Wednesday, February 9, 2011

Separate Trends Benefit Net Leases

Two recent developments should push investors towards net lease properties. A new rule from the Small Business Jobs Act demands rental properties be treated as other businesses – requiring 1099 forms to be submitted to all service providers for costs $600.00 or over in one year. Furthermore, municipal bonds are on thin ice and many cities are posting billions in debt. These developments make both active real estate management and passive municipal bonds less attractive. Those who have invested in either should see net leases as a safe harbor.

The Small Business Jobs Act, like all bills, naturally contains things many would think anti-productive to its intended nature. Its provision requiring 1099’s lives up to this by issuing heavy amounts of busywork where none was required. Specifically:

The act subjects recipients of rental income from real estate to the same information-reporting requirements as taxpayers engaged in a trade or business. Thus, rental income recipients making payments of $600 or more to a service provider in the course of earning rental income are required to provide an information return (typically, Form 1099-MISC, Miscellaneous Income) to the IRS and to the service provider. This provision will apply to payments made after Dec. 31, 2010, and will cover, for example, payments made to plumbers, painters or accountants in the course of earning the rental income.

Thus, private real estate owner/operators will be saddled with new paperwork. As owners grow older – which the advancing baby boomer population assures – the time and effort required to actively manage a property will simply not be worth it. For this reason, net lease properties become very attractive. They offer a passive asset which real estate owners can trade into via a 1031 tax free exchange.

Municipal bonds, long seen as a stable investment, are looking less secure everyday. Just to name a few, Chicago as $7.4 billion in debt, Detroit has $billion and New York has $60 billion. These are major metropolises in major debt. Though the idea of a bankruptcy or default may seem impossible – these cities cannot print their own money and many have guaranteed millions in lifelong pensions. At the very least – municipal bond owners should be wary. Those heavily invested should also look for a more stable source of income. The credit ratings of top-notch net lease tenant such as McDonalds and Walgreens would put many cities to shame and still deliver guaranteed passive returns.

The market is constantly changing and as it has proven recently – can be treacherous. Many so called “safe” investments were shown to be completely unsound. Net leases offer a secure asset with dependable returns. Of all the real estate segments – few to none offered more staying power during the recession. With actively managed real estate encumbered by paperwork and municipal bonds looking shaky – the migration to net lease assets should be natural.

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