Sponsors Reevaluate Risk Models Amid Transparency Challenges in 1031 Exchanges

Written by:

Steve Marcinuk

Date:

25 Aug 2025

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The $100 billion 1031 exchange market is experiencing a fundamental shift as investors demand greater transparency following years of disappointing returns from deals struck during the 2021-2022 peak. While traditional real estate transactions continue to dominate the tax-deferred exchange space, alternative investment vehicles like Delaware Statutory Trusts (DSTs) and 721 exchanges represent just 6-7% of the market, a figure industry experts believe should be closer to 20-30%.

The gap stems from a combination of product complexity, poor education, and what many see as misaligned incentives between sponsors and investors. Recent market turbulence has exposed these structural issues, with several major sponsors facing difficulties as deals underwritten at market peaks struggle to meet projected returns.

Capital Preservation Takes Priority Over Yield Chasing

Market conditions are forcing a recalibration of investor expectations and sponsor strategies. Rather than leading with projected returns, experienced operators are emphasizing downside protection and capital preservation as primary objectives.

“We all romanticize about the upside, but what we’re really trying to do is limit downside risk and preserve capital,” explains Mike Auerbach, who recently joined Bonaventure as Chief Growth Officer after building a qualified intermediary business. “That’s where you get in trouble if one lever goes down, groups haven’t really assessed the risks of the deal.”

This shift reflects broader market sentiment as family offices and institutional investors become more selective. Deal fatigue from the past two years has given way to cautious optimism, with many believing current conditions represent attractive entry points before broader market recovery drives up asset prices.

Skin-in-the-Game Model Gains Traction

The alignment problem has become particularly acute in the DST space, where traditional fee structures incentivize sponsors to raise capital quickly rather than focus on long-term performance. Some operators collected substantial upfront fees regardless of deal outcomes, creating a disconnect between sponsor and investor interests.

Bonaventure’s approach illustrates an emerging counter-trend: the company has invested $565 million of its own capital across nearly $3 billion in assets, with principals maintaining significant stakes in each offering. In their 721 exchange product, internal investment totals approximately $130 million.

“The consequences are more dire for us based on our allocation than them,” Auerbach notes, describing how this model influences decision-making. “If the deal goes sideways, they’re not really affected” when sponsors maintain only 2-3% co-investment levels.

Education and Partnership Models Evolve

The complexity of 1031 alternatives has historically limited adoption, with many investors and their advisors lacking familiarity with DST structures and 721 exchange mechanics. This knowledge gap becomes problematic during the compressed 45-day identification period when investors face time pressure to complete exchanges.

Industry veterans are responding by developing more comprehensive educational resources and partnership programs with qualified intermediaries, attorneys, and CPAs. Rather than competing directly with commercial brokers, sponsors are positioning these products as backup options when primary replacement properties fall through.

“We really are a Plan B, a just-in-case scenario,” Auerbach explains. “We don’t want to compete with commercial real estate brokers. We just want to be there as that resource if their client wants to see another option.”

Market Outlook and Structural Changes

The winnowing of sponsors following recent market stress mirrors patterns from previous real estate cycles, with an estimated seven to eight established players maintaining operations compared to numerous new entrants who launched during the bull market. This consolidation may ultimately benefit investors through improved underwriting standards and more sustainable business models.

Looking ahead, successful sponsors are focusing on product customization rather than one-size-fits-all offerings. Client needs vary significantly, some prioritize appreciation, others cash flow or professional management, requiring more sophisticated advisory capabilities.

The next 6-12 months will likely see continued emphasis on transparency initiatives, enhanced due diligence processes, and products offering greater optionality for investors. As Auerbach puts it: “A rising tide lifts all boats. I want the majority of sponsors in the space to continue to do well and have stamina.”

For an industry managing tens of billions in annual transaction volume, these structural improvements could unlock significant growth potential while better serving investors navigating an increasingly complex tax-deferred exchange landscape.