Tax-Reform Uncertainty Jolts Markets : Investors in Tax-Free Bonds and Real Estate Shelters Are Wary

No news may be better than bad news, but for a business, uncertainty can be the worst news of all.

“If you’ve heard the bad news, you can take some action to adjust to it,” says real estate investment analyst William G. Brennan. “With things up in the air, you’re hamstrung.”

Uncertainty has afflicted the markets for tax-free bonds and real estate tax shelters since Nov. 27, when the Treasury Department jarred the financial community by proposing tax reforms that would cut out a host of deductions and exclusions, while lowering personal income tax rates.

Though the proposal’s chances in Congress are uncertain, its unveiling brought immediate predictions that reform would unhinge the markets for tax-free bonds and real estate tax shelters.

Healthy Prospects Since the proposal was unveiled, many investment professionals have come to the view that tax-free bonds will survive, perhaps even thrive, if Congress adopts the Treasury plan or something like it. But many see dark days ahead for the recently thriving business of real estate tax shelters.

Sponsors of real estate tax shelters “have canceled deals or delayed deals or tried to offer investors better terms,” says Stephen A. Roulac, a real estate investment adviser in San Francisco. “Some are putting up a brave front, but the ones who are candid will admit everybody’s lost a lot of money already.”

The uncertainty has dropped the stock prices of publicly owned companies that handle real estate syndications, such as Integrated Resources Inc. of New York and Angeles Corp., of Los Angeles.

In fact, the stock prices of Integrated Resources and Angeles Corp. have hit all-time lows in recent weeks. Integrated Resources, which has sold as high as $29.50 in the last 12 months, closed Friday at $14.625, a recovery from its low of $12.125 on Dec. 3 but down 15.2% from the $17.25 it was trading at Nov. 26, the day before the Treasury plan was announced. Angeles, which had a 12-month high of $14.625, was trading at $8.625 on Nov. 26, dropped to a low of $6.375 on Dec. 27 and closed Friday at $7.25, down 15.9% from its pre-announcement price.

By lowering the maximum personal income tax rate to 35% from 50%, the Treasury proposal would reduce the savings that could be gained by investing in any kind of shelter. Specifically, for a taxpayer in the top bracket, the proposal would reduce the value of a tax shelter investment to 35 cents on the dollar from 50 cents on the dollar.

The Treasury proposal would cut the value of real estate tax shelters in several other ways.

In a typical real estate tax shelter deal, a syndicator acquires a property, controls or operates it as a general partner, and recruits investors as limited partners in the property. The tax benefits from the transaction flow through to the other partners, who can deduct their share of operating expenses as well as depreciation.

Accelerated depreciation now allows buildings to be written off in 18 years. Treasury’s proposal would stretch that period over many more years, according to a formula based on the rate of inflation, thus drastically reducing the amount that partners may write off each year.

Corporate Rates

It would also cut the interest expenses that partners may now deduct and require partners to pay back tax benefits if they sell their interests earlier than the tax code allows. And--in a proposal that the industry finds especially worrisome--it would tax limited partnerships with more than 35 partners not at individual rates but at higher, corporate rates.

Don Waldrop, executive vice president of U.S. Shelter, a publicly traded Greenville, S.C., firm, believes the company would have closed a pending, $15-million apartment syndication deal had it not been for the market’s queasiness. He says the firm hasn’t canceled any plans for syndication deals in 1985, but it will “go a little slower” in marketing.

Industry official say other syndicators are sweetening terms of their syndications to coax investors into buying their stagnating inventory. Several have recently offered deals in which investors are promised that if tax rates are lowered, the syndicator will reduce the payments they are required to make to compensate them for the reduced tax value of their investment.

Industry officials expect to see their colleagues rush out of real estate syndications designed to shelter taxes into deals designed to provide the investor with immediate cash flow from rents and, ultimately, capital gains from appreciation in the property’s value.

In the past, some of the most popular shelters have offered investors the chance to deduct from their first year’s taxes sums amounting to as much as five times the value of their first year’s investment. Many syndicators predict that the talk of tax reform will make such deals scarce, while increasing the number of syndication deals that offer cash flow and appreciation--so-called “economic” syndication programs.

“Suddenly everybody’s saying they only do ‘economic’ programs,” says William Elliott, chairman and chief executive of Angeles Corp. “Yesterday’s tax dealer is today’s economic fundamentalist.”

If the reform talk has delivered little joy to the real estate business, dealers in tax-exempt bonds have reason to be cheered after initial dire predictions about what tax reform would mean for their business.

Those dire predictions may have been one reason that tax-free bond prices declined in the late months of 1984. With the same interest income paid on bonds with a lower value, the overall investment yields on tax-free bonds rose. While the yields on tax-free bonds last spring amounted to only 80% of the yields on taxable Treasury bonds, the yields had increased to more than 90% in November and December, market watchers note.

But some investment professionals now believe tax-exempt bonds would continue to be attractive investments even after a major reduction in federal tax rates. This is partly because the reform would make competing investments, such as real estate and oil and gas tax shelters, less attractive.

Enactment of the proposal would also reduce the number of municipal bonds issued by curtailing issues of bonds for so-called private purposes, such as industrial development bonds. Richard Franke, president of John Nuveen & Co. Inc. of Chicago, a leading bond dealer, believes that restrictions on such issuances of private-purpose bonds might cut the number of tax-exempt bond issues by as much as 40%.

Such a reduction would increase the “scarcity value” of the bonds, thereby driving up prices, investment professionals say.