By Revathi Greenwood, Americas Head of Research
We expect tax reform legislation to be enacted by the end of 2017, but key provisions in the House and Senate versions have to be negotiated. Those negotiations may have a significant impact on passive investments made by pass-through entities, especially under the House version, which provides substantial benefits for investors. Multifamily looks to be a winner – at the expense of single-family residential – especially in states and municipalities with high state and local taxes. The retail and industrial sectors should see modest benefits, while the office sector will see minimal impact.
Let’s take a quick look at how tax reform legislation may affect different CRE sectors.
- Investment and capital markets: Overall, CRE is a winner. The majority of direct U.S. CRE investment, 61%, is held by pass-through entities – only 9% is held by corporations. Another 29% is held via direct or indirect tax – exempt entities. Passive investors in pass-through entities are likely to benefit substantially from lower rates under the House plan, but their eligibility for tax deductions is limited under the Senate proposal by wage provisions. REITs and publicly-traded partnerships, however, would be eligible for the full deduction without regard to the wage limitation. Should the Senate proposal be enacted, expect to see a shift over time towards REITs, as well as conversions to corporate structures.
- Office: Corporations will be big beneficiaries, likely seeing a net tax cut of $400 billion over 10 years. But we anticipate that the tax cut will be preferentially used to return capital to shareholders or reduce debt, rather than to increase corporate spending. There may be a modest pick-up in M&A activity leading to real estate consolidations. As currently constructed, the legislation likely will mitigate inversion and relocation risk for multinationals, which may boost office demand in the U.S.
- Retail: The retail sector pays the highest effective corporate tax rate of any sector of the U.S. economy and indeed the world—at or close to the maximum 35%. This is thought to undermine retail’s international competitiveness as well. A lower corporate rate might encourage foreign retailers to invest more in their U.S. operations, larger corporations and consumers with larger tax savings to spend more and retailers to invest additional capital in their own businesses and employees— all favorable outcomes for the industry. Furthermore, about 98% of retailers are small businesses with 50 employees or less who would directly benefit from special provisions for small businesses such as higher eligibility limits for cash accounting, favorable pass-through provisions and higher expensing provisions.
- Industrial: We expect similar, modest positive impact on eCommerce, perhaps industrial’s key driver. Apart from benefitting from the corporate tax rate reduction, eCommerce also benefits from full expensing that is geared towards industrial business/capital goods/manufacturing.
- Residential and Multifamily: Tax reform legislation points toward a short-term drag on home values and the number of home sales, with the greatest impact in areas with high state and local tax deductions, high property taxes, high median incomes and medium-to-high home values such as California, New York and New Jersey. Still, this is likely to be counteracted to some extent by robust underlying real estate fundamentals and job growth in those high-home-value markets. The doubling of the standard deduction and the cap on the property tax deduction are likely to have the largest impact on the rent vs. buy incentive, especially as it seems likely that there will be minimal changes to the mortgage interest deduction in any final tax reform bill. We see the bill as a positive for multifamily and single-family rentals. Given that elimination of the mortgage interest deduction for second homes and the impact on home equity would tend to reduce incentives for second homeownership, this could provide further boost to scale/ institutional SFR vehicles.
- Healthcare: Healthcare real estate investment is likely to be curtailed. The Senate’s provision to eliminate the “individual mandate” is likely to raise health insurance premiums by 10%, increase numbers of un- and underinsured and, thus, have a negative impact on overall demand for healthcare services. Both House and Senate bills reduce exemptions for charitable giving, which could significantly impact health systems’ philanthropic campaigns, many of which are used to fund new buildings. Also, increased deficits under the plan could trigger automatic cuts in Medicare and Medicaid as soon as next year, which will further affect the financial health of healthcare companies.
Modest growth at best
Some proponents claim that proposed tax cuts will lift real, annual GDP growth closer to 3% from the approximately 2% that has prevailed during the current expansion. However, most of their analyses do not consider the likely effects of tax reform on a higher-than-expected trajectory for interest rates or the impact of higher levels of debt that deficit-financed tax cuts will entail. When these are factored in, estimates of the GDP growth boost range from 3 to 9 basis points per year over the next decade.
While exact figures may differ, Cushman & Wakefield believes that the relatively modest size of tax cuts provided for under the current proposals is unlikely to generate significant growth or push up inflation expectations. Tax cuts can deliver growth when the economy is in recession. But with the economy at or near full-employment, multiplier effects are liable to be constrained, further reducing the potential impact on growth.
Read more in our latest report, The Great Tax Race: How the World’s Fastest Tax Reform Package Could Impact Commercial Real Estate.
How do you anticipate this tax reform plan will impact you and your business?
Disclaimer: This blog and the report referenced is not intended to provide tax advice. Any tax information provided in this document is not intended or written to be relied upon for tax planning purposes. You should seek advice based on your particular circumstances from an independent tax advisor.
Revathi Greenwood is the Americas Head of Research for Cushman & Wakefield with overall responsibility for the research platform within the Americas region. She provides leadership to hundreds of professionals who are focused on producing predictive, timely and interpretative analysis on the latest real estate trends.