With the real estate sector facing unprecedented challenges – from empty office buildings and a growing number of tenants falling behind on rent to the spiking number of coronavirus cases – investors should prepare for dramatic shifts regardless of who prevails in tomorrow’s election.
The Nov. 3rd election is long gone, and those overseeing Real Estate Investment Trusts (REITs) are now preparing to deal with president-elect Joe Biden and the changes his administration is likely to usher in over the next four years.
To help investors navigate the politics of property ownership, Laura Jackson, Senior Managing Director at FTI Consulting, the global business advisor, assessed both of the candidates’ positions on taxes and real estate prior to the election outcome to determine how they might impact REITs.
Book Income and 1031s
Jackson, a tax and REITs specialist, expects both candidates to leave the basic REIT structure untouched. However, she said Biden’s proposal to impose a 15% minimum tax on corporations could enforce higher taxes on real estate companies and expects a special carve-out for REITs.
Biden’s proposal calls for a tax on “book income”, which usually refers to a company’s financial income. The book income figure is the amount companies report to shareholders to provide insight into a company’s financial health. Tax income, on the other hand, is the amount companies report on tax returns. Proponents of Biden’s plan say it will help eliminate corporate tax avoidance.
Jackson said that exactly how Biden intends to tax book income is unclear, but noted that it could mean “some of the tools tax practitioners use to lower taxable income, such as using accelerated depreciation, may not be available because they might get swept up into Biden’s minimum tax.”
Another potential blow to real estate companies and REITs could come from Biden’s bid to eliminate popular “like-kind” exchanges. These exchanges, also known as 1031s because of their IRS code section, allow investors to defer paying capital gains taxes on an asset sale by reinvesting the profits in another asset. For many years, like-kind exchanges have been a successful tax planning tool for real estate investors.
Though Trump hasn’t issued a formal tax plan, it’s unlikely he’d alter like-kind exchanges. In 2005, the Trump Organization deferred paying capital gains tax on $1 billion in profits generated from the sale of a Manhattan property. In response, Biden has tried to cast 1031s as a tax dodge. By eliminating 1031s for investors with annual incomes above $400,000, Biden has said he would fund $775 billion in government spending on child and elderly care over the next decade.
Jackson said she believes doing away with like-kind exchanges would be a mistake because they spur investment by creating flexibility. The exchanges also allow property owners more mobility by enabling them to swap a property in one city for one located in another without having to sell and take a significant tax hit.
Most importantly, according to Jackson, her research found that 80% of like-kind exchanges result in more taxes paid than if the exchange had not occurred. She found that when investors are allowed to swap, they eventually realize about 19% higher gains than if they hadn’t made the exchange.
“There’s a common belief that people hold on to these 1031 properties forever,” Jackson said. “But when we actually looked at the data, that’s not really the case. They are very favorable to have as a tax structure. It encourages people to make deals.”
Return to a pre-pandemic world
The most vital issue for real estate investors, and indeed the overall economy, is defeating Covid-19. Commercial REITs need workers to go back to their offices and for landlords to once again collect full rents. The pandemic has wreaked havoc on office and retail REITs, while medical office and industrial REITs have faired much better.
What might be most attractive about Biden to the real estate industry may be his pitch to deal with Covid-19 more aggressively than the Trump administration. Thus far, the Trump administration’s efforts have been inconsistent. In October, Trump promised not to shut down the economy again, even as the number of coronavirus cases continues to climb.
“What’s important for REITs is getting back to where we were before the COVID pandemic,” Jackson said. “A lot of people are working from home and there’s a lot of uncertainty around office space. All of this comes down to how the pandemic is handled by whoever becomes the next president.”
Be prepared for anything
Jackson said that investors should have strategies tailored for each candidate. She said that if she were running a REIT she’d create a detailed plan in the event that Biden wins and does away with like-kind exchanges.
“I would look for what transactions I could accelerate into 1031s, making sure they get grandfathered in before these exchanges potentially get repealed,” Jackson said. “I’d also make sure that I’m going to have enough cash to pay off the dividend if I need to sell that property without the benefit of 1031s.”
Jackson added that she would also look for ways to help bring businesses get back to pre-pandemic form. Some REITs are leading the way in bringing people back to the office by offering childcare, tutoring, discounted parking.
“If I’m an office REIT,” Jackson said, “I’d ask ‘How do you get people back to the office to stimulate the economy, and which administration is best at doing that safely?'”
The views expressed herein are those of the author(s) and not necessarily the views of FTI Consulting, Inc., its management, its subsidiaries, its affiliates, or its other professionals. FTI Consulting, Inc., including its subsidiaries and affiliates, is a consulting firm and is not a certified public accounting firm or a law firm.