From left: Jim Costello, senior vice president with Real Capital Analytics; Jonathan Schultz, CEO of Onyx Equities LLC in Woodbridge; Len O’Donnell, CEO and president of USAA Real Estate Co.; Michael Brennan, CEO of Brennan Investment Group; and James E. Hanson II, CEO and president of The Hampshire Cos.
By Joshua Burd
With Election Day looming, real estate investors can’t help but think about Uncle Sam.
A panel of experts in that industry explained why last week, pointing to the prospect of changes to federal regulations that they have come to rely on to do business and improve their returns. Chief among them are the tax provisions for like-kind exchanges and carried interest, which could be scaled back under proposals by both Hillary Clinton and Donald Trump.
“(It is) the thing that nobody wants to talk about right now, which is politics,” said Jim Costello, an economist with Real Capital Analytics. “I think everybody … just wants the whole thing over. However, when it is over, there are some potential changes in the wind for real estate.”
Costello, a senior vice president with the global data and analytics firm, moderated a panel focused on private equity and investment management at the 2016 SIOR Fall World Conference. With CEOs of New Jersey-based real estate firms among the speakers, the discussion tackled everything from trends in transaction values to crowdfunding technology.
But the Nov. 8 presidential election was the first order of business for the experts on Friday’s panelists. They said that eliminating so-called 1031 or like-kind exchanges — which allows investors to sell a property and defer capital gains taxes if they use the proceeds to buy another property — would curtail deal volume dramatically.
“If you don’t have that advantage anymore, a private investor may say, ‘Well I’m just not going to sell,’ ” said James Hanson, CEO and president of The Hampshire Cos. in Morristown. “And volume may go down as a result because, if I’m going to pay taxes and get less return, I might as well keep this asset.
“So I think that’s something that has a more rippling effect, particularly around smaller transactions, where private investors play.”
Clinton has proposed placing limitations on 1031 exchanges, which refer to a decades-old section of the federal tax code. Trump has been less vocal about the issue in recent months, but a report last year by Bloomberg Politics said the loophole would be on the chopping block under tax reforms that the Republican presidential contender was mulling at the time.
Len O’Donnell, CEO and president of USAA Real Estate Co., said that reining in like-kind exchanges would have a more widespread effect than simply closing a tax break for the wealthy. Doing so would amount to “sucking that capital out of the economy” and limiting the opportunities for businesses to grow.
“I think it cuts deep. If the political will is go after the ‘fat cats’ on Wall Street, I think you’re hitting a lot more than that if you take away the 1031,” O’Donnell said. “You’re hitting small entrepreneurs, local business operators, the guy who has a tile business and sells his warehouse to get a different warehouse.”
Both Trump and Clinton have directly addressed another regulation that affects real estate investment managers, the so-called carried interest tax break that allows financial managers at private equity, hedge fund and other firms to pay a capital gains tax rate on their income instead of the higher income tax rate. Both candidates have called for reversing that policy, an issue that has attracted much more attention than 1031 exchanges during the campaign season.
While no one truly knows the future of the carried interest provision, last week’s panelists said the uncertainty is impacting their business.
“(It) definitely puts something in our heads to monetize faster,” said Jonathan Schultz, CEO of Onyx Equities LLC in Woodbridge. “And we have a bunch of deals now up for sale that we would much rather have close before the year ends than after — because it’s a huge hit. … You can only work with what you know, so if we can sell, we’ll sell now.
“If we can’t, we’re not just going to sell for the sake of selling. We’re going to sell because we think it’s right. And not only do we think it’s right — we don’t have to have any issues going forward with the change in the (tax code).”
Despite the positions of both candidates, the policy change is no sure thing. Michael Brennan, CEO of Brennan Investment Group, said there has been bipartisan support in the past for eliminating the carried interest loophole, but the real estate industry has fought to protect it.
“If it was going to fall, you would have thought it would have fallen seven or eight years ago,” Brennan said, later adding: “It can defend itself, I think, a little bit better than people think.”
O’Donnell also pointed to other points in the past decade in which politicians have called for changes to the tax code that would impact the real estate industry. And while the prospect of a major change can influence short-term behavior in the market, he said the actual implementation of one can have another impact altogether.
“I’d still be interested to see if there is the political will for it to happen,” he said. “But if it happens … is there a shift in how transactions get structured? Because it’s not a fundamental obstruction of the structure — it just means you’re going to give up 20 percent more in taxes than you’re giving it up today.
“And the yields certainly can’t support that, so is there going to be a new creative way in how we structure transactions and how we structure ventures? It doesn’t do me any good at all if my best development partners are not having the level of success that they need to have in order to have talented people and run their business. So the question is how much of your business is reliant on that last 20 percent?”