How Investors Can Use 1031 Exchanges as Portfolio Opportunities in Retail

The retail commercial real estate investment market is shifting. National chains are closing stores, insurance premiums are rising, and consumers are spending at a more cautious rate than in previous years. Yet, for investors who take a more proactive approach, these challenges are an opportunity. This is where the 1031 exchange comes in.  

The 1031 exchange is a tax-deferral strategy that allows investors to sell a property and reinvest the proceeds from that property into a like-kind real property asset, without recognizing or having to pay capital gains taxes at the time of the sale. Normally, when investors sell a property for a profit, they must pay taxes on capital gains. Depending on the property’s appreciation and how long it has been held, the taxes can be significant. Tax deferral allows investors to keep more capital in the real estate market, rather than losing a portion of their profit to taxes, making it easier to compound wealth over time. 

Store Closures Create Inventory, Opportunity 

One of the best times to leverage a 1031 exchange is during challenging market conditions. Currently, one of the main challenges in the retail market is major retailers closing underperforming stores, like Kohls and Macys.  

With store closures comes a wave of vacancy, resulting in greater availability of underutilized retail space, especially in markets where inventory has historically been tight. 

Investors who take advantage of store closures by using a 1031 exchange can trade out of fully valued or underperforming assets and redirect their capital into distressed or overlooked retail properties with greater upside.  

For example, if investors can move into properties where they can make strategic upgrades, such as modernizing facades, subdividing large footprints, or re-tenanting with service-oriented uses, they can reposition those retail properties and better meet today’s tenant needs and demands. Utilizing a 1031 exchange, investors can directly invest cash from the property they sold into these strategic improvements.  

Rising Insurance Costs Require Smarter Portfolio Decisions 

Investors in the retail market are also managing property insurance premiums, which are surging across the country. Driven by extreme weather events, inflationary construction costs, and changing risk models, this increase is eating into net operating income of many investors and squeezing cap rates. 

One solution is to exit higher-cost markets, or exit properties that have outdated systems, and use a 1031 exchange to reinvest in properties that are more insurable due to their location, newer construction, or potential for value-add renovations such as new roofing, HVAC, or fire safety upgrades.  

The strategy of looking for retail properties in more insurable locations relieves cost pressure and can also improve long-term asset resilience and enhance cash flow predictability. 

Shifting Consumer Habits Also Call for a Rethink 

Consumer spending remains relatively strong with sales primarily driven by durable goods such as vehicles, furniture, electronics, appliances and building materials. However, much of that spending has already slowed with concerns about price trends and many retailers are preparing for further spending cuts.  

Shoppers are becoming more selective, cutting back on discretionary purchases and favoring convenience, services, and experience. Food patterns too are also shifting with consumers now eating out less and eating at home more. These types of shifts are exposing vulnerabilities in some retail formats. Big box stores and older shopping centers, for example, are harder hit, as they are typically older centers geared toward product-heavy tenants.   

With a 1031 exchange, investors can reposition their portfolios to align with the new retail reality, which includes smaller strip centers with medical tenants, boutique fitness, fast-casual food, or other service-based concepts that thrive on in-person traffic and local loyalty. 

The bottom line is that the retail market is at a time of reset, not retreat. The challenges in the market are not a reason for investors to step back but, should, instead be a reason to recalibrate portfolios. For owners and investors willing to lean in, this is a moment to think creatively, act decisively, and use 1031 exchanges as the tool to transition outdated or underperforming assets into better-aligned, better-performing retail properties.