Wolf Hanschen is a consultant and 1031 specialist for Resource Royalties in Dallas, TX. He is also the co-founder and managing director of Peregrine Energy Partners, also located in Dallas.
Hanschen began his career more than a decade ago in the energy industry and has since served in a variety of roles. During his career, he has raised over $400 million in the broker-dealer and RIA community, specializing in 1031 exchange investments out of real estate and into producing oil and gas properties.
With oil prices currently low and real estate prices high, would now be a good time to sell out of real estate and invest in oil and gas?
This is one of the first times I can remember when investors have the opportunity to sell an asset at a peak and buy into another asset at a trough. Real estate prices have been heading up for the last few years while oil and gas prices have done the exact opposite over the same time period. While some investors might shy away from the “negative headlines” surrounding energy, many feel that this is the best time to invest in a commodity which, at roughly $40/barrel, is experiencing its lowest pricing environment in the past 15 years.
Are oil prices finally in a position to rise in 2016, or is another year of low prices ahead of us?
Prices for everything eventually boils down to the simple economics of supply and demand. When new technology allowed the U.S. to double our oil and natural gas production in just a few short years, the market was flooded with excess supply and prices subsequently fell as a result. In the latter half of this year, operators in the “fringe areas” of exploration across the country have ceased their drilling activities which, over time, helps correct the supply/demand imbalance at which point we should see prices start to move higher.
With a high concentration of investors focusing efforts on reducing their tax exposure, have you seen many real estate investors 1031 exchange into your product?
We tend to see about two-thirds of our clients invest though 1031 exchanges and one-third through traditional cash accounts. Almost everyone completing a 1031 into our energy offerings are investors who have seen significant increases in their real estate assets and are looking to take advantage of this seller’s market but don’t necessarily want all of the proceeds to go right back into traditional real estate.
The fact that real estate is like-kind to royalty interests represents a huge opportunity for investors to diversify their funds between hard assets and passive investments such as royalty interests. Can you elaborate?
Energy royalties have been considered “like-kind” to other forms of real property (real estate) for over 40 years but most investors aren’t aware that it’s even an option. Royalty rights are a deeded form of property (just like traditional brick and mortar real estate), only in this case our clients own the land UNDER the surface.
Keep in mind that royalty owners have nothing whatsoever to do with the drilling side of the energy business, but instead represent the “lucky landowners” who own property on which oil and natural gas are discovered. Royalty owners, therefore, don’t have any of the risk and/or liabilities found on the drilling side but instead get to enjoy a percentage of the gross income that’s derived from production on their property, paid by professional oil and gas operators each month.
By including royalties as part of a 1031 exchange, investors are typically able to increase their weighted annualized return and spread their portfolio risk across multiple asset classes. Royalties also provide clients with a natural hedge against inflation as well as additional tax benefits that might not be available through traditional real estate options.
In your experience why is it important for a client to hire a QI to handle the exchange versus a local attorney or CPA?
There are more rules and regulations involved in a 1031 exchange than almost any other type of investment I have seen. Having a qualified intermediary who focuses on nothing but 1031 exchanges can make all of the difference in the world to ensure a successful tax deferral. Which types of properties qualify for a like-kind exchange, what method should be used for identification purposes, and what key deadlines need to be kept in mind are all aspects of a 1031 that a trained QI will know.
I have seen several unfortunate examples in which clients chose not to engage a qualified exchange expert and ended up having their 1031 disqualified by the IRS because they failed to follow the exact guidelines of an exchange.