Analyst Spencer Levy has tracked the latest tax legislation through Congress, keeping a watchful eye on its potential impact on people who invest and work in the commercial real estate industry, a multitrillion-dollar driver of the U.S. economy.
Levy took time out from his vacation in Sausalito, Calif., on Wednesday to talk to the Los Angeles Times about the likely impacts of the tax bill on the business he tracks as head of research for the Americas at CBRE Group Inc., the Los Angeles-based global real estate giant.
This interview has been edited for length and clarity.
In a broad sense, how does commercial real estate fare under the new tax legislation?
We ended up in what I consider a good place — a neutral-to-positive impact on commercial real estate. The objective winners are retail and multifamily.
So suffering mall owners and other retail property landlords can be expected to benefit?
Yes. People who earn under $100,000 a year are going to save about $500 to $2,000 per person. People near the median income (of $59,000 annually) or below spend about 100% of their income. Their cash benefit will be spent on consumables, which will positively impact the retail business.
How do apartment owners stand to prosper? Do they benefit from the new limits on mortgage interest deductions on single-family homes or the increase in the standard deduction?
At the margins, yes — the high end and low end of the housing market. With the mortgage interest deduction capped at $750,000 of debt, wealthier families might find owning a home less attractive. The greater impact is at the lower end of the market. If fewer people itemize their taxes to achieve mortgage deductions, renting looks more attractive.
What happened to 1031 property exchanges, which many real estate investors use to defer capital gains taxes by immediately buying property after a sale? Those were on the chopping block.
They survived for commercial real estate. That's a very significant non-change in the tax code. The exchanges are an important equity preservation tool. There was concern that losing them would have reduced transaction volume, especially in the range of $10 million and below.
Many people buy stocks in real estate investment trusts. Will the new tax rules for pass-through entities affect REITs and their shareholders?
They do. Dividends from REITs were historically treated as ordinary income. Now as a pass-through entity, they have a lower tax rate on the dividends they pay out. That lowers the effective tax rate on them by several percentage points. REIT dividends become more valuable.
So investors who hold real estate through other pass-through companies such as partnerships and S corporations also stand to benefit?
Yes, it will reduce the effective tax rate for those folks who own real estate in a pass-through entity, which is most commercial real estate.
Depreciation has been an important deduction for owners of commercial properties. Will that allowance continue?
It will, and there are two key elements to those deductions. One is for real property and the other is for improvements to real property. If you are in the real estate business, you can continue to deduct interest payment on mortgages without limitations.
Those who continue to choose to do that, though, will not be eligible for some of what they call bonus depreciation for certain property improvements. But if you're not in the real property business, you would be eligible for bonus depreciation for most improvements.
This will become a key provision in landlord and tenant negotiations over who pays for tenant improvement allowances, such as the cost of retrofitting office space for a new occupant. The landlord is under more depreciation restrictions than a tenant who is not in the real property business.
Do the new limits on state and local tax deductions stand to diminish commercial property values in California?
There are a couple of mitigating factors in the [legislation] that will make the SALT impact not quite as dramatic. First, they lowered the marginal rate of federal income taxes so people at the top benefit from that and the new pass-through rules.
Second, the ability to attract talent to a state is a key factor in commercial real estate value and California has terrific infrastructure for that in world-class universities and job-creating companies.
What gives you the most concern about the new tax legislation?
In the last seven years, we have seen an abundance of liquidity and low-cost capital. The mechanism by which this bill is going to work is giving us more liquidity and more low-cost capital. So the economy has not been limited by the supply of capital, it's been limited by demand.
The ability to stimulate demand and capital expenditures will be the key to the success or failure of this legislation.