November 2020 Edition - A Look at the Presidential Election and How the Results will Impact the Multifamily Business
2020 is a year you will always remember. Who would have guested when the ball dropped to bring in the New Year what a mess we were going to have in 2020. Significant events that have divided our country during the year included the impeachment hearing of our President, a Supreme Court nomination hearing and confirmation, riots in the streets in several major cities, a movement to defund the police in several areas, presidential election campaigns, a worldwide pandemic that has been a major blow to our economy and a Presidential election that is still being contested. Even with all of this the multifamily real estate market in the Triad has continued to move forward with a number of significant property sales this year. As of this writing, nine multifamily properties in the area have sold for at least $32M. The highest sales price was $57M for the Fields at Lincoln Green, a 616-unit complex on the north side of Greensboro. Coming in second was the 344-unit Abbington Place Apartments, also on the north side of Greensboro, for $51.1M (Triad Business Journal).
There has been good news and a lot of bad news in 2020 but now it’s time to get ready for 2021. What are we looking at as the new year is just around the corner? The good news is that we now have at least two vaccines for the Covid-19 virus that look very promising. We must get control of the pandemic before normal operations can resume and anything else of significance can happen. Come January 20th we will have the inauguration of our next President and this will set the tone for at least the next four years. So, what will be the impact on commercial real estate if Trump remains in office or Joe Biden becomes the next President?
With a Trump administration for an additional four years and with Republicans’ continued control of the Senate we can expect more of the same as the last four years. The Trump tax cuts would remain in place and there would be a continued emphasis on reducing regulation on business and further conflicts over trade. If the Covid-19 vaccines prove to be effective, the business community, under a Trump administration, expects to see the industrial and logistics sectors bounce back to pre-Covid-19 levels in about a year. Multifamily is expected to take 12 to 18 months to fully recover depending on how long it takes to stabilize labor markets. A multifamily recovery rally depends heavily on the jobs market. It will probably take two years for the office market to recover and three years for retail. It may, however, take years for the huge number of small businesses to recover to full capacity
The bottom-line is don’t panic. Our current depressed economy was not created by a financial crisis but occurred because of an unanticipated global health crisis. We had a fine economy before the pandemic and, once we get people back to work, our economic strength will return
“It is a mistake to look at the entire real estate industry through a single lens. Multifamily will be fine. For the most part, people are paying their rents, they need a place to live, they’ll find a way.” (David Lynn, PhD, founder of Everest Healthcare Properties, LLC)
“Upper-end multifamily in good, strong markets will be fine. In general, rent collections in multifamily, office and industrial properties have been better than expected. These are very encouraging signs.” (John Chang, Senior Vice President, National Director, Research Services, Marcus & Millichap).
“On a macro level, commercial real estate was not overbuilt before the pandemic and was overleveraged coming into the crisis. As a result, the industry is in much better shape than it was going into the 2007-2008 global financial crisis. Ultimately, commercial real estate will do very well in the recovery because there is a great deal of capital waiting on the sidelines that needs and wants the tax-friendly yields the industry provides. Overall, the probability of a system-wide distress in the commercial real estate market is highly unlikely. The economy has a great deal of pent-up demand that has the potential to drive growth. Consumers are ready to emerge and make purchases. The money that would have been spent before the pandemic is still out there.” (John Chang, Marcus& Millichap).
Will it be any different for commercial real estate if Joe Biden becomes President, retains the majority in the House but continues to be in the minority in the Senate? The answer is yes. If Biden becomes President but has a democratic minority in the Senate, we will have political gridlock until at least the mid-term elections in two years. Biden has offered tax proposals that, if enacted, would substantially impact developers, operators and managers of multifamily housing. Many of these proposals have been introduced in the House and/or Senate within the past six or so years, while others represent the aspirations of more “progressive” Democrats who are seeking to readdress changes made in 2017 under the Tax Cuts and Jobs Act.
Biden is seeking to impose significant tax increases on income derived from investments and management of multifamily real estate, as well as diminish the ability of individuals to transfer assets to heirs on a tax-free basis. He is also seeking to significantly expand the Low-Income Housing Tax Credit and establish a renter’s tax credit (National Multifamily Housing Council).
There are several provisions included in Biden’s tax proposal that could impact apartment firms (NMHC). Such as:
Tax Increases on Individuals
The multifamily industry closely watches tax laws applicable to individuals as it is dominated by “flow-through” entities (e.g. LLCs, partnerships and S-Corporations) instead of publicly held corporations. This means the company’s earnings are passed through to the equity owners who pay taxes on their share of the earnings on their individual tax returns. Biden is proposing several significant tax increases on individuals earning over $400,000:
Marginal Tax Rates: Biden is proposing to restore tax rates in effect prior to the enactment of the 2017 Tax Cuts and Jobs Act. The top marginal income tax rate would increase to 39.6% from the 37% rate that is in effect through 2025. Also, the so-called Section 199A tax deduction would be phased out for taxpayers earning over $400,000. This 20% deduction, which is available through 2025 under current law, enables taxpayers to pay a top marginal rate of 29.6% on qualifying income.
Payroll Taxes: Under current law, a 12.4% payroll tax (paid equally by employers and employees) is applicable to income up to $137,700 in 2020. Biden proposes to impose payroll taxes on earnings over $400,000. While the proposal would help address the solvency of Social Security, it would also represent a significant tax increase on higher-earning taxpayers.
Itemized Deductions: Under current law, taxpayers may itemize deductions at the value of their marginal tax rate. Biden would cap itemized deductions at 28 percent. He would also restore the so-called Pease limitation, which is suspended through 2025, on taxpayers earning over $400,000 that further limits the value of itemized deductions.
Capital Gains Tax Increases
Multifamily taxpayers often face capital gains taxes when they sell properties. While the maximum capital gains tax rate for assets held over one year, long-term capital gains, is currently 20%, Biden proposes to increase this rate to 39.6% for taxpayers earning over $1 million. In this manner, Biden would effectively tax carried interest at ordinary income rates as there would be no differential between capital gains rates and ordinary rates.
Additionally, Biden proposes to tax unrealized capital gains held at death and would eliminate stepped-up basis, but the mechanics of how this proposal would work are unspecified. It is unclear whether gains at death would be taxed immediately or whether the original basis would be carried over.
Eliminate 1031 Like-Kind Exchanges
Biden proposes to eliminate 1031 like-kind exchanges. Like-kind exchange rules play a crucial role in supporting the multifamily sector by encouraging investors to remain invested in real estate while still allowing them to balance their investments and shift resources to more productive properties, change geographic location and to diversify or consolidate holdings. Like-kind exchanges enable property owners to defer capital gains tax if, instead of selling their property, they exchange it for another comparable property. As long as the taxpayer remains invested in real estate, tax on any gain is deferred. When the taxpayer ultimately does sell the asset, the property tax is paid.
Affordable Housing Tax Incentives
Biden proposes to address affordable housing by expanding the Low-Income Housing Tax Credit (LIHTC) and establishing a renter’s tax credit. LIHTC would be expended by $10 billion. Meanwhile, $5 billion per year would be allocated for a renter’s tax credit that would limit rent to 30% of income for qualifying taxpayers who earn too much money to qualify for Section 8.
Depreciation of Rental Real Estate
While there is no clear proposal, both the Committee for a Responsible Federal Budget and the Tax Policy Center for the Urban Institute & Brookings Institution indicate that Biden would increase the depreciation period applicable to multifamily buildings from the present 27.5 years to 30 years for taxpayers opting out of limits on the deductibility of business interest.
Biden’s 10-year, $775 billion tax plan proposes to fund universal childcare and in-home elder care by taxing real estate investors.
Who will be inaugurated on January 20, 2021 will be determined by the Electoral College on December 14, 2020. The Electoral College is required to cast their votes for president and vice president on the Monday after the second Wednesday of December which is December 14th this year. This means that states have a little less than a month to count ballots and conduct recounts if necessary. If on that date the election results are still unclear or disputed, and if the outcome cannot be decided by the Electoral College process, then according to the 12th Amendment of the U.S. Constitution, the House of Representatives elects the President and the Senate elects the Vice President. This scenario has occurred only once in U.S. history when John Quincy Adams was elected this way in 1825.
HAPPY THANKSGIVING! I hope you and your family find a way to enjoy this Thanksgiving together. Stay safe and healthy!
“Just-In-Case You Missed It” is a monthly letter prepared for multifamily owners and prospective owners. It is a compilation of multiple articles from multiple sources or a reprint of an article from a specific source (source credit given). Its purpose is to present both facts and opinions that may influence our multifamily business in the Southeastern U.S. If you have any questions and/or would like to discuss any of the comments above, my conclusions or your multifamily business, please contact me at your convenience. I can be a valuable resource to you without adding any expense to your budget. I look forward to speaking with you and having an opportunity to meet with you. I am always at your disposal to assist you with your multifamily business. If you would like to review previous editions of my monthly “Just-In-Case You Missed It” letter Just-In-Case You Missed It.
Respectfully
Rick
G.F. Rick Baker, CCIM
Multifamily Specialist/Investment Advisor
www.RickBakerMultifamily.com
2504 Tinderbox Ln.
Greensboro, NC 27455
Cell: 336.549.6083
Email: rickbakermultifamily@gmail.com
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