‘Tax Reform’ To Change CRE Investor Behavior
The tax reform bill recently signed into law by President Trump has given the CRE market reasons to celebrate. Fortunately, it retained numerous key commercial real estate provisions that will continue to fuel deals. The 1031 tax-deferred exchange, the mortgage interest deduction for investment real estate and asset depreciation had few material changes, according to Marcus & Millichap’s research team.
The new tax plan offers generous tax cuts to corporations and pass-through entities such as Limited Liability Companies (LLCs), and investors may see the new tax rules as an opportunity to reconfigure their portfolios. The new tax structure will apply to 2018 income for tax filings in 2019. Reduced taxes on pass-through entities may boost capital flows. Perhaps more important than the modest changes to the core commercial real estate tax rules that investors have been most focused on is the reduction of taxes on passthrough entities.
Owners of these types of companies will enjoy a 20 percent deduction on pass-through income, though there are several restrictions that will apply to this deduction. This favorable tax treatment will encourage investors to increasingly focus on after-tax yields when comparing their investment alternatives. On an after-tax basis, commercial real estate could offer a much stronger risk-adjusted return than options such as dividend stocks and bonds. This could entice additional passive capital to flow to the sector through syndicators, partnerships and other passthrough funds. This influx of capital, should it manifest, could place downward pressure on cap rates.
Tax-induced behavior changes will be meaningful, concludes our Marcus & Millichap research team. In addition to the direct effect the new tax law will have on commercial real estate investments, indirect effects could be equally important. The increased standard deduction and limits on local property and income tax deductions could significantly alter housing demand and behavior. At the same time, the elimination of the personal mandate of the Affordable Care Act (Obamacare) could impact long-term demand for healthcare real estate. The new rules could also spark increased consumption spending and more business investment into infrastructure.
To read the complete Marcus & Millichap report, go here.