MarketScoop: Tax Reform
Tax Reform: How Will Recent Changes Impact the Commercial Real Estate Industry?
Overall, it appears that the 2017 Budget Reconciliation Act, otherwise known as the Tax Cuts and Jobs Act, improves property fundamentals for almost all categories of commercial real estate in the near-term – especially single-tenant net leased properties. Improved economic conditions, coupled with the reduction of the corporate income tax rate from 35 to 21 percent, should benefit the retail and industrial sectors especially. Provisions that have benefited commercial real estate in the past, such as carried interest treated as long-term capital gains, interest expense deductions, provisions for depreciation, and 1031 exchanges, have generally survived.
Some economists say the cuts could increase economic growth by 50 basis points in 2018 alone. Many corporations will use their tax savings to grow their businesses, while many individuals will have more disposable income. On the other hand, critics of this bill suggest that it could, long-term, add nearly $1.5 trillion to the federal deficit. They argue that higher interest rates and accelerated inflation are likely. Here’s how the cuts may impact different sectors of commercial real estate:
This category will probably benefit more than any other. Retailers often pay a high corporate income tax because they cannot take advantage of certain deductions as other businesses can. The tax cuts will be particularly welcome to businesses in this sector as they could help some retailers grow by adding stores or new employees. Moreover, cuts in individual income taxes will lead to increased disposable income, which many consumers will spend on retail goods.
The tax cuts will benefit some industrial companies more than others, largely depending on where and how they get their income, the extent to which they depend on debt, and the extent to which they gain revenue by investing in depreciable assets.
The 1031 exchange – a vehicle that allows investors to defer capital gains tax – has survived. However, the 1031 exchange can now only be used on real property. It does not include other personal property, such as furniture, fixtures, and other valuables that might be part of a real estate deal.
The tax cuts’ effects on the office sector will be relatively insignificant. The cuts may spur some growth by these occupiers, but that growth is not likely to expand their real estate footprint unless they add a lot of new jobs.
The cuts could slightly reduce the benefits of home ownership and increase the desirability of renting – but not by much.
The greying of the population, with a growing dependence on medical care, will likely spur growth in this category more than tax cuts will.