Experts say a proposed tax on mezzanine debt would raise the cost of financing across the board in New York — making housing, among other things, more expensive.
State Sen. Julia Salazar and Assembly member Harvey Epstein proposed the tax this month in an effort to disincentivize real estate speculation, flag over-leveraged transactions and raise revenue for public housing. Their rationale was that “institutional investors and the extremely wealthy” finance risky multifamily investments with mezzanine debt out of public view, compelling them to raise rents to cover their “unrealistic debt obligations.”
But Louis Tuchman, co-chair of the tax department at Manhattan-based law firm Herrick and Feinstein, said the legislation would raise the cost of financing all kinds of real estate transactions.
“At the end of the day it’s the ultimate user who will pay,” Tuchman said. “If you want to encourage housing, this is not the way to do it.”
Suzanne deVries Decker, a real estate partner at Fried Frank, underscored the impact of subjecting mezzanine loans to the same taxes as reported mortgage loans, as the bill would do.
“It makes everything more expensive, from the owner and lender perspective,” Decker said. “It’s not actually the lender that pays the mortgage recording tax, it’s the borrower.”
Decker said the increased cost of financing would likely be borne by all parties involved in transactions, although the bill’s sponsors say they are going after private equity investors.
“In terms of what the legislation is trying to accomplish, it’s not clear whether it’s targeting property owners or lenders — and whether there’s a distinction,” she said.
A mezzanine loan is subordinate to equity in the capital stack that finances a real estate deal. Unlike a mortgage loan, it is secured by a pledge of equity interest in a property’s owner, rather than by the property itself. A mezzanine lender can foreclose on a pledge of equity interest, but if the mortgage lender forecloses on the property, the mezzanine lender’s collateral can lose its value. Because of this risk, mezzanine loans typically charge higher interest.
The potential for greater returns and the lack of a tax on mezzanine loans in New York — they are not recorded, and thus not subject to the mortgage-recording tax — has made the instrument popular with funds seeking high yields, such as those investing money for pension funds and university endowments.
Some in the real estate industry have expressed frustration at politicians and advocates who attribute many of society’s ills to real estate lending practices. Tuchman indicated that taxing mezzanine lending might seem arbitrary.
“There are those who argue, if you’re planning to tax debt beyond mortgages, why limit it to real estate debt? Why not a tax on corporate debt? Why not tax all debt?” he asked.
David Eyzenberg, whose eponymous firm specializes in debt and equity and has taught real estate finance at NYU Stern, said that a possible workaround would be just doing preferred equity. That would potentially affect “tax-exempt institutions like endowments or pensions” because it could subject them indirectly to tax for certain types of investments.
Those investors could shift to lending that is already subject to the mortgage-recording tax. Indeed, that is one of the stated goals of the legislation.
“The workaround would be just doing preferred equity,” Eyzenberg said.
The mortgage-recording tax has multiple components including a basic tax of 0.5 percent statewide, a “special additional tax” of 0.25 percent, and another 0.25 percent tax that rises to 0.3 percent in the 12 counties served by the Metropolitan Transportation Authority.
Mortgages do not have to be recorded, but generally are because doing so enables lenders to seek recourse if the loan becomes delinquent.
The tax, which its sponsors say could generate hundreds of millions of dollars annually, faces an uphill battle in Albany: In his budget proposal Tuesday, Gov. Andrew Cuomo called for no new taxes or major fee increases. He declared that no new revenues are needed to close a $6.1 billion budget deficit in the state’s annual spending plan, due by the start of its fiscal year, April 1. He called for finding Medicaid efficiencies and limiting spending growth instead.