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BULLET DODGED? CRE Groups Relieved and Concerned Over Fiscal Cliff Compromise

Leading Industry Advocates See Mixed Picture for Investors, While Beneficial Tax Measures Extended, Decisions On Spending Cuts And Debt Reduction Kicked Down the Road
January 9, 2013
With the fiscal cliff averted, at least until the U.S. Treasury runs out of money next month, commercial real estate advocacy groups are giving Congress bouquets for provisions of the American Taxpayer Relief Act that extend tax benefits for building owners and investors. At the same time, they're concerned about the other shoe dropping after lawmakers once again failed to address spending and continue to face what's certain to be another contentious debate on the raising of the government's debt ceiling.

The compromise legislation passed the House of Representatives last week at the 11th hour, helping fuel a rally in U.S. stock prices, not to mention a surge in year-end property sale transactions ahead of the market uncertainty. The legislation permanently maintains the reduced 2001 and 2003 tax rates adopted during the Bush era for individuals earning up to $400,000, and $450,000 for married couples, while allowing income above that to be taxed at rates rising to 39.6%.

The fiscal cliff legislation also resolves several issues of keen interest to CRE advocacy groups, including an extension of the tax provision that allows certain leasehold improvements to be depreciated over 15 years rather than 39 years. Further, the bill leaves in place current rules on the tax treatment of carried interest as capital gains that some observers feared would discourage investment activity.

At the same time, the act defers huge sequestration spending cuts for just two months, setting the stage for familiar partisan battles over entitlement reform, debt reduction and the raising of the debt ceiling.

"Real estate is still hanging onto the cliff," said Jeffrey H. Cooper, executive managing director at Savills US. "The act didn't do anything to pull it back up from the cliff."

In fact, the act is mislabeled because there's no relief in the so-called relief act for businesses, aside from the continued right to depreciate leasehold improvements over 15 years, Cooper added. Taxes are going up, especially on capital gains and for higher income individuals. However, the shrinking of paychecks for upper middle-income and other taxpayers leaves less disposable income for retail and leisure travel spending, hurting those CRE sectors.

The higher taxes on capital gains and personal income -- combined with the continued uncertainty over sequestration and federal spending -- will make businesses reluctant to expand this year following the burst in activity late in the fourth quarter of 2012.

"For commercial real estate, this act did little. It may be somewhat negative for retail and hospitality. And it may have reduced the level of excitement or concern about the fiscal cliff temporarily, but that's going to come back again in 60 days," Cooper said.

Like many others, Roundtable President and CEO Jeffrey DeBoer welcomed the fact that the cliff was averted, but also criticized the lack of a plan for long-term structural deficit reduction.

“While we are relieved that the U.S. economy will be spared the worst effects of the cliff - at least for now - the law enacted [last] week does nothing for deficit reduction and fails to put in place a mechanism for dealing with this urgent issue in the future,” said DeBoer in an update post on the Roundtable web site. DeBoer added that deficit spending and unsustainable debt levels “remain a drag on economic growth and job creation and put upward pressure on long-term interest rates.”

NAIOP and the Building Owners and Managers Association (BOMA) International, both applauded Congress for including the so-called "tax extenders" package as part of the bill.

The leasehold provision permits building owners to continue to depreciate leasehold improvements over 15 years rather than revert back to the previous 39 years. The measure is now retroactively effective for 2012 and extended until Jan. 1, 2014.

The shorter depreciation term reflects the realities of a marketplace where leasehold improvements typically don’t last longer than 15 years before they are replaced, BOMA said.

"Continuing the leasehold depreciation 15-year schedule helps a recovering economy by increasing investment in commercial real estate and employment in related industries, such as architectural and design firms, construction companies, building suppliers and other construction-related services," said BOMA International Chair Joseph W. Markling, who serves as managing director of strategic accounts at CBRE Group.

While depreciating over 39 years discourages investment in such improvements, the 15-year schedule spurs job creation and economic growth since almost $250 billion is invested in commercial real estate improvements annually, with $15 billion of that going to leasehold improvements, BOMA said.

The bill also extends the New Markets Tax Credit on investments in certain low-income areas, and extends the accelerated "bonus depreciation" rule that allows businesses to deduct up to 50% of the cost of certain new property and equipment, according to NAIOP.

The National Association of Real Estate Investment Trusts (NAREIT) hasn’t released a formal reaction to the cliff deal but will be tracking the issue closely throughout the year, especially as the sequestration issue is again tackled early in the year, NAREIT Chair Ed Walter said.

Speaking as a senior executive in the REIT industry and not as either NAREIT chair or Host Hotels & Resorts CEO, Walter said higher tax rates for wealthier Americans was generally anticipated by the market, as were most of the extensions of investment-related tax rules such as carried interest. Some investors did move to complete deals before the end of the year to avoid potential higher taxes out of concern the extenders might not get passed, Walter said.

“What would be a shared concern by most executives in our industry would be the lack of clarity on what's going to happen on the spending side and how the federal government is going to address the increase in the debt ceiling. That poses a problem for businesses in the U.S. in general,” Walter said. “Because there's loose discussion about tax reform and spending and the fact that they haven't done the big deal, there's still a high level of uncertainty out there.

"The economy is moving forward, but unfortunately not as quickly as it could because of the lack of clarity around some of the fiscal issues,” he said.

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