Demand for Discount on Black Friday

Here are some recently released numbers from Nielsen on this years Black Friday:

• 76%s said they will be shopping at department stores
• 55% will shop at supercenters/mass merchandiser stores
• 52% will shop at electronics stores
• 35% at toy stores
• 23% online
• 22% at dollar stores

The top buys on Black Friday will include apparel (64%), electronics (60%) and toys (47%).

The most interesting thing about these numbers is the percentage of people planning on shopping at dollar stores. Nearly 1/4^th of all shoppers said they plan on doing so. This lends credence to the recent expansion plans by such stores as Dollar General, Dollar Tree and Family Dollar. The demand for discount clearly remains an important feature in today’s retail market.

We asked whether Dollar General’s IPO made sense back in November ’09 in our blog “Does the Market Still Crave Inferior Goods”. A year later it clearly does.

Who is Interested in Zero Transactions?

Typically those interested in zero transactions fall into one of three categories: Distressed Owners, Highly Leveraged Sellers, and 1031 Buyers looking to maximize the amount of cash they refinance out shortly after closing on a transaction.

Distressed owners are entirely interested in burying their former basis into a 1031 exchange replacement property as a means to defer an otherwise crippling tax bill. Zero’s are typically priced at somewhere between 8%-10% of the debt load on the underlying property – making them a cost effective solution.

Foreclosed properties are deemed to have sold for the balance on the debt owed. This is the amount needed to be covered in a new 1031 transaction to defer your gain. In simple terms if you defaulted on a $10Mil loan, you’ll need to replace that property with a new $10Mil property. Generally speaking that would cost between $800K and $1Mil. Compared to your potential tax bill a zero transaction could produce a savings of close to 50%.

A person in the second group (highly leveraged sellers) is in a similar situation. Their property is sold, albeit in an orderly transaction, but ultimately because they borrowed so much relative to the sales price they walk away from closing with very little money. Sometimes not enough to pay the tax bill. Once again, the zero provides a low cost way to defer the tax consequences.

The third and probably smallest group consists of 1031 buyers looking to use a structure commonly found in zero’s called “Paydown-Readvance”.

The “paydown” part involves dedicating all equity from your old property to the transaction (this is still a 1031 fundamentally). After the deal closes you “readvance” or draw on the loan to the point where only the minimum required equity remains in the deal. This allows a 1031 buyer to walk away from the closing table with extra cash. The downside is that you are left with a 20 year investment you can’t refinance and a property that doesn’t produce cash flow.

A Decade of Deferrals

According to the IRS, in 2002 individuals entered into 143,184 1031 exchanges. By 2005 that number had peaked to 283,560. Everyone can guess what happened next. The market dropped - dragging investments down with it. As a result, anywhere between 59,192 and 78,923 exchanges were estimated to be performed by individuals in 2008. However, it’s likely we’ve already returned to 2002 level numbers.

Institutional investors and traditional buy-and-hold investors believe the market is improving- thus, why "sell in a soft market?". However, clients with low-basis property that have certain events (death, retirement, financial distress) trigger property sales are opting to conduct like-kind exchanges. The natural processes of the life cycle along with an improving market have forced many investors out of the trenches.

An example would be an apartment building investor retiring to Florida and swapping out of an Arlington Apartment building and buying a Walgreens NNN lease as replacement property. The client gets cashflow without the "toilets, tenants, and trash". The market may not be perfect – but time waits for no one. Many of the baby boomers who could afford to wait just a few years ago are acknowledging and accepting current realities.

Another interesting and timely example are landowners selling to energy companies drilling on their property. This low-basis acreage with no depreciation benefits is great fuel for an income-producing commercial replacement property whether it be retail, industrial, or office. These clients often do not know that their land is "like-kind" with commercial real estate, and they do not know that passive real estate investments are out there that they do not have to actively manage.

Clients should really try to plan for both capital gains events and estate events. Unfortunately too much attention is put on deductions, current income, and economics of deal. Investors now face 25-50% in capital gains taxes upon disposition and upwards of 45-55% in estate taxes. This level of taxation will erode a substantial amount of the cash you will net from an investment when attempting to build real wealth.