study indicated that repositioning was financially feasible and resulted in the highest and best use of the property.
The developer obtained funding and built the property out as a mixed-use office and hotel development. The pivot paid off: it has been a viable mixed-use property for over a decade, moving from 17% occupancy to 100% occupied.
Another scenario involves a 38-story office building located in a tertiary market in upstate New York. After the property sold in 2014, the buyer considered redeveloping the tower and plaza into a mixed-use complex with retail, restaurant, hotel and office space and residential condominiums, along with an apartment component.
A feasibility study revealed that redevelopment was financially viable and offered the highest and best use of the property. Redevelopment started once funding was in place, with the property undergoing a $150 million renovation of the office tower and a partial repositioning, adding over 100 prime-rate apartments, event space and a 75,000 square-foot retail mall. Before the start of the renovations, the tower was approximately 20% leased. As of Q3 2024, it was more than 70% occupied.
In each case, valuation and feasibility studies helped facilitate decision-making. Otherwise, it’s all guesswork, and that could cost you greatly.
It’s no secret that some sectors of the commercial real estate market are still facing challenges. Office properties in some markets are dealing with lower occupancy levels due to the normalization of hybrid work schedules, which is limiting demand growth. And segments of the multi-family sector have experienced slowing rental rate growth due to the biggest wave of new supply in decades.
While the industrial sector remains strong, national vacancy rates almost doubled from mid-2022 to Q2 2024. Year-over-year rent growth in the sector has slowed and new inventory is growing at the fastest pace in more than three decades. The risk of oversupply is most associated with the segment of industrial properties containing more than 500,000 square feet of building area.
As attractive properties hit the market at what seem like bargain prices, is it prudent to jump into a deal because the cost basis numbers are enticing?
Word to the wise: just because a deal has a good price doesn’t mean it translates to a good financial opportunity. Will that property ever lease up or will you be left holding the bag? Some markets are no longer attractive to lessees, which can result in a long-term hit if you purchase a property in a deteriorating market — even at a reduced price.
It’s easy to get caught up in a must-happen-right-now deal. But it is important to carefully evaluate what the property is likely to be worth over the long term. Interest rates have started to decline and inflation has shown signs of easing. Converting or repositioning underperforming office properties may become more attractive and financially feasible if broader economic trends continue to improve.
Performing feasibility studies on such properties before interest rates decline to anticipated levels and before inflation eases to a stable/sustainable level will help position you to take advantage of opportunities once market conditions become more appealing.
Taking the time to evaluate your long-term obstacles and property potential can truly support your wealth strategy. Armanino puts its 30-plus years of experience in valuation and feasibility studies to work for your property assets so you can preserve and maximize value. Find out how our valuation experts can help you support estate planning, repurpose properties and understand the long-term impact market conditions may have on your real estate holdings.
Contact our experts today for a complimentary consultation to explore the smartest next steps to strengthen your valuation.
