Archives for February 2014

Can commercial real estate afford another year of gridlock? What is the legislative outlook for commercial real estate in 2014?

Peering over a fiscal cliff is not a comforting way to begin a new year. On January 2, 2013, Congress somehow managed to negotiate a deal on the American Taxpayer Relief Act that prevented financial collapse. Nearly 10 months later, similar fiscal threats created unease among investors, global markets, and U.S. businesses and families when the federal government shut down. The figurative fiscal cliff was nearly forgotten until national parks closed. As people were denied access to the nation’s natural wonders, the warfare in Washington, D.C., set a new tone of political frustration.

Commercial real estate professionals recognize the importance of negotiation skills in closing a deal, and many must have cringed watching some of the tactics U.S. lawmakers employed last year. So it is no surprise that the past 12 months did not bring a close to many of the important pieces of legislation pertinent to the commercial real estate industry. Most of CCIM Institute’s legislative and regulatory priorities remain open, including the 2013 Capitol Hill Visit issues. The short review below discusses where these issues are and where they need to go in the coming year.

Tax Policy

CCIMs have perpetually voiced the importance of keeping carried interest under capital gains tax treatment. The idea of switching carried interest to ordinary income is counterproductive when considering all the elements for real estate investments. If carried interest were to be taxed as ordinary income, investors in business partnerships would lose an important incentive for taking risks just when they need it most — during business startup and expansion periods.

However, some politicians view carried interest as a loophole that could save the federal government more than $17 billion over a 10-year period, a debatable and possibly inaccurate estimate. For their part, CCIMs must continue the carried interest dialogue with lawmakers, making clear the message that real estate investments are critical funding sources for economic drivers, particularly for small businesses, which often take years of growth and may or may not result in a return.

Murmurs on Capitol Hill suggest a complete overhaul of the federal tax code. Rep. David Camp, R-Mich., chairman of the U.S. House Ways and Means Committee, is not seeking re-election and aspires to leave a legacy as the federal tax bipartisan negotiator. However, failed negotiations in 2013 and an upcoming election this year might substantially delay Camp’s vision. Major changes to the tax code may actually come to fruition following the 2016 presidential election, but any type of tax code structure created this year could be used as the framework for the future.

Additional tax policy priorities for commercial real estate include 1031 like-kind exchanges, leasehold improvements, estate tax, depreciation, Foreign Investment in Real Property Tax Act or FIRPTA, and the 179D energy efficiency deduction for commercial buildings.

Online Sales Tax

The U.S. Senate approved the Marketplace Fairness Act, which would grant states the ability to level the playing field between brick-and-mortar and online retailers. However, the House of Representatives has done little to ensure final passage of the bill. Advocacy on Internet sales tax fairness will continue into this year. While each state will determine its own online sales tax policy, federal law is needed to clarify the blurry lines between states with and without an online sales tax.

EPA Lead Paint

Another issue is an Environmental Protection Agency lead paint proposed rule for commercial and public buildings. In June 2013, the EPA held a public hearing on proposed rules on renovation, repair, and painting projects. Rules that apply to residential housing have begun to seep into EPA’s vision for other properties following legal issues with environmental groups claiming the EPA has not fully protected public health. If finalized, the requirements for commercial or public building renovations would unnecessarily increase projects’ cost and completion time, despite the lack of facts linking lead paint to health risks in commercial and public buildings. The EPA will determine final rules by 2016.

FASB Lease Accounting

The Financial Accounting Standards Board’s lease accounting proposal has not been finalized. Although FASB made some revisions from the original proposal in 2009, businesses would still be required to capture lease terms of property on a balance sheet. Within the 2013 proposal, the lessor would recognize income over the lease term on a straight-line basis. The lessee would recognize the lease liability and would amortize the right-of-use asset on a straight-line basis over the lease term. The proposed changes may increase lending costs and debt covenant breaches and inaccurately characterize an organization’s financial stability.

FASB’s proposed rules were never justified by economic impact studies. Nonetheless after hundreds of negative comments and years of push back, FASB continues to target lease accounting as a way to increase transparency and accountability among U.S. businesses. FASB has said it will release a final rule in 2014 with implementation by 2017.

Regulation

The sweeping Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 brought about Basel III rules, which were finalized in July 2013. The changes will have an impact on commercial real estate by increasing the risk-weight of high volatility commercial real estate exposure loans for acquisition, development, and construction projects. In other words, commercial real estate loans that pose the greatest risks will have different requirements. Ultimately, banks will be required to hold more capital against credit lending. Multifamily loans are considered as less risky, so there are fewer requirements for those projects.

While not a favorable outcome, ultimately the final rules were less drastic than the original Basel III proposed rules. In addition, community banks will have more time for implementation compared to larger banks, which must implement Basel III rules this year.

The Dodd-Frank Act also generated credit risk retention rules. Originally proposed in 2011, risk retention was reintroduced in 2013 as a way for borrowers to have more “skin in the game.” Federal agencies claim that low-risk commercial loans will not be subject to risk retention requirements. In contrast, the commercial real estate industry is very much concerned with how the proposed changes would alter the dynamics of the commercial mortgage-backed securities market and may unnecessarily burden a viable funding source. Although implementation is possible for 2014, final rules may take years to complete.

Local Agendas

While federal policy dominates the legislative discussion, often local issues have greater effects on commercial real estate in the area.

Smart Growth – Local governments around the country are promoting smart growth policies, which they hope will restore vibrancy to town centers and central business districts. Homeownership, job creation, business growth, community improvement, quality of life, and health and safety are all intimately connected. For example, residents who have easy access to a centralized marketplace help to create jobs, which ultimately produces a stable workforce and base for homeownership. Smart growth also fosters commercial development such as transit-oriented residential and mixed use projects. Smart growth policies are the future. By understanding local trends, CCIMs can build new relationships and/or partnerships.

Commercial Lien Laws – Considering the time and expertise needed to close a deal, commercial lien laws protect the effort CCIMs put into projects. In 2013, two states passed commercial lien laws, making 31 states with some form of broker lien laws. Twenty-three states or jurisdictions do not have specific laws to prevent costly and lengthy legal battles. CCIM chapters in the 23 states without lien laws are called to act by building a grass-roots lobby and making passage of commercial broker lien laws a priority.

Nationally, the greatest legislative concern for 2014 is over federal taxes. While the commercial real estate market has shown steady improvement, changing tax policies and regulatory proposals over the banking industry pose great risk to recovery. With the election in November, re-election prospects have taken priority over finalizing policy, possibly resulting in continued deadlock over many of these issues.

Regardless, government policies and private markets must work in tandem for economic growth. CCIMs and other members of the commercial real estate industry need to clearly communicate their issues to lawmakers. Discussions today are almost certain to lay the groundwork for laws of tomorrow, whether in 2014 or subsequent years.

By: Adriann Murawski (Commercial Investment Real Estate Magazine)

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Over the last eight months interest rates have gyrated more dramatically than in years. This process has not only whipsawed investors but seriously called into question the nascent housing recovery. After all, how can housing starts rise from their near historic lows if rates are one percent higher than they were in late spring and with interest rates expected to rise somewhat higher over the course of 2014? Is not the housing sector highly interest rate sensitive? And isn’t the Federal Reserve deliberately buying tens of billions a month in mortgage backed securities to keep 30-year mortgage rates low to help the housing market? Relax. While new residential construction is indeed interest rate sensitive, it is also heavily dependent on other macroeconomic factors and they will more than compensate for the recent rate rise.
To use an analogy, interest rate movements are like a thermometer. A rise in body temperature may or may not be a good thing; it all depends on the initial level. A rise in body temperature of two degrees from 94 degrees to 96 degrees is excellent news and suggests a patient recovering from hypothermia. By contrast, a rise in body temperature of an adult from 102 to 104 is serious, and suggests a very ill patient in need of prompt medical attention. Changes in interest rates should be similarly viewed.
Interest rates are the cost of borrowing money. When times are good and economic growth is robust, interest rates rise because investors borrow funds for investment purposes while households borrow to finance purchases of cars, houses and other big ticket items. This increase in demand raises rates and this rise is healthy. Returning to our thermometer analogy, this would be like a rise from 96 to 98 degrees. Sometimes, however, the economy grows so fast that shortages of workers and supplies start to materialize, resulting in inflation. If allowed to fester, inflation can spin out of control. That is why interest rates continually rose during the 1960s and 1970s. Eventually, things got so bad the Federal Reserve raised rates to 20% to weaken the economy and squeeze inflation out of the system. This would be equivalent to a rise in body temperature from 103 to 105 degrees. This rise was necessary but was a sign of a profoundly sick economy.
Until recently, despite amazingly low interest rates, no one borrowed; witness the ridiculously low levels of new home construction and investment in plant and equipment by firms, because everyone was pessimistic about the future. This would be akin to fall in temperature from 95 to 93, a bad sign. However as the economy improves, and trust me it is, albeit way too slowly, and as we become increasingly optimistic about the future, interest rates will rise and this is what is finally starting to happen. The thermometer is now in the process of going from 94 to 95.
In this early phase of the recovery, firms hire workers, begin buying equipment and start building plant. As a result, unemployment rates decline, wages start rising and household spending increases. And this boosts GDP growth, which results in yet more corporate spending and more household consumption on, among other things, housing. Given the immense slack in our economy this process could last several years, accompanied by slowly rising interest rates akin to the thermometer rising from 96 to 98.6!
Elliot Eisenberg, Ph.D. is President of GraphsandLaughs, LLC and can be reached at Elliot@graphsandlaughs.net.  His daily 70 word economics and policy blog can be seen at www.econ70.com.
By: Elliot Eisenberg (GraphsandLaughs)
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NAR Commercial Issues Brief – February 2014
Issue: Alternative Minimum Tax (AMT): On January 2, 2013, President Obama signed into law the American Taxpayer Relief Act, providing a permanent “patch” that prevents tens of millions of taxpayers from being subject to the alternative minimum tax (AMT), starting with the 2012 tax year. Specifically, the measure sets the exemption amounts (i.e., the amounts yearly for inflation. It also allows various non-refundable personal credits to be claimed against the AMT. The AMT was created by the Tax Reform Act of 1986 to prevent higher-income taxpayers from using credits and deductions to completely offset their federal income tax liability.
NAR Action: NAR successfully worked with Congress to ensure a permanent patch to the AMT.
Issue: Basel III: The Federal Reserve, Federal Deposit Insurance Corporation (FDIC), and Office of the Comptroller of Currency (OCC) have finalized a new risk-based capital category – High Volatility Commercial Real Estate Exposures (HVCRE) for commercial acquisition, development, and construction (ADC) loans. Specifically, the new  changes raise the risk-weight for an ADC loan from 100% to 150%. In response to the final changes, it is highly likely that banks would be substantially change their current lending practices and reduce the amount of available credit in order to avoid the higher capital charges associated with ADC loans
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(NAR Issue Brief)