Hogan: “This fight won’t be for the faint of heart.”

COLUMBUS, OH—There’s much at stake for the private sector from decisions emanating—or promising to emanate—inside the Beltway. Of course, prime among these is tax reform, always a dicey issue when it comes to commercial real estate. Dan Hogan, locally based research director for RED Capital Group, lays out his thoughts on possible outcomes in this exclusive interview.

GlobeSt.com: If you were serving as presidential advisor on the issue of tax reform, what would be your recommendations for the most beneficial outcome for the multifamily industry?

Dan Hogan: The guiding principle of tax reform should be “first do no harm.” As it relates to the multifamily housing industry, this principle would lead the Trump Administration to refrain from eliminating longstanding provisions in the code on which multifamily investors have relied before the benefits to the industry from lower rates can be established.

As a threshold matter, it’s important to understand the constraints that bind the freedom of Congress and the Administration in this reform initiative. Although the prospects for a bipartisan bill cannot be discounted, the greater likelihood is that the Republicans will seek to pass a bill through the reconciliation process. In this way, only a simple majority of votes in the Senate will be required to advance the bill as opposed to a 60-vote supermajority for ordinary business.

But reconciliation comes with a price. Budget bills passed under reconciliation must either not increase the federal deficit after 10 years or be subject to a 10-year sunset provision. A sunset provision may be useful for individual tax reform; it was used successfully by the Bush Administration in 2001 and 2003, but it would be inappropriate for business tax reform, which must be permanent to have the desired impact on investment decision making. In other words, business tax reform must be revenue neutral to be brought into law unless a bipartisan approach can be agreed upon, an unlikely prospect.

So the heaviest lift for reformers will be identifying ways to offset the revenue impact of lowering the top corporate income tax rate from the current 35% to the proposed 15% or 20%. The temptation to strike some of the so-called tax expenditures that real estate investors rely on will be difficult to resist. These include generous depreciation schedules that create tax losses for real estate partnerships, the tax deductibility of interest and some of the advantages associated with using pass-through ownership vehicles that are not taxed at the entity level.

Achieving an equitable balance between the benefits of lower marginal tax rates and the detriment associated with foregoing critical benefits will be nearly impossible. No one-size-fits-all solution is possible. Relative benefits will vary from partnership to partnership based on the nature of the property in question and the desired makeup of the capital stack. With this in mind, I would advise the president to consider allowing real estate partnerships to elect to be treated under existing law or to choose the revised schedules and provisions. In this way, ownership entities could tailor their tax planning to best address the specific needs of their partners and singular capital stacks without substantial impact on net tax liabilities to the Treasury.

GlobeSt.com: What hurdles do practitioners/occupants face now that could be relieved if tax reform is done properly?

Hogan: First, lower corporate tax rates may make it possible for owners to create new, more efficient ownership vehicles. As it stands, investors seeking the advantages associated with C-corporation status must elect to be treated as a REIT or bear the cost of high entity-level taxation. Under the proposed changes investors may achieve some of the tax advantages of a REIT while gaining the ability to build capital through earnings retention and the freedom to engage in a variety of operating businesses not permissible for trusts. In addition, investors will have greater liberty to correspond depreciation schedules with real property economic value and thereby negate the need for basis-preserving like-kind exchanges when they choose to divest. In this way an owner would be free to reinvest proceeds in any asset that may seem attractive at the time, unhindered by adverse tax consequences.

GlobeSt.com: Do you believe the industry is doing enough to get its message heard inside the Beltway?

Hogan: Yes, definitely. The industry is ably represented by the NMHC and NAA, organizations that have earned broad bipartisan support on the Hill. It is no accident that the interests of the apartment industry are top priorities for both Capitol Hill Democrats and Republicans. This clout is the direct byproduct of their hard and politically shrewd work over the years.

GlobeSt.com: There seem to be two primary themes in the Trump approach to tax reform. What are the implications of–and the industry’s stance on–reducing the marginal tax rates applied to corporate and pass-through entity earnings?

Hogan: The Trump Administration seeks to accelerate US economic growth, persuade American multinationals to repatriate profits earned abroad and encourage foreign investment in US assets and businesses. It believes, and I think there is broad consensus on this point, that domestic corporate income tax rates, arguably the highest among OECD countries, are the single greatest impediment to achieving these goals.

The domestic real estate industry would benefit from each of these objectives but understandably has been reluctant to express support while the manner in which lost revenues will be offset and the rates at which pass-through entity distributions will be taxed is uncertain. But it’s fair to say that policy changes that may give rise to higher after-tax returns, increased investment and lower capital costs will be beneficial to the industry. The only question is whether the burdens associated with the loss of some of the benefits of current law will exceed the gains associated with lower-cost and more abundant capital. How this balance will evolve is impossible to know.

GlobeSt.com: Similarly, what are the implications of–and the industry’s stance on–eliminating tax breaks available to certain businesses that distort economic decision-making and capital allocation?

Hogan: That’s a good question. Certainly industry groups haven’t staked out a public stance on the issue. But speaking for myself, the industry will be well-served by sensible, balanced tax reform that leads to faster domestic growth and encourages global capital to migrate to these shores, even if this means sacrificing some valuable carve outs. Of course, reform will be a problem for the multifamily industry if it is perceived to bear a larger burden than others. Indeed, I’m concerned that reforms will be manufacturing-centric and work to the disadvantage of service and real estate industries. Time will tell, but I suspect the K Street community will have a field day ironing this issue out.

GlobeSt.com: What hurdles do you see to tax reform that is both fair and favorable to the multifamily industry as a whole?

Hogan: There will be as many hurdles as there are pages to the tax code. Each effort by drafters to find incremental revenue by eliminating a tax expenditure will be unfavorable to one or more industries, and one can expect every proposed change to be contested. Reaching some grand compromise between dozens of competing interests will be bruising at times, and stakeholders that lack lobbying firepower risk being left with the short straw. The risk to the apartment industry is that its voice may be lost in the din and its interests compromised in the rush to find ways to meet the revenue neutral test within the tight time frame staked out by Republican leadership. This fight won’t be for the faint of heart.

Note: The views expressed herein are those of the author and do not necessarily reflect the views of RED Capital Group or of the author’s colleagues at RED.

About Daniel J. Hogan

Mr. Hogan directs Market Research and reporting activities for RED Capital Group, LLC. He performs research on the multifamily and senior housing industries, the performance of real estate as a portfolio investment and metropolitan market dynamics. Previously, he worked as Director of Asset-Backed Research for Banc One Capital Markets’ Fixed Income Group. Mr. Hogan also worked for Resolution Trust Corporation and Kidder Peabody & Co. in New York. Mr. Hogan graduated Cum Laude from the University of Massachusetts, Amherst with a B.A. in Economics and he earned his MBA from The George Washington University with concentrations in Finance and International Business.