Could 1031 Exchanges Bring More Investors Into Commercial Equestrian Real Estate?

One of the biggest challenges in the horse business is the cost of real estate. A professional may have a solid business that can support the cost of operating a good facility but still be nowhere close to being able to buy a $1.5 million or $2 million property (or more).

At the same time, real estate investors have a different problem. In many markets, property prices have risen much faster than rents. By the time you account for property management, vacancies, tenant turnover, insurance, taxes, repairs and maintenance, the return on a conventional rental property may not be nearly as attractive as the purchase price suggests.

This got me thinking about commercial equestrian properties and 1031 exchanges. Could a good commercial horse property make sense as an investment property? And could that create a win/win for both the investor and the horse professional?

First, What Does a 1031 Exchange Have to Do With a Horse Property?
A 1031 exchange allows an owner of qualifying investment or business real estate to sell that property and potentially defer capital gains taxes by purchasing other qualifying real estate. What is particularly interesting is that the replacement property doesn't have to be the same type of property. Someone selling rental houses doesn't necessarily have to buy more rental houses. Someone selling an apartment building doesn't necessarily have to buy another apartment building. Under current IRS rules, qualifying real property can generally be exchanged for other qualifying real property held for investment or productive use in a business.

That means a commercial equestrian property could potentially be an option. The investor isn't buying a horse business. The investor buys the real estate and leases the facility to a professional who runs their own business there. That's not much different conceptually from an investor owning a building that is leased to a restaurant, veterinarian or other business. The question is whether the numbers work.

Let's Look at a $2 Million Property
Let's say we have a $2 million commercial equestrian property with a 25-stall barn, a good arena/s, turnout, a barn apartment and a separate rental house. The professional leases the entire equestrian facility. (I wouldn't base the lease on all 25 stalls because most professionals need to keep some stalls available. So let's base the facility rent on 20 revenue-producing stalls at $400 per month.)

Sample Investment Projection

*Illustrative operating expenses include property taxes,  insurance, management, vacancy and repairs. The capital/replacement reserve is shown separately. Actual expenses could be substantially higher or lower depending on the property, market, lease structure and applicable agricultural or current-use tax treatment.

A 4.3% return after the capital reserve isn't going to appeal to every investor. But that's not really the question. The question is what else that investor can buy for $2 million, what that property will actually net after management, vacancies, tenant turnover, insurance, taxes and maintenance, and what the underlying real estate is likely to be worth over time.

In markets where conventional rental property has become very expensive relative to achievable rents, the comparison could get interesting.

Purchase price can materially change the return on exactly the same income stream:

This Isn't a Passive Investment With No Risk
There are some things I really like about the model, but there are also risks that need to be taken seriously. If a residential tenant moves out, all the owner needs is another residential tenant. If a professional equestrian tenant leaves, they need another professional capable of leasing and running that facility. That could take time and it certainly takes skill to identify the right professional and business owner for this kind of arrangement.

So I wouldn't necessarily describe an equestrian property as easier to manage than conventional rental property. It is a different management problem.

The Property Still Has to Be a Good Real Estate Investment
This may be the most important point.  A beautiful horse farm isn't necessarily a good investment property. They would want to look at the land first. Where is it? What is the underlying land worth? Is there demand for commercial equestrian facilities in that market and is there a professional we can identify to lease it.

What is the housing worth? What are the property taxes – does it qualify for greenbelt? What does the property cost to maintain? What else could the property eventually be used for? And what would it cost to replace the barn, arena and infrastructure?

In some cases, an investor may actually be able to buy existing equestrian improvements for substantially less than it would cost to build them today. In other cases, the seller may be asking such a large premium for a beautiful horse property that the rental income can't possibly support the purchase price. That's exactly the same calculation investors should be making with any other real estate.

Here's Where I Think 1031 Gets Really Interesting
The investor doesn't have to enter this investment through a 1031 exchange. Someone could simply buy a commercial equestrian property as an investment today. If the property is operated as legitimate investment real estate and later sold, the owner may then have the option of completing a qualifying 1031 exchange into another real estate investment, assuming the transaction meets the applicable requirements.

That changes how we can think about the property. Let's say our investor buys the property for $2 million, leases it to a professional for a number of years and eventually sells it. The buyer might even be the professional who has been leasing it. If the professional's business has grown and their financial position has improved, they may now be able to purchase a property they couldn't afford when the relationship began.

The investor sells. The professional becomes the property owner. And the investor may be able to take the proceeds and complete another 1031 exchange into a completely different qualifying real estate investment.

That is very different from buying a horse property because you like horses. It is an income-producing real estate asset. And I think that distinction matters.

Could This Bring New Capital Into the Horse Industry?
This is the part I find most interesting. The horse industry requires an enormous amount of real estate. Yet we tend to assume that the people operating horse businesses also have to provide the capital to own that real estate. Why?

A successful trainer may know exactly how to make a 25-stall facility profitable. That doesn't mean they have $400,000 for a down payment or can qualify for a $1.6 million commercial real estate loan. Meanwhile, an investor may have $2 million that needs to go somewhere and absolutely no desire to train horses. Those two people may actually need each other.

The investor gets an income-producing real estate asset. The professional gets a good, secure place to operate their business. And if the professional eventually becomes financially capable of purchasing the property, there may even be a natural exit for the investor. That's where I think this idea deserves more attention.

Not every commercial horse property will work. In fact, I suspect many won't once you actually run the numbers. But some might. And if commercial equestrian real estate can produce a competitive return, attract long-term professional tenants and provide investors with a viable entry and eventual 1031 exit strategy, we may be overlooking an important source of capital for the horse industry.

It is in fact, how I was able to buy my first horse facility, but that's a story for another time.  In the meantime I do get calls from investors who “want in” on the horse industry and I always tell them the same thing, “you are going to need a good horse professional to run it.”  Maybe it's time we starting introducing investors to select professionals. 

This article is intended for educational purposes and is not tax, legal or investment advice. 1031 exchanges have specific requirements and deadlines, and individual transactions should be reviewed with qualified tax and legal professionals.

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