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Stand Back: CRE's View of Fiscal Cliff from Two Months Out

CRE Executives Assess Impact If Pending Drastic Tax Hikes, Spending Cuts Kick In
October 31, 2012
The perception of just how steep the "Fiscal Cliff" is depends a lot on where you're standing. From Menomonie, WI, for example, it doesn't look all that severe.

Home to Swiss Miss Hot Chocolate, Menomonie is on manmade Lake Menomin and its 14,999 residents enjoy the recreational advantages of the great Wisconsin outdoors. At the same time, it is one hour east of Minneapolis-St. Paul, MN, close enough to enjoy all of the benefits a major metropolitan area.

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"Approximately 90% of the businesses in this market are individually owned," said Rich Ellefson, principal of The Ellefson Group in Menomonie. "The owner works 40 to 60 hours per week in the business. There are fewer than 50 employees, and the owner cuts his salary and benefits before considering any cuts to the employees."

Ellefson Group is a small firm of six people that does commercial appraisals, commercial realty and business brokerage in an eight-county area of West Central Wisconsin.

"In 2012, we have seen more purchases of commercial and industrial properties since 2006," Ellefson said. "Businesses have started to expand with additions to manufacturing facilities. Commercial contractors and architects are doing more quotes than in the previous three years. Unemployment numbers have continued to decrease for three straight periods."

As Ellefson sees it, things are getting better: "The economy is improving. But there is always a national group of experts that yell "the sky is falling," while the majority of businesses go about their work and make decisions based on local factors that affect them."

Ellefson's is just one of many views of the so-called "fiscal cliff" -- that point in January 2013 when an array of federal policies are scheduled to kick in that will end some Bush-era tax cuts and force billions in mandated federal spending cuts unless Congress and the president reach a budget compromise.

Commercial real estate executives from around the country have widely varying views on the fiscal cliff and whether the country is in for a precipitous collapse or whether it will be just a roll down a grassy knoll or even, business as usual. CoStar Group queried a wide-range of professionals in various fields of the industry on what they see happening now as a result and what they expect to happen in January.

Not surprisingly, the issue is fraught with election-year politics which generated some very contentious opinions. We've tried to leave the politics out of it and report the views on how the impact the fiscal cliff is having on commercial real estate.

Addison, TX: It's a Very Scary World Out There

From a real estate investment standpoint personally, (office and industrial), I see the impact to be less in commercial real estate asset classes than alternative forms of investments, fortunately. Our values are determined over much longer periods of time, (5-year lease terms that are locked in), than most other investments such as stocks or bonds.

However as we all have experienced in the most recent downturn, most real estate does not work well when we have periods of negative growth or very slow growth. The chaos in the alternative investment markets may lower cap rates because investors will have few places to chase yields. This works well in the short term and helps the demand for our assets and real estate values. But when tenants start to downsize and demand lower rents to survive, it has a long term negative value effect that lasts much longer than we ever like.
Kevin R. Brands, Managing Principal, Frontier Equity

Atlanta, GA: Not the 'End Times'

While the dreaded "fiscal cliff" is a distinctly real concern for our country and for our government to address, it will not result in an "end of days" calamity. As is typical with our dysfunctional government, they will find a way to put on a short-term Band-Aid and continue to kick the can down the road.

I expect there will be a temporary lag in business activity and decision-making as we traverse the uncertainty of the election, typical end of year malaise and then finally resolve the fiscal cliff crisis in the spring. After that, our paltry recovery will continue at a mediocre pace.

We are starting to see a slow down across the board with new activity (i.e. leasing) and anticipate this temporary decline will drag on through early spring. While sellers anticipating potential increases in capital gains taxes may be more eager over the coming months, buyers will remain less eager for the reasons mentioned above. Institutional buyers of investment grade assets will be the most wary. This could provide a value opportunity for those willing to take on the risk.

On the distressed side, most savvy investors already wear their skeptics' hats when acquiring properties. The uncertainty risk is factored in and offers will reflect that. We should continue to see a high volume of these deals (at stable low pricing) over the coming several months.
Rush Bradley, Office and Investment Sales, Lavista Associates Inc.

Bethesda, MD: The World Is Round

I spoke at the RealShare NY conference earlier this month. There was a panelist who said that if Obama wins, commercial property owners are going to shed assets due to increase in cap gains rate. I got on stage later and said the guy was a delusional sales broker hoping his words come to reality.

If a property is not currently being marketed, it's not likely to be sold this year. One gentleman in the audience calculated there are 36 business days between the election and year-end -- hard to get a property marketed, financed, and sold in that time frame -- particularly at one of the busiest times of year for sales, appraisal, and finance companies.

And as well, if you sold a commercial property, where are you going to replicate the cash flow and inflation hedge you have by owning it today? Makes no sense.

The world continues to spin. Lawmakers in Washington will figure out the fiscal cliff.
Willy Walker, President and CEO, Walker & Dunlop

Brooklyn, NY: Bigger Question Is Where To Invest

Whether or not there is a "cliff" on the horizon, the question in this market and financial climate is more a matter of where to invest available capital in order to both retain value and create a predictable return. Tax advantage should be a side benefit of an otherwise sound deal, based on its fundamentals. And an investor selling assets based on tax rate assumptions would still be faced with the question of where to invest the liquidated capital.

The future value and viability of various assets, currencies and other tangible assets is the larger, overweening question. We are seeing a market less driven by buying and selling tand more for investing to both retain value and secure a predictable return over time. Commercial real estate in a proven market like New York City, and with certain key elements in place that will optimize maximum return, is a great place to find value right now. For this reason, we are attracting investors from all over the world.
Minnette Le Blanc, President and CEO, The Le Blanc Organization Inc.

Evergreen, CO: No Time To Sell

I'd think about selling, but not when prices are as depressed as they are. I have vacancies, not as many as a year ago. I've reduced rents and am more flexible on lease terms. If we go over the fiscal cliff, I, and I expect others, will be even more fed up with our government (if that's possible).
Judy Obrien, Ravens Wood LLC

Lansdale, PA: Lack of Confidence

I fully expect the fiscal cliff issue to be resolved (or at least postponed) without going into sequester. Anyone with an ounce of business sense knows that the deficit needs to be addressed ultimately both by tax increases AND spending cuts. Neither one will solve the $1 trillion plus deficit alone.

Unfortunately, I believe that the primary remaining issue with our economy/anemic recovery is a continuing lack of confidence. Allowing this issue to go to year end / January will only serve to tear at the fibers of the fragile confidence that we have worked so hard to rebuild since 2008.
James R. Wrigley, Executive Vice President, Trefoil Properties LP

Las Vegas, NV: Investors Increasingly Motivated To Sell

2013 looms with threat of new taxes which will hit hard at capital gains. The likely expiration of the Bush tax cuts, will increase the capital gains tax by five points from 15% to 20%. In addition, beginning Jan. 1, 2013, a 3.8% "Obamacare" tax on some investment income will further erode capital gains. Another tax break that ends in 2013 is bonus depreciation. Now add a likely repeal or reduction in carried interest and you're finding investors increasingly motivated to sell before year's end.
John Mendoza, Broker, New Growth Commercial Real Estate Co.

Lexington, MA: The Fiscal Cliff Is Over-Rated

As the world turns, the fiscal cliff, in retrospect, will be seen as an over-rated issue within six months of the election. Regardless of the outcome, there will be a political compromise that will not alter the landscape visibly.

Yes, there may be some new structure to the capital gains tax, but, as history has shown, we will revert to the mean - some compromise, not radical change. It's the way Washington works.

For capital transactions, the tax damage will likely be manageable for most, so, unless the need for "cash now" is intense, it will not affect those sellers who take a balanced view of the impending fiscal cliff problem. It should be business as usual for most of us.
Leonard Bierbrier, President, Bierbrier Development Inc.

Louisville, KY: Decision Delays

We are seeing lots of business people delay decisions until then (and until after the elections). Our auction business is slower than we have seen in a fourth quarter for the past three to four years. We are normally covered up at this time of year. We are still busy, but not covered up.
Don Erler, Senior Advisor, Real Estate Auctioneer, Erler Menish Auctions - Sperry Van Ness Ward Commercial Group

Malvern, PA: Smart Investors Are Getting Out Now

Smart investors and business owners are selling their real estate and businesses right now. They are getting out before the economy goes off a cliff and before we are forced to default on our debt or print our way out of this (hyperinflation) which will ultimately and eventually lead to default. Rates on debt are sure to rise no matter how hard the Fed tries and keep rates below what the market wishes to set them at. When rates do rise, cap rates will probably go twice as high, as liquidity will dry up and uncertainty will set in.

We are also seeing some investors trying to unload their real estate strictly out of fear that capital gains are going to rise next year but many don't understand what we are facing within the next year or two. Buyers / owners that hunker down and try and whether the storm may be looking at a decade before they see any positive gains on their investments.

All aspects of real estate are overbuilt and most all will decline in value. They may rise in dollar terms, much the way the Dow has, but priced against gold they are declining in value.
Ed Costa, Agent Zommick McMahon Commercial Real Estate Inc.

Metairie, LA: Sitting on Cash

Here in Louisiana, we're seeing most commercial property owners sitting on cash and hoping for good reasons to buy more of the right properties. I've encountered a few sellers cashing in where they sold at higher than market pricing, and taking advantage of capital gain treatment. Good property deals still are best found through off market sources.
Craig Daste, Owner, High Performance Properties

Miami, FL: No Widespread Impact Yet

I believe action by property owners will simply be determined by the investment life cycle stage and strategy. Those who are more risk averse and nearing a stage of disposition may accelerate the process to hedge their risk, otherwise I don't see any widespread extraordinary action taking place. Regardless, the situation will be resolved as it's in the best interest of the politicians to sustain one of the largest current economic drivers, which is real estate.
Nelson B. Garcia, Senior Associate, CGI Merchant Group

New York, NY: A Big Kick in the Gut

With the fiscal cliff looming, the real estate sector is about to take a big kick in the gut. Property fundamentals will decline in every sector, of which some haven't quite recovered as well as others during this past recovery cycle. The office and industrial sectors will be hit particularly hard as government spending and consumer spending decline. Office vacancies will increase as a result of the decline in government spending. Delinquent rents will increase as well. There will be a higher proportion of Class B and C properties impacted than Class A properties. Property values will decline, and capital needs will increase as a result of re-tenanting. Competition will increase, driving rents down. Large users of space, which have been on the decline over the past 3 years, will continue to decline as companies cut back the amount of space needed with smaller work areas, and work from home arrangements that are becoming more common.

Additionally, there is more than $1 trillion of maturing real estate loans coming due in the near term. Although interest rates remain low, that hardly makes up for declining property fundamentals coupled with higher capital requirements for improvements, and shrinking values. Such borrowers will find it difficult to refinance with higher vacancies, capital costs for lease up and build outs, and equity gaps from declining values.
David A. Kessler, Commercial Real Estate Industry - National Director, CohnReznick

Philadelphia, PA: People Afraid To Shift Strategies

I think people tend to react rather than pre-empt. Regardless of what might happen, investors and businesses tend to either hunker down and minimize market exposure or continue with business as usual. Very few people have the courage to drastically shift strategies or rearrange their portfolios. If the economy goes off a cliff, it seems like a lot of people will go over with it.
Andrew Benioff, Founder and Senior Managing Partner, Llenrock Group

San Diego, CA: Defensive Posture

If the fiscal cliff is allowed to happen as scheduled, it will put a damper on the economy, likely to the point of recession. The true question is, will politicians (who are) ever focused on short-term implications, find a way to lessen and/or delay the blow, vowing to truly fix the problems later? Or will our elected officials let the fiscal cliff occur because they are unwilling to work together, or even let the fiscal cliff happen to put themselves in a better position for coming policy negotiations?

In anticipation of the fiscal cliff, a couple large defense contractors, which have a very strong presence in our market, have told us that they are laying off workers now in anticipation of coming government cuts. Conversely, there are sales happening because of low interest rates, and to avoid the coming tax raises, but overall it's been a mixed bag. Local sales volume has been moderate to low depending on the type and class of property, with multifamily leading the pack. If there were no fiscal cliff looming, there would likely be a wave of sales with the low interest rates and impending capital gains tax increases, but the economic uncertainty has scared some people out of the market for now.
Joshua Brant, Director of Research for San Diego Region, Voit Real Estate Services

Seattle, WA: Disaster Will Be Averted

Regardless of who is elected president, I'm not optimistic in the near-term on the prospects for the two parties reaching a "grand bargain" compromise that rationalizes our tax code and balances the need for some stimulus and investment in the short-term with the need to put us on a clear path to deficit reduction in the medium-to-long term. But I do think that they will come together within a few months after the election on a smaller bargain that averts "sequestration" and allows at least some of the Bush tax cuts to expire. Assuming that happens, the fiscal cliff should be mostly avoided, and business should go on as usual.

I do think that uncertainty regarding the election and the fiscal cliff is inhibiting investment right now, both in commercial real estate and in the broader economy, but I don't think that uncertainty, or concerns regarding a potential increase in capital gains taxes, is materially affecting sellers' decisions regarding when to bring assets to market.
Joshua Anderson, Partner, The Roseview Group

Seattle, WA: Escrow Dates Booked Thru Year-End

I am personally working with several sellers who have negotiated 2012 closing dates,... the escrow agents are struggling to schedule me in,... and it's only October!
Lise Ward, Senior Real Property Agent, Seattle Parks and Recreation

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