by Todd McNeill

It appears the overhaul of the tax code signed into law on Dec. 22, 2017, represents a big win for commercial real estate.  Some sectors will benefit more than others.   Let’s take a look at some of the asset classes within commercial real estate to better understand the potential impact of the new tax reform and what economists think on the topic.

According to Colliers Chief U.S. Economist, Andrew Nelson, the retail sector will likely be the biggest beneficiary because of the lower corporate tax rate. The tax reform law reduces the corporate tax rate to 21% from 35%, but because of deductions, not all types of businesses had effectively paid the higher rate. Under the old tax laws, Retailers traditionally paid a high corporate tax rate because they did not have the same kind of deductions as other sectors.  The lower corporate rate will benefit the retailer sector. Moreover, changes to the individual tax code could also benefit retail through an increase in consumer spending.  Individuals in low to middle-income families will have more income to spend and with the tax bill in effect, increased consumer spending should materialize in 2018.

Hospitality should also see a slight increase due to consumer spending, although this may not be as immediate as retail.  This will be measured when school ends, towards the middle of 2018 when family vacations typically happen.  There is also a specific provision in the law that will help hotel owners, a clause was added to include depreciable tangible personal property used predominately to furnish lodging, which might also be useful for apartment operators that provide furnished apartments or student housing. This will allow hotel owners to reduce costs by deducting capital expenses paid on furniture.

Single-Family housing & lot developers may see some slippage in demand as the law somewhat discourages homeownership by lowering the cap on the mortgage interest deduction from $1M to $750K. Multi-family housing, on the other hand, should continue to do well.  The theory implies that if people have fewer benefits to buy a home, they should have a greater incentive to rent.  In addition to the mortgage interest deduction changes, the new law could also force homeowners to pay more property taxes because of its $10K limit on state and local tax deductions. This will mostly be seen in states where housing prices and property taxes are higher. The effects of these will take much longer to measure than in retail or hospitality.

The office sector really does not see much if any negative or positive impacts from the new tax laws.  From a macro perspective, if the tax laws spur economic growth, it would in turn benefit companies that occupy office space; however, there really is no way to determine how much of the increased profit will go toward expanding an office user’s real estate footprint. The savings could just as easily be passed on to shareholders through dividends vs. expansion.

In summary, the retail, hotel and multi-family sectors seem to be the early favorites out of the gate to benefit from the recent tax reform.  Only time will tell; however, it is clear that the Commercial Real Estate sector will, by far, be the biggest beneficiary of the tax reform changes versus other investment classes. No shock, as this is Trump’s lifeblood. Commercial property landlords will still be entitled to full mortgage interest deductions, in addition to benefitting from reduced corporate tax rate (i.e. 21%).    Pass through entities such as LLCs and Partnerships, commonly used in real estate will also benefit from this lower tax rate.  The 1031 exchange provisions remain in place.

There are a few negatives, however.  Multi-family and commercial properties will now have to depreciate over 25 years vs. the previous 27.5 years under the old tax bill.  The tax cuts are also expected to add $1 Trillion of debt to the U.S. balance sheet, which many believe will ultimately cause interest rates to rise.  Given that we have been in a very long cycle since 2011, it will be interesting to see how this new tax law may or may not extend this current real estate cycle.

The author, Todd McNeill, is a Principal in the Dallas office of Metropolitan Capital Advisors.  Todd may be contacted at tmcneill@metcapital.com or 972.267.0600