Now Is The Time To Invest In Commercial Real Estate
Given that President Donald Trump made his fortune in real estate, it shouldn’t come as a surprise that multiple provisions of the 2018 tax reforms stand to benefit commercial real estate directly, says Ian Prescott, a partner at the Salt Lake City-based CPA firm WSRP. And though the final details have yet to be worked out, those looking to buy, sell, or rent commercial space will likely benefit from broader tax cuts and deductions, as well.
Between the reforms and the current economic outlook, Blake Rigby, managing director at Colliers International, says the market seems to indicate that now is a good time to invest in real estate, regardless of whether buyers are considering short or long-term goals. “Were it me,” he says, “I would be more prone to do things now than to hold off, but I would be prudent in how much I did and where I did it, realizing that at some point there will be an adjustment.”
New Reforms Expand Opportunities
Thanks to the bullish real estate market, Mr. Rigby doesn’t expect that the new reforms will have a dramatic impact on growth. But they could sway developers when it comes to deciding where they invest.
One of the most significant reforms to come out of 2018 is the creation of nation-wide “opportunity zones.” This provision allows state governors to use federal criteria to select census tracts in need of economic development and gift them special tax deductions. Developers won’t be able to invest in these areas completely tax-free—but they could take advantage of significant savings.
Traditionally, when a property’s owners choose to sell, they have 45 days to reinvest the proceeds or risk paying sizable taxes on any appreciated value of the building. And even if they choose to defer the taxes of the sale now, they’ll eventually have to pay taxes on the difference between the final sale price, and the value of the original property when they choose to exit real estate.
But if the property’s owners reinvest the proceeds of their sale into an opportunity zone, which are now available in all 50 states, the tax rate paid on the proceeds of future sales decreases. To make the deal even better, properties within opportunity zones are allowed to appreciate tax-free. These benefits may spur economic development in previously disadvantaged areas by attracting new development, says Mr. Rigby.
In hot markets with low vacancy rates, the existence of a nearby opportunity zone may also solve a key problem for investors, says Jared Booth, a certified commercial investment member and federal commercial policy chair for the National Association of Realtors. When markets are tight, investors may have difficulty finding a suitable property within the 45-day window. Opportunity zones may point them toward new possibilities, which may, in turn, take the pressure off some high-demand neighborhoods.
Investors’ fear that they won’t be able to find a new property before the taxes kick in and “stops a lot of transactions,” Mr. Booth says. “They are sitting on millions of dollars in equity, and it stifles the economy.”
Tax Cuts Make Real Estate More Affordable
While opportunity zones redistribute real estate investment, Mr. Rigby believes the across-the-board tax cuts provided by the 2018 reforms will leave the commercial real estate sector with more money available to explore new ventures.
Most developers and real estate investors operate as pass-through entities which, in the past, have been subject to tax rates as high as 39.6 percent, Mr. Prescott says. Those rates now top out at 37 percent, and in many cases, property owners may benefit from a new provision allowing them to write off the first 20 percent of their real-estate-related profits.
While the write-off is subject to limits based on the value of any buildings on the property, Mr. Prescott estimates that being taxed on just 80 percent of their income will drop the effective tax rate to less than 30 percent for most within the commercial real estate industry.
While that’s still higher than the 21 percent corporate tax rate, Mr. Prescott believes the new 20-percent pass through will prevent many real estate ventures from pursuing incorporation.
But because the pass-through applies to industries beyond real estate, Mr. Booth expects to see many smaller companies with more money in their pockets—giving them plenty of breathing room to potentially invest in real estate of their own.
“What we deal with is people who say, I need to put on a new roof, I have to pay the mortgage, property taxes… at the end of the day, I can’t afford to own real estate. I have to rent,” Mr. Booth says. “With a higher operating income, they may have a little more margin to maybe afford property.”
Mr. Rigby expects this effect to extend to corporations, as well, thanks to sizable corporate tax cuts that “leave a whole lot more in the coffers of the corporation to expand their business… If you have 14 percent more savings, you have the ability to invest in infrastructure and expand your business sooner than you would have.”
Tax Reform Also Benefits Corporations
But will corporations use their spare change to invest in real estate? Mr. Rigby certainly thinks so.
“They’ve got to keep wages and benefits competitive,” he says, “but if you’re going to grow a business and need more office space, you need to invest in real estate.”
So far, Mr. Rigby says, the prophecies about the death of retail and the rise of telecommuting have yet to come true. Retail is enjoying a comeback, and what Mr. Rigby calls “the new Walmart model” has digital retailers such as Amazon opening small neighborhood warehouses and stores where customers can pick up their orders in person. Education, even continues to expand its property footprint, despite an explosion of online schools.
“As long as you’ve got to have bodies, you’ve got to have real estate,” Mr. Rigby says. “Every time I go to a university they’re building more buildings. At what point does this prophecy come true? Because it seems like it’s not really happening. Virtual has not come to fruition; in fact, it has gone backwards in a way.
Barring an economic downturn—which Mr. Rigby points out is due in the next two-three years, based on the cyclical nature of the market—Mr. Rigby believes commercial real estate has nowhere to go but up. And these latest tax reforms, he says, are “going to do nothing but positively affect the real estate industry.”