While highly controversial, it is widely agreed that the 2017 tax bill passed late December will have major positive implications for the commercial real estate markets. The National Realtors Association has stated that “Congress has greatly reduced the value of the mortgage interest and property tax deductions as tax incentives for homeownership.” Congressional estimates indicate that only 5-8% of filers will now be eligible to claim these deductions by itemizing, meaning there will be no tax differential between renting and owning for more than 90% of taxpayers.
While, we do not believe that the bottom will fall out of the single-family housing market or that wide portions of the population will stop buying homes, we do believe that there will be an impact on occupancy rates in multifamily markets as people choose the freedom and flexibility of renting now that ownership benefits have been significantly reduced. This is especially true of higher end class B and class A apartments.
In addition to potentially increasing occupancy, the new tax laws also have a major impact on Real Estate Investment Trusts (REITs). Under the new tax laws, qualified business income paid to owners or investors of pass-through businesses is allowed up to a 20 percent exemption. This income used to be taxed at the maximum 37 percent rate but will now be taxed at a rate of 29.6 percent. While there are limitations on that 20% based on income brackets, the majority of investors making below $315,000 filing jointly and from $157,000 for single filers will be able to take full advantage of the new exception. The size of the 20 percent deduction falls for joint-filers until the $415,000 and $207,500 for single-filers where it is totally phased out.
This is especially promising for investors who choose to take their returns in the form of distributions-as it allows investors to add additional passive income streams with less overall tax liability.
The new tax code also preserves 1031 like-kind exchanges, which give REIT managers the ability to use the proceeds of one property sale to immediately acquire another, without paying tax on the proceeds. This is especially valuable when looking at opportunistic and value-add real estate opportunities where there is an opportunity for large potential returns buying an underperforming multi-housing asset, making an improvement to the building and occupancy and selling it in a relatively short period of time.
1 NY Times, ‘Tax Plan Crowns a Big Winner: Trump’s Industry’, December 5th, 2017
2 National Association of Realtors, Issue Brief, ‘The Tax Cuts and Jobs Act – What it Means for Homeowners and Real Estate Professionals’ December 2017