Developer in Chief

With a new President in the White House, and a new agenda on the table, it's a good time to take stock of what this could mean for our real estate industry. I am taking a purely non-partisan sober look of the most likely impacts the new President may have. Given his background and involvement in the real estate industry, one would think that it can be nothing but positive for real estate as a whole. Overall, I predict that he will do nothing to negatively impact this industry, however we shall take a closer look at each area within real estate where his impact may be felt.

Housing

Any changes to the Mortgage Interest Relief for personal taxes would have a massive impact on the housing market. It would negatively impact the home ownership market, and conversely have a very positive affect on the multifamily rental market. Although the President's background is as a real estate developer, his loyalties may lie more towards the multifamily developer than the single-family developer. That being said, I doubt anyone would touch mortgage interest relief in any meaningful way, and suffer the public backlash.

Taxes

The President's new business tax reform agenda calls for a 15% corporate tax rate. Consumer based companies, users of retail property, would get a huge increase in after tax cash-flow because of this. Indeed, any corporate tax paying entity would. The increased cash-flow may provide a cushion to any negative inflationary impacts due to international Trade Agreements being overturned, and potential import tariffs.

It is unclear if the President supports affordable housing, as no mention of it was made during the election campaign. The Republicans now control Congress and the Presidency, and it is well known that they want comprehensive tax reform. How this will impact Low Income Housing Tax Credits (LIHTCs) and New Markets Tax Credits (NMTCs), both very important to new Affordable Housing development, is yet to be seen.

Currently income from partnerships (LLCs, LLPs, etc.) flows down to the shareholder's personal tax returns as Pass-through Income. Most real estate entities are set up as partnerships. The operating income flows to the individual and is taxed at the taxpayer's highest tax bracket, say 39.6%. For capital events, it gets taxed at the capital gains rate of 20%. The President's tax plan, and the GOP tax plan, both call for reforming this. The President proposes a single rate of 15% (for income & capital events), and the GOP call for 20%, on the Pass-through Income.

If the Affordable Care Act (Obamacare) does get repealed, or significantly refined, then up for consideration would be the Net Investment Income Tax (NIIT). This is a 3.8% tax rate on investment income, which gets applied to real estate income as well as other investment income. This tax was heavily criticized by the industry when introduced. If the Act only sees some minor reforms, don't expect this tax to go away, however if the Act is repealed there would be no justification to keep it in place.

1031 Exchanges, where one asset is sold and another like-kind asset acquired shortly thereafter without triggering a tax event, was not addressed during the campaign. The real estate industry is the main user of this tax code and I would guess it will stay in place as-is. The code does not give the seller of an asset a tax-free event, it's a method to defer the ultimate tax liability down the road until the asset owner sells the asset. By allowing the tax liability to be deferred, it gives the tax payer more capital to acquire the new asset.

Carried Interest

The President has made his disdain known for Carried Interest. This is where a party to a transaction gets compensated, but has the compensation/income treated as a capital gain rather than income. This gives significant tax savings, from an income tax rate of 39.6% to a capital rate of 20%. The main users of carried interest are hedge fund managers who take a piece of their investors ownership in a transaction as compensation.

Given that many real estate developers also use carried interest, it may seem surprising that the President would go after this. Personally, I suspect he is only targeting Hedge Funds, who he sees as making paper profits, and that he may offer exemptions to real estate, or similar corporate situations. For example, a real estate developer may get a carried interest in a project for sourcing the land, bringing it through entitlement, putting together the investors, and finding the end-user or buyer. Through this process the developer assumes a lot of risk, risks such as entitlements not being approved, environmental issues, not finding the investors, or market timing. In this situation, if anything goes wrong the developer is left holding the bag. In addition, in many cases the developer (Sponsor or General Partner) often must personally guarantee any debt on the project, and occasionally make guarantees to the investors (Limited Partners) too. A similar looking scenario can be painted for corporate transactions as well. In such circumstances, with so much risk resting on the developer's shoulders, it would seem fair that a carried interest position has been earned. I expect this fact to be recognized in any carried interest reform.

Infrastructure

It has been proposed to spend up to $1 trillion in infrastructure. When spent correctly, this spending can have tremendous long-term knock on affects. If not spent wisely, it only gives a short-term boost to the construction industry, but a long-term hangover to the country's balance sheet.

EB-5 Investment Visas

These visas offer investors into the US a quick path to a Green Card, and ultimately citizenship. Almost $9bil was invested into the US in 2015 via this program. Some new reforms were proposed in the last administration which could curb the use of this program. Real estate developers have used this program to fund large projects, particularly where there is long-term employment created. Many developments in New York City were recipients of EB-5 funding in recent years. Don't expect this to change anytime soon.

CAP Rates

Capitalization Rates, otherwise known as real estate values, could move with inflation and interest rates. As Cap Rates rise, real estate valuations decline. Interest rates are expected to start rising, which will have a negative affect on real estate values. There is also a risk of some inflation if a lot of existing, and proposed, Trade Deals are dismantled. Increased inflation will also see property values decline in the short to medium terms, as most commercial rental income is fixed in advance for periods of 5, 10, or 20 years. To counter these negative affects, any tax reductions and GDP growth would have a positive impact.

CMBS

New risk retention rules have only just come into place. It is likely we will see a loosening of these, which will increase CMBS issuance, decrease borrower costs, and therefore make CMBS more competitive, on rates & costs. Depending on the outcome of the GSE's, and how they will get funded from 2018 onwards, this could have a huge impact on the CMBS market.

Federal Reserve

There are two vacancies to be filled at the Federal Reserve. Although completely independent of the Government, this will allow some influence to be exerted in Federal policy and rate setting going forward, by picking nominees aligned with the President's viewpoint.

Dodd-Frank Regulations

The Presidential campaign was firmly in favor of lightening the load of regulations. It is unlikely that a wholesale repeal of Dodd-Frank will happen, but at the very least amendments to it are sure to happen. Stress testing of banks would probably remain in place, but the capital requirements might change, and the burden on smaller financial institutions may get lifted.

Any easing of regulatory burdens on financial institutions should mean less costs, and more capital available to lend. The increased appetite to lend will make the market more competitive and could spur further real estate development. Ultimately, any new development will be controlled by demand, at least we hope that's how it will work and not find ourselves in an over-supply situation again.

GSE (Fannie Mae & Freddie Mac)

Steven Munchin, the President's Treasury pick, stated during his hearing that he is not in favor of privatizing these two huge GSE lenders. They were both taken into conservatorship during the financial crisis. They play a very significant role in the US Apartment market, being the biggest lenders to this asset class. However, insurance companies and banks have started taking back market share from the GSE's. It is important to note that both these GSE's have paid back the capital used to bail them out in 2008, and are now operating at a profit for the Government. Still, they are only funded up to the end of 2017 and therefore will need to be reviewed shortly.

HUD

Ben Carson has no real estate background, and it is unclear what the President's agenda maybe for HUD and Affordable Housing, so we will have to reserve judgement. HUD has an annual budget of $48bil. which may come into focus in any budgetary tightening in favor of other pet projects, such as infrastructure spending.