Included in the House Ways and Means Committee hearing on tax reform in May was the Republican House proposal to eliminate net interest deduction. This is causing anxiety for commercial real estate investors and developers as it would disallow the conversion of ordinary income into capital gains for a lower tax rate. Instead, it would be taxed as regular income.

Opponents say that the net interest deduction is a key incentive for commercial real estate investment and that without it the economics of underwriting would be dire and could alter how developers account for debt. The policy was intended to reduce double taxation – where the development’s accrued interest is viewed as income, and a payment on top of that interest is in addition to that income and therefore viewed as a deductible expense.

While President Trump is against the proposal to remove net interest deduction, the House GOP has kept it as an option for tax reform saying that as it currently stands it’s a tax loophole and its elimination would make the economy less susceptible to recessions. They further allege that corporate entities are overstating deductions and underreporting income. House Republicans are looking to deliver a reformed tax plan where companies would be able to treat capital expenses like money spent on hard equipment as a write-off, where they would immediately be able to expense a payment for its full amount.

Although the House plan intends to show how tax reform will grow the economy by generating investments and creating jobs, economists have weighed the impact of the two changes and it has been calculated the tax revenue loss from capital expenditures in the near term would greatly outweigh the positive economic impact from ending the net interest deduction.

Sources:

NAIOP, House Ways and Means Committee Hearing on Tax Reform

Bisnow, Why Eliminating the Net Interest Deduction Is Giving Some CRE Players Anxiety

As office occupiers shutter space, e-commerce induced expansion of the distribution and logistics industry drives industrial leasing and investment activity. Many industrial occupiers are focusing on “last-mile” delivery systems and retrofitting existing assets to include fulfillment centers for online orders. One company that is finding ways to fill pockets of empty space within occupied warehouses is Flexe. Flexe connects organizations that need warehousing space to organizations with extra space by subletting empty warehouse space to small retailers. Its network of more than 400 warehouses in over 45 markets allows online retailers to position products where they can be delivered overnight by truck.

U.S. seaports also play a big role in the industrial industry. As one of the top industrial real estate demand drivers, U.S. seaports continue to drive industrial demand in a big way by generating economic growth, to the tune of $5 trillion, and jobs. With the increasing popularity of online shopping, ships and ports are undergoing improvements to accommodate the increase in import and export volumes. Seven major seaports highlighted in Colliers International’s Industrial U.S. Seaport Outlook report shows that the flourishing U.S. economy should assist in keeping import volumes high, at least in the short term, until it is seen how possible shifts in U.S. trade policy will play out over the longer term.

In terms of the West Coast ports, they are better suited for the increased volume and subsequent ship sizes due to deeper harbors – the ports of Long Beach, Los Angeles and the Northwest Seaport Alliance (Seattle and Tacoma) boast harbor depths of 76, 53, and 50 feet respectively, while East Coast ports hover around 45 – 50 feet in depth.  Regardless of harbor depth, all ports were found to be the main economic driver in surrounding markets, and in some cases the state, which not only contributes to job growth but also to strong industrial occupier interest, development activity, leasing, and rent growth.

With industrial supply growing – nearly 200 million square feet was under construction in early 2017 – user demand is set to be met for the first time in over ten years. However, the effects of the proposed border adjustment tax and new shipping alliances are still yet to be seen on global trade and U.S. port activity.

Sources:

NAIOP, Warehouse Startup Sublets Unused Storage Space

NAIOP, Canadian and U.S. National Industrial Trends

Colliers International, Industrial U.S. Seaport Outlook

Bisnow, 7 U.S. Seaports Driving Economic Growth and Industrial Demand

Retailers are against the proposed border adjustment tax for good measure. The possible import tax could result in higher prices for goods, costing consumers roughly $1,700 more a year, CNBC reports. Retail executives were set to meet with the Treasury Secretary in May to protest the implementation of the controversial tax that would allow companies to deduct the cost of American-made products, but increase the cost of foreign imports.

As one of the Republicans’ key measures in their tax reform tax plan, the tax proposal aims to help keep jobs in the U.S. but retailers have been lobbying against it as they only see the risk of losing millions in profits if passed. Major retail associations, including the National Retail Federation and Retail Industry Leaders Association, want pro-growth tax reform but they want it accomplished in a way that doesn’t disrupt the supply chain while allowing American companies to retain their profits.

The House Ways and Means Committee started their series of hearings in late May to discuss the GOP’s tax reform blueprint, including the highly controversial border adjustment tax proposal. The U.S. is only major industrialized nation that uses a “worldwide” tax system, taxing U.S. exports twice – once by the country where they are sold, and a second time when profits are repatriated to the U.S., rather than a “territorial” tax system, where goods are taxed by the country they are consumed in. Despite differences, Republicans and Democrats agree that lower tax rates and a broadening of the tax base would lead to greater economic growth and increase jobs. The outcome is yet to be seen but there is concern that eliminating tax preferences would cause economic disruption to the retail industry and businesses at large that have made investment decisions based on existing tax law.

If the proposed border adjustment tax does not receive support and its estimated $1.1 trillion increase in federal revenues is not felt over the next decade, Congress and the White House will look elsewhere for revenue generation. Possibly putting provisions such as Section 1031 like-kind exchanges and capital gains treatment for carried interest on the chopping block.

Sources:

Bisnow, Major Retail CEOs Meet With Mnuchin To Lobby Against Proposed Import Tax

NAIOP, House Debates GOP Tax Reform Blueprint

NAIOP, Trouble for Tax Reform?

While office rents in the hottest markets – such as Manhattan, San Francisco, and Washington, D.C. – soften, landlords are looking for new ways to remain profitable. One area that is gaining the attention of building owners is flexible space – a relatively new market where landlords offer flexible options to tenants who desire temporary space or a lease commitment under three years. The reasoning behind a tenant’s need for flexible space can vary from shorter business cycles, increase in contract assignments and temporary staffing, and flexibility for growth of early-stage incubators.

Building owners are recognizing this need by providing flexible workspaces that are move-in ready, complete with open floor plans, technological tools and collaborative software, and a full-range of amenities. As more office occupiers are downsizing due to only using 40% of their desks, landlords are leveraging the shed square footage to establish flexible space that will not only attracts tenants among the likes of technology companies, consulting firms, and financial services, but that does so at about $139 per square foot, compared to the average rent of $49.59 per square foot for traditional Class-A office space as reported by a JLL Shared Workspaces report. The number of office landlords entering the flexible market is rising but it might be just a glimpse of what’s yet to come due to the continued innovation of how and where work gets done.

Another new trend for landlords with empty office space located in prime markets, is to rent virtual space to tenants on a need-by-need basis. This solves the building owner’s vacancy dilemmas, while also fulfilling many small business’ needs of maintaining a prime business address in a major market. The benefits to the landlord are many – no build-outs, little to no common area management – as the tenants don’t actually occupy the space. Instead, tenants pay a monthly fee for the desired business address, a local phone number, a receptionist to answer calls, and the option to hold occasional meetings in the space.  While this model may work with strong office market fundamentals, it’s unclear as to how it will fare when those markets soften.

Sources:

National Real Estate Investor, Landlords Enter the Flexible Office Marketplace

Bisnow, Landlords with Empty Prime Space Turn to Virtual Offices for Profits

Bisnow, Tech’s Greatest Impact May Be in the Workplace Itself

Trepp, Office Rents in Top Markets Begin to Soften

Despite uncertainty as to how President Trump and Senate Republicans will approach tax reform ideas and several controversial proposals, NAIOP’s annual study of “Economic Impacts of Commercial Real Estate,” published by the NAIOP Research Foundation, showed positive improvements made by the commercial real estate industry. Namely that commercial real estate generated significant economic growth to the U.S. economy. Development, construction and operations of office, industrial, warehouse and retail property types, at the state and national levels, supported 6.25 million American jobs and contributed $861 billion to U.S. GDP in 2016. With 410 million square feet of commercial space built in 2016, the industry continued to improve infrastructure and create places to work, shop and play.

Cushman & Wakefield’s report that assessed President Trump’s impact on nationwide commercial real estate in his first 100 days in office highlighted several positive points, including a 2.4% increase in commercial real estate values since the election, and a 10% rise in the S&P stock index. Although the first 100 days rendered some positives to the industry, there are still some key policy issues that could affect commercial real estate demand.

1. Defense Spending —the rollback of the defense budget sequester and increases in defense and Homeland Security spending could benefit commercial real estate professionals in jurisdictions that have historically attracted these budget dollars.
2. Trade Policy — Potential changes to U.S. trade policy is a hot topic, and trade-related movement of goods is an essential part of the industrial market. Trade policy uncertainty can slow companies’ site selection, leasing and investment decisions.
3. Border Adjustment Tax — Trump’s proposed Border Adjustment Tax (BAT) is opposed by the retail industry, among others, because it would levy a 20% tax on all imports of goods and services into the U.S. This increase may influence commercial real estate occupiers’ decisions regarding expansion or relocation.
4. The wall and immigration — Trump’s plan for a wall along the U.S. – Mexico border that has yet to move forward but might be funded through a destination-based “cash flow tax” applied to U.S. – Mexico trade could raise import prices and disrupt the flow of workers.
5. Health Care Reform — Due to the uncertain status of health care reform, new medical office and health care property development and demand may slow and soften.

Sources:

NAIOP, Latest Report: U.S. Commercial Real Estate Development Supports 6 Million Jobs, Contributes $861 Billion to the Economy

San Diego Business Journal, Political Changes Begin to Play Out in Real Estate

NAIOP, While Waiting for Tax Reform, Do Not Overlook Recent Victories

If you’re a warehouse laborer or freight stocker looking for work, you’re in luck. Warehouse fulfillment and distribution employers are competing for qualified labor, meaning wage growth is underway in these sectors. E-commerce is the leading factor behind this trend, with every $1 billion in added e-commerce sales equaling 1 million square feet more in warehouse space. It’s also been the most active industrial sector over the past two years in the U.S., representing 22.5% of all big-box deals with 500,000+ square feet.

Driving the high demand for e-commerce workers is the fact that fulfillment operations require two-to-three times more labor than nonfulfillment operations due to the intensive picking, packing, and shipping an array of product types in varying combinations to consumers or pick-up centers. With signs pointing towards big-box leasing being mid-cycle and still on the rise, site location and warehouse technologies have become key factors in making market conditions successful. Logistics, access to markets and transportation routes, and consumer demand are all driving industrial site selection. With the demand for same or next-day delivery and demographic shifts to urban areas, vacant offices and parking centers are being repurposed into fulfilment and distribution centers.

Another new type of industrial use is making headway, “creative industrial” – integrating the creative office environment with modern industrial elements. By incorporating the onsite amenities in desired locations that the younger generation of workers demand and seek, industrial users are able to deliver their goods or services while building their corporate images. Consolidation is also a leading factor in the creative industrial trend as industrial users seek to consolidate their engineering, R&D and corporate operations under one roof to reduce operating costs and maximize efficiency.

Sources:

NAIOP, It’s All About the (Industrial) Fundamentals

NAIOP, It’s a Small World with Big Economic Challenges

NAIOP, E-Commerce Is Growing, and So Is Demand for Warehouse Labor

BISNOW, How North America’s Shifting Demographics Are Changing Industrial Real Estate Trends

NAIOP, Creative Industrial Workspaces