2012 Year-End Review from CCIM

Throughout the past year, CCIM Institute had three top priorities: increase liquidity, prevent burdensome regulations, and create awareness of how federal tax policies impact commercial real estate. Read more.

Federal Tax Policy with Fiscal Cliff Updates

Federal tax code has not substantially changed for over two decades. 2013 brings a new set of rules and guidelines for all U.S. tax payers. Keep in mind that filing for 2013, is not due until April 2014. Individuals, families and businesses across the board (not only higher-income individuals or households) will be to some degree, impacted by federal tax rate changes negotiated through the fiscal cliff deal. Capital Gains/Carried Interest The capital gains/carried interest rate will increase to 20 percent for individuals with and adjusted gross income more than $400,000 and married couples with AGI more than $450,000. Individuals/couples below the $400,000/$450,000 AGI level will still pay 15 percent. 3.8 Percent Healthcare Tax Passed under the Affordable Care Act in 2010, the 3.8 percent healthcare tax will affect some real estate transactions. Individuals with AGI more than $200,000 and married couples with AGI more than $250,000 may be subject to the 3.8 percent healthcare tax. Payroll Tax In February last year, the payroll tax cut was extended until Dec. 31, 2012. Payroll tax includes Social Security payments that were cut to 4.2 percent instead of 6.2 percent. Without language included in the fiscal cliff deal, the payroll tax reverted back to the pre-recession level, 6.2 percent. It is estimated that the average worker will pay about $1,000 more in taxes annually, or about $42 per pay check. Alternative Minimum Tax Under the fiscal cliff deal, the AMT received a permanent fix and will adjust for inflation. The AMT will be less burdensome on lower-income levels with more exemptions for credits or tax deductions whereas higher-income levels will receive less exemption opportunities.  Exemptions and Deductions Individuals with AGI more than $250,000 and couples with AGI more than $300,000 should expect a phase out of the personal exemption of $3,800 and itemized deduction write-offs. Direction on the "Pease" provision was included in the fiscal deal ("Pease" is named after Congressman Don Pease (OH) who created an itemized deduction phase out in 1990). The itemized deduction phase out was avoided with the recession and Bush-era tax cuts. As clarified by the fiscal deal, the "Pease" provision will now eliminate up to 80 percent of deductibles for $300,000 AGI couples or $250,000 AGI individuals: including charitable donations and mortgage interest. Estate and Gift Tax Estate or gift taxes will be taxed at or above the $5 million (per person) level but the tax rate will increase from 35 percent to 40 percent in 2013. Depreciation ("bonus") Businesses may deduct up to 50 percent of expenses (property and equipment), not including real estate for the 2013 tax year. Leasehold Improvements There is a 15-year straight-line cost recovery for qualified leasehold improvements on commercial properties that extends through 2013 and is retroactive for 2012. Income Tax Rates The greatest change will be for individuals with AGI over $400,000 and married couples with AGI over $450,000; a new tax rate of 39.6 percent applies to this income level. For incomes below, the Bush-era tax rates became permanent. On January 3, 2013 the Internal Revenue Service released a guide on new federal tax rates, Updated Withholding Guidance for 2013. Read more. The fiscal cliff negotiations did not produce changes to federal tax policies on depreciation recapture or passive loss.

Final Fiscal Cliff Stages

CCIM Institute's summary of the fiscal cliff negotiation stages and final details preventing the U.S. economy from going over the cliff can be reviewed online. Read more.

Regulation

FASB Lease Accounting Proposed Rules The Financial Accounting Standards Board’s lease accounting proposal has the potential to reduce the U.S. GDP by $27.5 billion annually and cause a loss of approximately 190,000 U.S. jobs. It is expected that FASB will release more information by April 2013. Read more. Basel III/Dodd-Frank Act The Dodd-Frank Act requires federal agencies to protect consumers. Basel III is a proposed rule under Dodd-Frank. Basel III is overly complex and has the potential to hurt local economies. Read more.

Healthcare/Affordable Care Act

Individual Healthcare Mandate By 2014, the individual mandate upheld by the U.S. Supreme court will go into effect. Read more. CCIMs (and all U.S. citizens) will either continue having coverage through their employer, purchase insurance coverage through a health insurance exchange, or pay a tax penalty. Health Insurance Exchanges will be set up through their state or the federal government. States had to determine by 2012 whether they will create their own exchange or use the exchange the federal government creates.

Small Business

SBA’s 504 Refinancing Loan Program The Small Business Administration’s 504 Loan Program provided another refinancing opportunity for small business expansion plans, the program expired in 2012 but Congress is considering extending the program. Read more.

State Tax Policy

Internet Sales Tax Online retailers put brick and mortar storefronts out of business because there is an unfair advantage when tax season rolls around. Read more.

ACA is Boost for Medical Office Real Estate- By guest blogger Mark Alexander, CCIM

                             

Mark is a specialist in medical office
and national team leader for Sperry Van Ness

                                              

Regardless of how you feel about the Affordable Care Act (ACA), the cloud of uncertainty has been removed. The ACA was passed by Congress and signed into Law by the President on March 23, 2010 and upheld by the Supreme Court on June 28, 2012.  This new direction for health care will ensure dramatic change in demand for real estate used by hospitals and doctors. This is especially true locally given the large number of elderly Americans that retire in Florida, combined with our large proportion of poor uninsured and under-insured who will soon be added to the ranks of medically insured.

There are two main segments of medical office real estate: hospital-controlled buildings and doctor-controlled buildings. The problem over the past three uncertain years during health care reform debate was that neither hospitals nor doctors knew how health care reform was going to wind up. Well, now we know. 

Hospitals

Health care (HC) systems have been more proactive regarding their real estate needs than doctors over the past three years while the debate raged. While not knowing for sure how reform was going to shake out, most hospitals felt change, was inevitable in one form or another, which would lead to more Americans becoming medically insured.  Many HC systems have already taken steps to expand their real estate needs to accommodate this anticipated increased demand for care.  Now that the Presidential election is over, eliminating any reasonable speculation about ACA repeal, many hospital systems across the U.S. are accelerating their expansion plans.  HC systems are partnering with developers to construct new projects while others are using Sale/leaseback transactions involving existing facilities to self-fund their expansion.

Doctors 

Most private practice physicians adopted a “maintain the status quo” attitude over the past three years while hoping for an eventual repeal of ACA. This MD uncertainty fueled today’s pent up demand for medical real estate that is now being released. This is a new environment for doctors and is causing them to change the way they manage their businesses. I find that doctors focus on the bottom line today more than ever before.

For example, over the past twenty years it had become common for doctors that owned their own medical buildings to have their medical practices pay themselves (as Landlord) rent that often exceeded fair market rental rates. This was a popular way for doctors to create exceptional “in-house investments” where their medical office building (MOB) investment returns where often quite remarkable. But this meant their practices often paid very high rental rates that sometimes exceeded fair market rental rates by as much as 200%. When many of these doctor/MOB owner’s decided to sell their buildings prior to retirement, they quickly learned that a sale/leaseback to an investor created much higher sale prices than selling to another doctor or even to their own practice.

The reason for this phenomenon is that owner occupied MOB’s get appraised as though vacant because the appraiser is not allowed to use the existing lease (that would normally drive value higher) because the lease is between related parties and not deemed “arm’s length”. This is great for the acquiring practice but it causes the seller to leave a lot of money on the table.

On the flip side, when the MOB is sold in an arm’s length transaction to an investor and the MOB is then leased back by the medical practice, the appraiser must use the lease to calculate value. The market rent lease steers price much higher and in some cases by as much as 40% higher compared to selling the same MOB to another doctor. 

Consequently, over the past 20 years, doctors that understood these advantages employed the sale/leaseback approach, often choosing the highest rental rate possible to set the highest possible sales price.  This “pushing the envelope to the top” of fair market rental rates created some eye-popping sale prices and saddled medical practice tenants with very high future rents. While this was not a significant issue under the old way of doing business for doctors over the past twenty years, it is today.  Now that ACA is anticipated to bring lower reimbursement rates to doctors in the future, doctors are very concerned and look to keep overhead as low as possible.

Today I see doctors doing the opposite of the past two decades and are either choosing a moderate rental rate for their lease back future; or they pick a below market rent sufficient to retire debt so they can lock in the lowest possible rent to maximize future practice profitability. This is a sound business move as doctors’ incomes are expected to be reduced. This is the fiscally responsible approach, in my view, and it is one example where ACA is helping to reduce the overall cost of health care in America.

Since ACA rewards doctors who work in bigger groups or alliances, there is a trend for single practice doctors to merge with larger medical practices or switch employment to hospital systems. Since stronger tenants are preferred by MOB investors, this trend of smaller groups merging into bigger medical groups is helping the single practice MD get a better price for his MOB than he would have when he was a solo practitioner.

Some forward thinking medical groups were ahead of this curve and started alliances years ago. Others are just getting started. But the trend is clear. Large medical groups are becoming more prevalent.

The Affordable Care Act is not perfect, and most doctors don’t like it because it reduces their future income. But ACA will add millions of individuals to the roles of the medically insured, and this will create higher future demand for health care services. This, in turn, will create higher future demand for medical office space for doctors to treat patients.  There are strong, long-term, underlying business fundamentals for medical office building investments. 

Apartment Market Shifting Focus To New Supply

CoStar article by: By Randyl Drummer May 16, 2012

Current Lull In Multifamily Fundamentals Expected To Be Overtaken by Demographics, Jump In New Construction

The ongoing recovery of the U.S. apartment market is entering a new phase, one marked by an increasing level of permits and construction starts for multifamily development projects. The upwelling in new development is expected to increase supply across many markets starting in 2013 after years of almost zero growth.

The new phase follows the dramatic vacancy declines and strong apartment rent growth that has occurred in the tightest and more desirable coastal markets, and a rare moment of solid income growth even in vacancy-challenged markets.

The rising supply pipeline, coupled with the gradually improving market for single-family housing, is expected to help bring some equilibrium to an apartment market which experienced strong renter demand and plunging vacancies from late 2009 through middle to late 2011.

Demand has tapered off somewhat since last summer due to slower seasonal leasing -- and perhaps some sticker shock among tenants that have watched asking rents eclipse pre-recession highs in some supply-challenged metros, according to Michael Cohen , head of advisory services for CoStar Group’s economic and market forecasting company, Property and Portfolio Research (PPR).

Cohen, along with PPR’s new director of multifamily research Luis Mejia and senior real estate economist Erica Champion, made the observations during CoStar’s First Quarter 2012 Multifamily Review and Outlook.

"Vacancies have been slipping in the apartment sector for several years due in large part to favorable cyclical demand factors and little-to-no new supply," Cohen said. "But the next chapter in the apartment recovery is going to look pretty different, particularly on the supply front."

Overall, the national apartment vacancy rate has dropped by a precipitous 170 basis points through the first quarter of 2012 since peaking at 8.3% at the end of 2009, with the lion’s share of occupancy gains recorded during the six-quarter period between fourth-quarter 2009 and second-quarter 2011. That's equal to demand for about 270,000 additional units, two-thirds of them occupied in 2010 alone, the single strongest year for multifamily demand since 2005.

Rent Hikes Bring Sticker Shock

But demand has eased in the last six months, with the year-over-year vacancy closing the first quarter at 6.6%, down only 60 bps. Several tight coastal markets have already reached or are approaching pre-recession vacancy lows, however, and it’s likely the seasonally weaker pace of demand over the last two quarters will pick up over the rest of 2012, the analysts said.

Four of the top five rental markets that experienced the sharpest vacancy declines are fast-growing southern metros, led by Charlotte, Austin and Raleigh, NC. Detroit, with its surprising auto industry rally, ranked an impressive fourth place, followed by San Antonio. Apartment vacancies have not dropped as sharply in markets like Washington, D.C. and Seattle, where new supply is already starting to come on line.

The recovery has shifted away from the southern metros and toward West Coast markets in the last six months, much of it driven by strength in technology sector. Los Angeles was ranked first in the nation in the first quarter in year-over-year nominal demand growth with about 12,000 units, followed by Dallas, Chicago, New York and Houston.

Ranked by the percentage rise in demand growth, Richmond, VA, led all markets with a year-over-year gain of over 4%. Charlotte, Raleigh, San Antonio and Houston garnered the other top five spots.

Salt Lake City and the San Francisco Bay Area metros saw the largest declines in vacancy. But at least 30 of the top 54 U.S. metro areas have seen their vacancy rates increase at least slightly over the last six months.

"I’m not suggesting that’s indicative of the health or the trajectory of the market, but it’s not a straight line down in absolute vacancy improvement. There is a little bit of a lull," Cohen said.

Although job losses and the housing collapse are still fresh in the minds of 20-to-34-year-olds who make up the bulk of the renter base, and mortgage underwriting standards are stricter, the math is becoming more appealing for people deciding to buy a home or condominium over renting an apartment, Cohen said.

Those decisions are being influenced by spiking rents that have already pierced their pre-recession highs in such markets as San Jose, Oklahoma City, Denver, East Bay, San Francisco, Chicago, Portland and Pittsburgh.

Apartment Starts Ramping Up

While only 60,000 new apartment units are expected to be added this year, well below longterm average, construction starts and permitting activity are beginning to pick up from historical industry lows not seen since 1993.

"In advising our clients on market selection, we are starting to get calls with concerns about the rate of supply and net completions," Cohen said.

But developers who have delayed decisions to build are seeing the window close as capitalization rates reach record lows.

"2013 will be the first year we’ve seen deliveries above 100,000 units. We need to readjust our perspective on supply for Chapter Two (of the recovery). We haven’t seen 100,000 units come to market since 2009."

CoStar's outlook for supply is moderate through 2015, with between 100,000 and 130,000 units delivered per year, a rate expected to achieve equilibrium between supply and demand, Cohen said.

Homeowner Distress Continues To Help Apt. Investors

Meanwhile, apartment investors continue to reap benefits from the current weak housing market, with the flow of distressed homeowners-turned-renters still above average, while the flow of renters turning into buyers is still quite low, according to Mejia, who recently joined PPR as director of multifamily research.

A comparison of homeownership and foreclosure trends confirms that the homeownership rate could continue to decline -- possibly falling below 65% -- until the delinquencies and foreclosures that have plagued homeowners finally ease.

In the early 2000s, optimism about rising home prices and loose underwriting standards helped push the ownership rate up to almost 70%, leading to a price bubble that began to deflate in 2006, causing a surge in foreclosures and sending the homeownership rate tumbling.

"Apartment markets will continue to see additional demand while the foreclosure rate remains above pre-crisis levels and potential home buyers are cautious about committing to a purchase, even amid all-time low mortgage rates," Mejia said.

Mejia also pointed that as foreclosures remain elevated and renters mull their home-buying decisions, the ownership rate will likely continue to decline, although the extent of the decline depends on the length and strength of the housing recovery.

Alex Ruggieri Is Featured in CCIM Magazine

Commercial Investment Real Estate magazine is the premier national Trade publication for commercial real estate. Recently I was contacted by CIRE magazine. The editor asked if I would be willing to share some of my thoughts on marketing and public relations with their readers. The demographic for CIRE includes real estate professionals from all strata's of the real estate profession including bankers, developers and syndicators. Their readership also includes commercial real estate practitioners as well as a very high percentage of CCIM's. The elite designation of some of the most professional commercial brokers in the country. Naturally I readily agreed. The piece turned out better than I expected because it was set to be a Q and A type interview but when the article came out it was really something more. A full color two page spread featuring a couple of photographs of yours truly. Anyway it was a humbling experience to be asked and I felt it a privilege to be asked to participate is such a prestigious publication. If you would like to read the article click on the photo of CIRE magazine and see pages 12 and 13 or click here.

Ruggieri named to CCIM post

Alex Ruggieri has been appointed to serve as a vice-chairman for the candidate guidance committee of the Illinois Chapter of CCIM.

"One of the first things I got to do to help with the candidate committee was to oversee the CCIM scholarship to a University of Illinois student," Ruggieri said. "It is very rewarding to see our organization support excellence in the next generation through their scholarship awards."

CCIM, which stands for Certified Commercial Investment Member, is an elite group of recognized experts in the disciplines of commercial and investment real estate. A CCIM is an invaluable resource to commercial real estate owners, investors, and users, and is among an elite corps of more than 9,000 professionals who hold the CCIM designation across North America and more than 30 countries.