New York preferred equity investors face tax hike

State bill to tax mezzanine debt is expanded

Assembly member Harvey Epstein and State Sen. Julia Salazar (Getty)
Assembly member Harvey Epstein and State Sen. Julia Salazar (Getty)

Preferred equity investors in New York real estate would pay a new tax and the public could see who is backing some high-end projects under a state bill.

State Sen. Julia Salazar and Assembly member Harvey Epstein unveiled a bill in January to tax mezzanine debt just as mortgage loans are taxed when recorded with the state. This month Epstein added preferred equity to the measure.

Many commercial real estate projects in New York use mezzanine debt and preferred equity as financing.

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Preferred equity is becoming more common because it allows investors to be repaid sooner than other equity and debt investors in a project. Developers have also used preferred equity and mezzanine debt in their capital stacks, as lenders are becoming more reluctant to finance entire ground-up developments and assume all the risk.

The bill would mean that recorded preferred equity and mezzanine debt would have to pay the mortgage recording tax, which starts at 0.5 percent for mortgages. It would also make public who is providing mezzanine debt and preferred equity in real estate projects — which is currently private.

Epstein said the goal of the bill is to treat mezzanine debt and preferred equity “the same as other borrowed money.”

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The real estate industry has pushed back against the bill, arguing that it will lead people to move out of New York and investors to look elsewhere for opportunities.

“If it is enacted there will be fewer mezzanine and preferred equity deals in New York,” said Stuart Saft, a partner at Holland and Knight and its New York real estate practice group leader. “The legislature is looking for ways to chase people out of New York.”

Legislators, however, view transparency as a tool to prevent overleveraged purchases, which compel borrowers to raise rents.

They also want revenue from the proposed tax to go toward public housing. Last year, New York City alone collected $1.4 billion from 66,180 mortgages — but its public housing system has a $42 billion repair and maintenance backlog.

The bill could in theory pass this year but is more likely to happen in 2021, according to Salazar’s counsel and legislative director, Mark Mishler. The Senate and Assembly are still technically in session but are not moving legislation at the moment.

The bill also comes at a time when the state is facing massive budget cuts to close what Gov. Andrew Cuomo has said is a $30 billion budget deficit over the next two years. Before the pandemic he called for no new taxes or major fee increases and has not strayed from that position. But the federal aid package he requested has not materialized.