VOL. 11 | NO. 8 | Saturday, February 24, 2018
CRE Owners Look To Reap Rewards Of New Tax Cuts
By Michael Waddell
The start of the year enjoyed a flurry of commercial real estate sales and building permits, on the heels of federal tax cuts passed late last year that are expected to benefit CRE owners and possibly impact the number of new projects and sales announced this year.
“Overall, it’s clear to see the major benefits the Tax Cuts and Jobs Act will have on the CRE market, but it is widely considered to be too early to say what the impact will be,” said Shane Soefker, a principal in the Memphis office of commercial real estate firm Avison Young.
One month into 2018, Shelby County has seen 25 percent fewer commercial real estate sales than a year ago, but the average sales price has spiked, according to the latest information from real estate information company Chandler Reports, chandlerreports.com.
Avison Young principal Shane Soefker says the Tax Cuts and Jobs Act will benefit the real estate market. (Memphis News/Houston Cofield)
Seventy-one commercial sales were recorded for the month, down from 95 in January 2017, but the average sales price rose 57.4 percent across all sectors compared to a year ago.
Linchris Hotel Corp.’s $31 million purchase of the Hilton Memphis, 939 Ridge Lake Blvd., from Davidson Hotels and Resorts, recorded Jan. 3, marked the highest-dollar transaction recorded during the month. That was followed by Priam Capital’s $14.1 million purchase of the 130,000-square-foot office building at 6060 Primacy Parkway from Lone Star Funds.
Among the other notable transactions, lender THM Memphis Acquisitions LLC reclaimed the 100 North Main building in a $1 million substitute trustee’s sale after the 37-story Downtown tower failed to receive any bids in a foreclosure auction. And Orion Federal Credit Union paid $1.5 million for the 1.2-acre parcel at Monroe Avenue and Danny Thomas Boulevard in the Memphis Medical District, where it plans to build its new headquarters.
While many of January’s sales were likely in the works before President Donald Trump signed the Tax Cuts and Jobs Act of 2017 into law Dec. 22, the new law – which marks the first major change to the U.S. tax code since 1986 – is expected to impact the commercial real estate market moving forward.
“There is a lot in the bill that’s not necessarily black and white, so everyone in real estate is slowing down in order to give the Treasury enough time to clarify definitions and how they will treat the sections of the act,” said Sam Zalowitz, owner of Zalowitz Commercial Realty LLC. “Despite the many unknowns in the law, the new tax laws will ultimately boost the performance of real estate assets during the course of the next year.
“After-tax yield on commercial real estate investments increase, so there will be a larger pool of investors considering the yields of different assets and investment structures, making real estate all that more compelling.”
Zalowitz, a 45-year industry veteran who holds the Certified Commercial Investment Member designation, sees the new law mainly impacting corporate real estate owners, not individuals and small businesses.
Companies should find commercial real estate deals more attractive thanks to changes to the tax code reducing the corporate tax rate, increasing the benefits for depreciation and expensing, reducing periods for depreciating assets and adding a new deduction against qualified business income for pass-through entities, while imposing limits on personal business losses, net operating losses and business interest expense deductions.
“Most analysts are predicting under the new tax code that commercial property owners stand to benefit, but more specifically the demand for multifamily, corporate investments as well as new development,” Soefker said. “Certainly one of the most important aspects of the changes to the tax code was that 1031 Exchanges remained intact. The provision enables sellers to defer capital gains taxes by reinvesting the proceeds in ‘like-kind’ properties. This is and has been an important aspect of the buying and selling of commercial real estate.”
He added that while most businesses are limited by a 30 percent limit on interest expenses, CRE owners aren’t impacted by this limitation. CRE owners can still deduct their mortgage interest in full and also benefit from the tax rate on net income dropping to 21 percent from the previous rate of 35 percent.
“Another provision of the tax code that will have a positive effect on CRE is the generous change to depreciation schedules,” Soefker said. The time over which owners can depreciate properties has been reduced to 25 years for both commercial and residential assets; previously it was 39 years for commercial properties and 27.5 years for residential.
Another positive result of that change could be the new asset schedules spurring new construction over the next five years.
“Not only are corporations giving their employees money, they’re also putting their money into new facilities and improving what they already have as far as real estate facilities,” Zalowitz said.
The tax code now allows businesses to immediately expense many asset purchases; after five years of 100 percent expensing, the rate phases out at 80/60/40/20 percent over the ensuing four years.
“This proposes the likelihood that richer corporations may decide to overinvest in real assets and development in the coming five years, which would spur supply expansion in stagnant sectors such as office and retail,” said Soefker, who sees one negative impact being on construction costs, especially with retail development, which could have the opposite impact on e-commerce companies contemplating building their own facilities.
Primary anxieties for many, Soefker said, come down to overbuilding and over-borrowing, along with the expected increases to U.S. debt, how the government plans to finance it and how it will impact long-term interest rates. As interest rates rise, borrowing costs will inflate – impacting the overall economy, which ultimately slows growth.
Zalowitz, meanwhile, thinks the new law will affect behavior on a massive scale, especially as people better understand the nuances of the legislation.
“For example, there is the assumption that fewer people will be buying homes going forward because of the law. That means apartment demand will increase,” he said. “The law may lead to increased consumption, which would boost demand for retail and retail real estate, as well as industrial real estate. The elimination of the individual mandate of the Affordable Care Act will influence insurance behavior, which affects health care real estate.”
Chandler Reports is a division of The Daily News Publishing Co.