New York City commercial real estate is enjoying a significant comeback. Commercial properties were less affected by the economic downturn than residential property or business ventures. Now, as the economy improves and as interest rates remain dramatically low, lenders have regained confidence in the sector. All of that moves commercial real estate farther along the road to recovery.
But even as activity picks up, there is uncertainty – in particular over tax policy. In the absence of action by Congress, the Bush-era tax cuts are set to expire at the end of 2012. But political gridlock in Washington makes it unclear whether congressional action is possible. If Congress fails to act and “taxmageddon” happens, federal tax rates will change dramatically. The capital gains tax rate is likely to increase and the current $5 million gift tax exemption will probably be significantly reduced.
Given these circumstances – an uptick in lending offset by significant tax risk – developers will want to move forward on new projects. At the same time they will want to consider accelerating sales and gifting – all the while keeping a weather eye on Washington for clues about future tax rates.
The best advice for property owners and management companies, in a nutshell, is this: review your entire portfolio and improve properties where necessary to make them more attractive to lenders; pay particular attention to properties in need of refinancing, in order to take advantage of low interest rates, and consider the implications of potential tax increases for any properties you might wish to sell. While exercising appropriate caution, keep in mind that lenders are confident that New York City real estate is always a good buy. It will always improve, even when there are dips in the real estate market.
Refinancing represents one of the biggest challenges. Over the next 12-24 months, many loans will be coming due, and developers will want to take advantage of low interest rates to secure the most favorable refinancing terms. The good news is that lenders are willing to lend to property owners. Business lending remains slow, but for property owners, the purse strings have opened up.
There are caveats. Lenders are more demanding now than they were in the boom years about the quality of commercial properties. The years of “extend and pretend” are over – lenders want to see properties with healthy tenant lists and sound financials. Banks are working with landlords to ensure the property meets quality standards. Landlords need to do the same – cooperate with lenders by making sure that the property is in the best possible shape, and that the rent roll is as full as possible.
The same logic applies to other forms of financing – for example, new lending for property improvement. The funding is there, but property owners and management companies will need to work to take advantage of it.
The tax picture creates a different set of concerns. As noted, it remains to be seen whether Congress can act, and whether the tax code will be modified, or if tax rates will simply be allowed to reset to Clinton-era levels. What does seem clear is that, thanks to budget shortfalls and political pressure, federal tax rates will increase, just as tax rates have already increased in New York City. An increase in capital gains tax rates and a drastic reduction in the federal gift tax exemption both seem likely.
The implications for commercial property owners are clear – 2012 may be a good year to sell. That is, if an owner is contemplating selling a property sometime in the next 3-4 years, it may make sense to accelerate the sale into 2012 in order to take advantage of favorable capital gains tax rates while they are still available.
Clearly, this advice won’t apply to everyone. For many owners, investment considerations will outweigh tax considerations, as they should. Investment considerations should take priority. Some owners will be able to realize losses to offset the capital gains. But if a sale is already contemplated, and if tax sensitivity is an overriding concern, then selling in 2012 might make good sense.
Owners considering gifting commercial properties also have reason to accelerate the process and make their move in 2012. The $5.12 million gift tax exemption will probably not survive past this year. Wherever the new exemption level is set, it will almost certainly be lower, perhaps sharply lower. That, in combination with depressed property values, creates optimal conditions for gifting this year. The future tax picture is unlikely to be as favorable.
Obviously, final decisions must be individual. Developers, managers and owners and their counsel will want to work with tax professionals to arrive at a strategy that balances tax advantages with business and investment considerations. But speaking broadly, 2012 seems to provide tax opportunities that lead to highly favorable results.
Published March 22, 2012.
