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First Take: CRE Groups, Analysts Offer Initial Reaction to Republican Tax Reform Framework

Lacking Specifics, Analysts Say Tax Bill Faces a Long Process Getting Through Congress
September 28, 2017
Initial reactions of real estate groups and analysts to the tax-reform framework released yesterday by GOP leaders in Congress ranged from outright support to opposition of a proposal included in the framework to limit or ban the deductibility of interest on business debt.

The real estate community has been on edge over rumors the tax plan advanced by Congressional leaders would do away with some of the industry's favored tax treatments. Different reports noted that discussions included possibly eliminating 1031 tax-free exchanges and reducing the deduction for interest on debt and reducing the tax rate for pass-through business income.

Yesterday was supposed to be the big reveal of the new framework from the "Big Six" in tax reform - House Speaker Paul Ryan, Senate Majority Leader Mitch McConnell, Treasury Secretary Steve Mnuchin, National Economic Council Director Gary Cohn, Senate Finance Committee Chairman Orrin Hatch and House Ways and Means Committee Chairman Kevin Brady.

Despite general surprise at the limited amount of detail included in the framework, real estate's chief advocate in Washington, Real Estate Roundtable President and CEO Jeffrey DeBoer, hailed the framework released this week as "another significant step toward pro-growth tax reform."

"As envisioned in the framework, reducing the tax on business income, encouraging capital formation and maintaining the strength of our capital markets will spur economic investment and job creation," DeBoer said. "Critical issues and details certainly are ahead and we intend to work closely with Congressional tax-writers as they take tax reform forward."

DeBoer testified on Sept. 19 before the U.S. Senate Finance Committee on business tax reform - encouraging modest changes for the current taxation of commercial real estate that would promote economic growth while cautioning policymakers on specific business tax reform concepts that could cause severe market dislocation.

Other groups, including Businesses United for Interest and Loan Deductibility, or the BUILD Coalition, voiced sharp criticism of the proposed new tax targeting interest deductions as "simply not reform."

"True reform works to improve the U.S. economy and create jobs rather than raise costs on businesses. Interest deductibility is critical to the U.S. economy," the coalition said in a statement.

"The BUILD Coalition opposes the proposal from the ‘Big Six’ to limit interest deductibility as part of tax reform, spokesman Mac O’Brien said. “This action would effectively create a new tax on business investment, which runs counter to pro-growth tax."

Short on Details, Framework Facing Long Road to Approval
Morgan Stanley equity analyst Richard Hill cautioned in a note to investors that the tax package faces "a long road ahead."

"There are likely hundreds of 'billion dollar' fights to wage before anything is passed," Hill said, noting the potential for specific carve outs for REITs and other CRE owners. After noting that the proposed elimination of 1031 tax exchanges was not addressed at all in the framework, Morgan Stanley's Hill commented on two other provisions that were included.

The potential elimination of the reduction in the interest deduction for c-corporations would remove one of the two primary benefits of owning commercial real estate, with depreciation being the other. Under current tax law, building owners may deduct interest on money borrowed to purchase or improve property.

Hill said eliminating that deduction would have negative implications for commercial property valuations to varying degrees. Morgan Stanley's sensitivity analysis estimated a 0.1% to 14.8% reduction in property prices depending on the reduction in the interest deduction under various tax rates.

However, he noted the proposed 20% tax rate would help to mitigate some of the impact from a reduction in the interest deduction.

The framework also calls for allowing businesses to immediately write off or expense the cost of new investments in depreciable assets (other than structures made after Sept. 27, 2017) for at least five years.

Hill noted that allowing the immediate expensing of capital investment would likely help to mitigate some of the impacts of a reduction in the interest deduction. In addition, he said such a change could incentivize selling of properties to purchase a new property that can be fully expensed up front, a situation that could pose challenges if there isn’t corresponding demand.

Morgan Stanley also noted it's entirely possible there could ultimately be specific carve-outs for commercial real estate, or REITs specifically, as negotiations get started.

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