Now that the dust has settled and tax reform legislation has been signed into law, we can re-examine its true impact for commercial real estate.
CRE investors are set to benefit from a number of provisions:
- All REITs and most partnership-investors should be eligible for a 20% deduction on pass-through income, supporting valuations, particularly in markets and product subtypes with fewer tax-exempt investors.
- Reduced depreciation lives on for residential property and for qualified improvement property.
- Higher standard deduction, SALT and mortgage interest deduction limitations support greater demand for multifamily, particularly in the higher-tax/higher-income markets where much supply has been delivering. This also should lead to net migration from higher- to lower-tax states and from urban to suburban areas within metros.
- Corporate tax rate reductions should make it more attractive for multinationals to expand U.S. ops or locate new operations in the U.S., driving increased demand for office and industrial.
- Immediate expensing for 5 years combined with foreign profit repatriation and the aforementioned lower tax rates should translate into greater business investment, driving capital goods orders and investments in manufacturing and logistics space
- Retailers will see some of the largest benefit from lower taxes. This will help those on the margin adapt to the changing competitive landscape, which should, in turn, be reflected in industrial (expansion) and retail space (selective upgrading).
- Interest deductibility elections for real estate businesses mean that more owner-occupied stock may be monetized in sale-leaseback.
CRE also avoided many potential pitfalls:
- 1031 exchanges retained for real property
- Carried interest retained past three-year hold for most real estate deals
- Private activity bonds / LIHTC retained, although the lower corporate tax rate reduces value for taxable investors
- Real estate businesses can elect not to be subject to the interest deductibility limitation in exchange for using (slightly) longer depreciable life
For the broader economy, recently enacted tax reform lends additional near-term support to the economy and to CRE in the near/medium term, potentially boosting growth by 30-50 BP in 2018 before tapering off. Higher deficits and higher inflation expectations are likely to result in higher interest rates that could place pressure on cap rates, especially in markets and product segments (e.g. gateway CBD apartments/office) where spreads are already compressed. We may also see fewer refinancings of these same properties, which could translate to greater sales volumes and price discovery in the capital markets
This is the largest change in the tax code in over 30 years, and it was put together in record time. As such, there remain a great many items that will need to be clarified through guidance. None of these are liable to change the broad outlines of the impacts, but it would not be surprising if they represent a near-term friction in capital markets transactions, even as the anticipation of this legislation is liable to have had a similar effect in 4Q17. However, for all of the reasons enumerated, the tax reform in conjunction with the broader, positive economic momentum should support fundamentals and capital market liquidity and pricing throughout 2018 and into 2019.
David Bitner is Head of Americas Capital Markets Research at Cushman & Wakefield. His research focuses on how macroeconomic trends, real estate fundamentals and dynamics in the broader capital markets interact to shape commercial real estate risks and opportunities for investors.
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.