- ECONOMIC & CRE MARKET CONDITIONS – Roundtable Survey Shows “Tempered” Outlook on Commercial Real Estate, as Industry Executives Worry About Economic and Policy Risks, Maturing CRE Debt, Weak CMBS Market Recovery
- TAX REFORM – Administration’s Corporate Tax “Framework” Seeks to Eliminate Distortions But Would Pick Industry “Winners and Losers”; Revenue Raisers Include Higher Carried Interest Taxes, Limits on Interest Deductibility; No Mention of Individual Tax Reform
ECONOMIC & CRE MARKET CONDITIONS
Roundtable Survey Shows “Tempered” Outlook on Commercial Real Estate, as Industry Executives Worry About Economic and Policy Risks, Maturing CRE Debt, Weak CMBS Market Recovery
Although the outlook for commercial real estate has improved somewhat since late last year, the industry’s recovery remains slow, uneven, and vulnerable to macroeconomic and policy risks as well as borrowers’ continued difficulty in refinancing maturing debt, The Real Estate Roundtable’s latest quarterly Sentiment Survey showed. After last year’s disappointing economic performance — influenced by European debt woes and an unprecedented downgrade of U.S. debt — senior real estate executives participating in the Q1 2012 survey expressed wariness in their predictions for the coming year. (News Release and Full Reporthere)
Watch 3:00 video of Roundtable President and CEO Jeffrey DeBoer on the Q1 2012 Sentiment Index.
“The expectations of leaders in commercial real estate for 2012 are tempered by the whipsaw of last year’s experience,” said Roundtable President and CEO Jeffrey DeBoer. At this time last year, “People thought . . . growth was around the corner” — only to see renewed financial turmoil and economic weakness as the Eurozone crisis deepened and as U.S. policymakers clashed over the debt ceiling (GlobeSt.com, Feb. 24).
The Sentiment Survey’s “Overall Index” rose to 68 in the latest quarter — a 9-point increase over the Q4 2011 reading of 59, which represented the index’s lowest point since the fall of 2009. The “Current Conditions” Index also improved since the last survey (rising from 58 to 66), while the Future Conditions Index rose from 60 to 70 between Q4 4011 and Q1 2012.
The latest survey also suggests continued improvement in capital market conditions — with more than half of survey respondents predicting growth in both debt and equity for commercial real estate. At the same time, many said securing deals will depend largely on meeting lenders’ “ideal” conditions (in terms of asset quality, vacancy levels, NOI, etc.).
Industry CEOs’ expectations on asset values also improved over the past quarter — with nearly 60% saying they expect an increase in values — yet these, too, were tempered by past experience. As one respondent noted, “Even though 2011 is now behind us, much of the uncertainty that characterized the year has carried over into 2012. Despite encouraging signs of recovery, much like this time last year, a number of threats persist that could derail improvement.”
Noting the ongoing headwinds facing the economy and real estate, Roundtable Chairman Daniel M. Neidich (CEO, Dune Real Estate Partners) said, “Commercial real estate faces continuing pressure from underlying economic problems — weak job creation, erosion of equity throughout much of the country and a massive amount of loans coming due.”
Complicating borrowers’ ability to refinance is the fact that:
• many loans are “underwater” (with owners owing more on the loan than the underlying collateral is worth)
• lenders are demanding more equity in transactions
• commercial real estate credit capacity remains inadequate
$1.4 Trillion in CRE Debt to Mature by 2015: Equity Infusion Needed to Refinance (page 7 of The Roundtable’s 2012 Policy Agenda – Capital & Credit section)
Although an estimated $362 billion in commercial mortgages are scheduled to mature in 2012 (see p. 7 of our 2012 Policy Agenda), issuance of commercial-backed securities (CMBS) — a key source of commercial real estate credit — is only expected to reach $30-50 billion this year. “The commercial mortgage-backed securities market continues to struggle,” said Neidich.
“What this Sentiment Survey shows, and our 2012 Policy Agenda supports, is that specific policy steps must be taken to bolster employment, business investment and economic certainty,” Neidich asserted. DeBoer added that “the industry needs to see as much equity capital as possible enter the market to recapitalize properties throughout the country. It is imperative that policymakers adopt measures now that will encourage increased equity investment.”
A top policy priority in this regard is reforming the outdated and discriminatory Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), which would encourage foreign equity investment in U.S. commercial real estate and help bridge the roughly $1 trillion equity gap needed to refinance commercial mortgages between 2012 and 2016+.
DeBoer is scheduled to discuss the survey results on Washington Business Report — ABC’s Washington, DC affiliate (WJLA) — and the program will be available online in its entirety early next week at http://www.wjla.com/news/washington-business-report/. The interview will first appear this Sunday in the Washington, DC area at 9:30 am on WJLA-channel 7 (before This Week With George Stephanopoulos) and then rebroadcast Sunday night at 11pm on news channel 8.
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Administration’s Corporate Tax “Framework” Seeks to Eliminate Distortions But Would Pick Industry “Winners and Losers”; Revenue Raisers Include Higher Carried Interest Taxes, Limits on Interest Deductibility; No Mention of Individual Tax Reform
The White House and Treasury Department on Wednesday jointly released a five-point “framework” for business tax reform that would eliminate or reduce dozens of credits, deductions (e.g., for business interest payments), “loopholes,” and subsidies (e.g., for oil and gas companies) in order to broaden the corporate tax base and offset the cost of cutting the top corporate income tax rate from 35 percent to 28 percent.
As previewed in the President’s budget plan last week, the proposed “reforms” would be also paid for with revenue raisers including a tax hike on partnership “carried interest” — which would disproportionately affect the nation’s roughly 1.2 million commercial real estate partnerships.
As previewed in the President’s budget plan last week, the proposed “reforms” would be also paid for with revenue raisers including a tax hike on partnership “carried interest” — which would disproportionately affect the nation’s roughly 1.2 million commercial real estate partnerships. The carried interest language in the framework is part of a “menu of options that should be under consideration . . . to get the [corporate] rate down to 28 percent.”
To discourage U.S. firms from locating production facilities overseas and to discourage a “global race to the bottom in tax rates”, the Administration proposes a new minimum tax on overseas earnings by U.S. companies.
GOP lawmakers appear to have anticipated some of the president’s tax proposals, according to a report in Wednesday’s Wall Street Journal. At a House Ways and Means Committee hearing last week, for example, Rep. Pat Tiberi (R-OH) asked Treasury Secretary Geithner, “How can we create more jobs . . . if we tell the pass-through entities that their taxes are going to go up, if we tell the oil and gas companies that they’re not going to be able to drill, and if we tell our corporate folks that we’re only going to get to 28 [percent], apparently, in the president’s proposal [ as the] corporate tax rate, and not even the average of what the world is at…25 [percent].”
The Administration’s framework presumes that all tax expenditures for specific industries should be eliminated, with a few exceptions “that are critical to broader growth or fairness.” For example, part II of the framework seeks to strengthen U.S. manufacturing and innovation by reducing the effective tax rate on manufacturing to no more than 25 percent; permanently extending the research and experimentation (R&E) tax credit; and permanently extending the production tax credit for certain renewable energy technologies such as wind and solar.
Other key goals outlined in the report include:
• reducing the bias toward debt financing
• reforming treatment of insurance industry and products
• establishing greater parity between large corporations and large non-corporate counterparts (to improve equity, reduce distortions in how businesses organize themselves, and finance lower tax rates)
• “mak[ing] tax filing simpler for small businesses and entrepreneurs so that they can focus on growing their businesses rather than filling out tax returns”
• Ending tax code “distortions that can result in a less efficient allocation of capital, reducing the productive capacity of the economy and U.S. living standards”
While the Administration document sidesteps the issue of individual tax reform, it includes provisions that would allow small businesses, including small pass-through businesses, to receive a net tax cut from reform. In particular, small businesses would be allowed to expense up to $1 million annually in purchases of equipment and other “qualified investments” and more businesses would be eligible to use the cash accounting method. Additionally, other “small business” provisions in President’s FY 2013 budget would be adopted.
Starting Point for Discussion; Mixed Reviews on Capitol Hill
House Ways and Means Committee, Rep. Dave Camp (R-MI)
Intended as a starting point for debate on tax restructuring, the report states that the “President recognizes that tax reform will take time, require work on a bipartisan basis, and benefit from additional feedback from stakeholders and experts.” On Capitol Hill, Democrats reportedly gave mixed reviews of the President’s plan, while the chairman of the House Ways and Means Committee, Rep. Dave Camp (R-MI), “assured Obama that ‘this administration will find a ready and willing partner in House Republicans when it comes to comprehensive tax reform that cuts rates to spur economic growth and job creation’” (The Washington Post, Feb. 23).
As the tax restructuring debate gathers momentum, The Roundtable will continue to educate policymakers about commercial real estate industry perspectives on key elements of reform.
For one thing, corporate and individual taxes must be addressed in tandem. While The Roundtable agrees with key congressional tax-writers that the 35 percent corporate tax rate is too high — and that it hurts U.S. competitiveness — this area of taxation must not be “de-coupled” from issues of individual taxation, which apply to millions of small business owners (including many in commercial real estate).
Since many commercial real estate ventures utilize a pass-through business model [i.e. they are organized as S corporations, partnerships, limited liability companies (LLCs), or sole proprietorships], their income is subject to the tax rates faced by their individual owners — rates that are already scheduled to go up in 2013, if the Bush tax cuts are not extended.
The Roundtable’s 2012 Policy AgendaTax Section (.pdf download)
The Roundtable also objects to the idea of offsetting the cost of a corporate rate reduction by simply eliminating tax breaks (“expenditures”) used by C corporations or pass-through entities. Under such proposals, pass-through businesses could lose the benefit of widely used business tax provisions such as accelerated depreciation, interest deductions, the research tax credit and the low-income housing tax credit (LIHTC) — but without the benefit of lower corporate tax rates.
As for proposals to recharacterize carried interest as “ordinary income” (vs. capital gain), these are based on a series of invalid assumptions — principally the idea that a carried interest and/or “enterprise value” tax hike would largely impact only Wall Street hedge funds or private equity funds. In reality, real estate accounts for nearly half of the nation’s 2.5 million partnerships, so a 133 percent tax increase on carried interest would be a 133 percent tax increase on a substantial amount of commercial real estate activities.
Given the vast consequences of changing 30-40 years of partnership carried interest taxation — which raise deeper issues relating to the tax treatment of wages and investment capital — this issue is too important to be used as a means of addressing short-term budget goals. Instead, any proposals to re-characterize income in this area must only be discussed in the context of broader tax code restructuring.
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Source: The Real Estate Roundtable