Are some 1031 exchange deals leaving region?

Real estate 1031 exchanges once the territory of sophisticated investors only have gone mainstream and become a major factor in Nevada's real estate market.

Some experts wonder, however,whether dollars involved in residential 1031 exchanges are beginning to flow out of Nevada after years in which they boosted the region's real estate market.

Everyone who owns a rental property can use the 1031 exchange regulations to make a tax-deferred trade out of that property into a new one.

And they are.

From major corporations trading in the millions, to individual rental property investors.

Alongside the Californians who have been packing up businesses and families and moving into Nevada properties, investors from over the hill have been converting out-of-state dollars into Nevada property investments.

"Everyone is doing it," says Craig Chagnon, division manager of Asset Preservation, Inc., a subsidiary of Stewart Title Co.

that handles 1031 exchanges for investors.

Yes, business is booming, says Kandas Myer, regional manager for Starker Services, Inc., another 1031 exchange intermediary firm, but she also voices some early concerns in the residential exchange segment that 1031 dollars are leaving Nevada.

The exchanges are all part of the real estate boom in Nevada.

The actual size of the 1031 market is difficult to pin down, says Scott Saunders, vice president of Asset Preservation, Inc.

"You get a good feel for the pulse,"he says, "but it's hard to really quantify the increases in the market or to break out categories."

Still, an October 2004 study by Deloitte Tax LLP, a national tax

consulting firm,made a stab at estimating the national transaction volume, extracting numbers from a survey of 1031 exchange intermediaries, which garnered a 22 percent response, and a sampling of Internal Revenue Service data.

Deloitte's report estimated that in 2003 almost 220,000 federal tax returns reported 1031 exchanges.

The national dollar volume of like-kind equity exchanges exceeded $105 billion, with total property values estimated at $210 billion.

Those numbers were up by about 27 percent over the year before, says Saunders.He estimates that Nevada was close in line with a 15 to 20 percent increase.

About half of those investments came in with under $500,000 equity indicating that a good percentage of them were investments in residential rental properties.

Myer does about 60 percent of her business in residential investment exchanges.

She expects to see out-of-state dollars continue to come in, but she also points to a few early indicators of a possible market shift.

In her business, she says, she saw an increase in 1031 exchange money going out of the state last year a first for her.

A sale is a sale for an exchange intermediary and for real estate agents working the exchange.

But what does it mean for the state? When 1031 dollars leave Nevada, then the state loses money on a few little-noticed levels.

In residential rental investments, says Myers, her concern, beyond the money leaving the state, is also the fact that ultimately the loss trickles up into the rest of the economy.

"It doesn't trickle down," she says."It trickles up."

Retail investment follows rooftops.A slowdown in rooftop expansion coupled with a shrinking inventory can equal a slowdown in retail growth, says Myers.

A slowdown in 1031residential exchanges would indicate that property costs are outstripping investors' purses, both in-state and out.

If real estate prices cease to pencil out for investors, then they'll go elsewhere.

Competition for out-of-state 1031 dollars increasingly comes from states such as Idaho, Arizona, and Oregon.Myers tells the story of an Idaho colleague complaining about Nevada dollars coming into her region and inflating the local market so the local workers can't afford to buy homes in their own town.

"Sound familiar?" she asks."Those states are gaining an edge on us (in residential) as our prices go up."

If you break out the residential component, says Bill Kearney with Keller Realty Company, then it makes sense that you'll see people begin to be drawn to other states as northern Nevada prices go up.

But that's not happening on the $2 million to $100 million commercial level,where the majority of his clients invest.Nevada's prices are still competitive in those segments.

But also, the region's location, infrastructure, and business-friendly environment are all huge magnets for incoming business.And that's not likely to change any time soon, according to Kearney.