Download Multifamily and Commercial Mortgage Market Liquidity

IREM and CCIM Institute 2012 Capitol Hill Visit Day Issues Briefing Paper
Multifamily and Commercial Mortgage Market Liquidity
ISSUE: While the broader economy is starting to turn around, the commercial real estate sector continues to
struggle due to reduced operating income, property values and equity. Additionally, commercial practitioners
continue to experience difficulty in obtaining financing and refinancing for mortgages, construction and land
development loans, small business loans, and short-term loans for capital improvements.
Another important fact to note are the hundreds of billions of dollars in commercial real estate loans
coming due within the next year. The Real Estate Roundtable reported that roughly $360 billion in
commercial mortgage debt will be due this year. Many of these loans are five year balloon loans that were
locked in at the height of the real estate market in 2007. During a Senate Finance Committee hearing in
February, Senator Robert Menendez brought up this concern with Secretary Geithner, stating that there is
nearly a $1 trillion equity gap in properties in an effort to facilitate refinancing loans that will be maturing
shortly. Senator Menendez notes that these properties are potentially in “serious trouble” if they do not
receive refinancing. There are several factors contributing to the tight lending practices: lenders have
overemphasized a borrower’s creditworthiness, a lower loan-to-value rates that require more upfront equity,
uncertain and rocky economic environment, and uncertainty stemming from the pending regulatory
changes. A Dodd-Frank regulatory proposal that would require banks to keep more capital in reserve for
securitized assets versus whole loans that are held in a portfolio is causing concern among financial
institutions. Furthermore, there is a need to increase liquidity and lending options during a time when
hundreds of billions of dollars of commercial mortgages are coming due and must be refinanced.
Having a sound and well-functioning commercial and multifamily real estate sector is critical to our country’s
economic growth and development for millions of U.S. businesses of all sizes that provide local communities with
jobs and services. It is estimated that the commercial real estate sector supports more than 9 million jobs and
generates billions of dollars in federal, state and local tax revenue.
POSITION: We support protecting and enhancing a healthy flow of capital to multifamily and
commercial real estate. Recent regulations, proposals, and actions, such as Dodd-Frank, have become too
extreme, which hinders commercial real estate recovery and limits further economic growth.
OPPOSING VIEWS: Some believe it is the role of regulators to implement oversight programs to prevent
negative economic conditions. It is believed that transparency and accountability will protect against
financial failure which in turn creates cumbersome administrative processes.
1
IREM and CCIM Institute 2012 Capitol Hill Visit Day Issues Briefing Paper
STATUS: It is necessary to protect against economic failures; however, in any economy there is ebb and
flow to the marketplace. By implementing too many restrictions on the market, business transactions lose
momentum. Any sort of “bailout” is past its prime. There are alternative sources of multifamily and
commercial real estate loans, such as Commercial Mortgage-Backed Securities (CMBS); however, current
lending level demands are far higher than the supply.
IREM and CCIM Institute support two tools that can help with the liquidity crisis:
Covered Bonds
Covered bonds are securities created from loans, including mortgage loans. They are similar to
mortgage-based securities (MBS), but with one major difference. The loans backing the bond remain on
the balance sheets of the issuing banks. Covered bonds have long been an important sector to
strengthen financial markets in other countries.
Several economists now believe that covered bonds in the United States have the potential to
supplement securitization and to form part of a well-diversified liquidity management program for
financial institutions and other issuers. Covered bonds allow banks to raise funds by selling bonds to
investors. The bond is backed by the collateral of the asset and the banks contract to repay. Investors
like covered bonds because the investor has recourse against both the financial institution who issued
the bond and the assets that back the bond. Therefore, banks who issue bonds have a stake in assuring
the long-term viability of the mortgages underlying the bond.
In 2011 Rep. Scott Garrett (R-NJ) and Carolyn Maloney (D-NY) have introduced H.R. 940, the “United
States Covered Bond Act of 2011”. H.R. 940 was carried over from 2011 into 2012 in the 112th
legislative session. IREM and CCIM Institute members lobbied their Members of Congress on this
issue in 2011. H.R. 940 will establish standards for covered bond programs and a covered bond
regulatory oversight program. A companion bill has been introduced in the Senate. S. 1835 by Senators
Kay Hagan (D-NC) and Bob Corker (R-TN) is identical to H.R. 940.
OPPOSING VIEWS: We are unaware of any opposing arguments to the covered bond issue at this
time.
2
IREM and CCIM Institute 2012 Capitol Hill Visit Day Issues Briefing Paper
ACTION: IREM and CCIM Institute urge Congress to pass H.R. 940 and S. 1835, which will allow for
the development of a covered bond market in the United States.
More information about covered bonds can be found here:
“Legislative Proposals to Create a Covered Bond Market in the United States”
Credit Union Lending
During previous economic crises consumers and businesses have relied on credit unions to fill in the
gaps where banks could not serve them. Credit unions have been providing business loans for more
than 100 years. Today, however, credit unions are hampered by a business lending cap of 12.25% of
total assets. Many commercial real estate professionals have reported having strong, long-lasting
relationships with credit unions, which could help them refinance and sustain their properties but find
the lending cap presents an obstacle. More than half of the outstanding business loans held by credit
unions have been extended by those approaching or at the cap. That means credit unions with
experience in handling commercial loans are unable to support significant economic growth and
development.
H.R. 1418 and S. 509 would increase the credit union business lending cap to 27.5% for qualified credit
unions. These bills, sponsored by Rep. Royce (R-CA) and McCarthy (D-NY); and Sen. Udall (D-CO)
and Snowe (R-ME), would only allow increased business lending for those credit unions that meet safety
and soundness criteria.
OPPOSING VIEWS: The American Bankers Association (ABA) is strongly opposed to increasing the
credit union lending cap. The ABA believes the cap credit unions face is necessary to prevent unfair
advantages as credit unions and banks are taxed at different rates. Congress has held hearings about
these differences.
ACTION: IREM and CCIM Institute urge Congress to pass H.R. 1418 and S. 509, to increase liquidity
for small businesses.
3
IREM and CCIM Institute 2012 Capitol Hill Visit Day Issues Briefing Paper
More information about credit union lending can be found here:
Credit Unions: Member Business Lending
American Bankers Association: Credit Union Regulation
4
IREM and CCIM Institute 2012 Capitol Hill Visit Day Issues Briefing Paper
Taxes and Real Estate
ISSUE: The impact of real estate on the nation’s economic health and welfare has been apparent in recent
years. Real estate plays an essential role in every American’s life, as it provides the space in which we live,
work, shop, recreate, learn, worship and heal. Real estate enhances our quality of life and is vital to the
nation’s productivity.
Real estate is strongly affected by the way it is taxed. The turmoil in the industry created by tax changes of
the Tax Reform Act of 1986 provides evidence of how the tax treatment of real estate matters. Real estate
tax laws should bear a rational relationship to the economics of the real estate transaction. In cases where
certain social results are clear, such as homeownership, entrepreneur start-ups, and affordable rental
properties, tax laws should help bring about such results. They also should not unduly restrict the ability of
investment real estate owners to respond to changing economic and market conditions – an ability critical to
the competitiveness of any investment asset.
In mid-February, President Obama released a $3.8 trillion budget blueprint. He proposes several tax
changes in an effort to “shore up our economy and fiscal situation.” The language included revisions that
would:

Allow the 2001-2003 tax cuts to expire for individuals who earn over $200,000 annually and families
who earn more than $250,000. This would result in a maximum rate of 39.6% ordinary income tax
rate, a dividend rate of 39.6% (up from the current rate of 15%), and a capital gains tax rate of 20%
(currently at 15%).

Restore the estate tax to 2009 levels, including a $3.5 million exemption with a top tax rate of 45%.
Currently, there is a $5 million exemption and a top rate of 55%.

Have all carried interest income be treated as ordinary income instead of falling into capital gains
rates. This would increase the tax rate to a maximum rate of 39.6%, rather than the 15% rate it is at
currently. Treasury Secretary Timothy Geithner testified in a Senate Finance Committee hearing
essentially supporting the carried interest tax rate increase that Obama proposed.
Although this proposal would be hard-pressed to pass both chambers, it is important to monitor this
initiative as it would negatively impact commercial real estate practitioners.
After President Obama
5
IREM and CCIM Institute 2012 Capitol Hill Visit Day Issues Briefing Paper
discussed this proposal, U.S. Representative Sander Levin reintroduced legislation, H.R. 4016, to raise
carried interest tax rates to ordinary income levels. We oppose this legislation.
POSITION: IREM and CCIM Institute believe that it is in our nation’s best interest for Congress to
encourage real estate investment in the United States by creating a tax system that recognizes inflation and a
tax differential in the calculation of capital gains from real estate; while stimulating economic investment;
and consequently leveling the playing field for those who choose to invest in commercial real estate.
Carried Interest
ISSUE: Real estate partnerships are often organized as limited partnerships (or LLCs) in which the limited
partners provide capital and the general partner(s) provides operational expertise. When the partnership
property is sold, the limited partners generally receive the profits in proportion to their capital investment.
Often, however, the limited partners grant a profits interest to general partner(s). This profits interest is
known as a “carried interest.”
A carried interest is designed to act as an incentive for a general partner to maintain and enhance the value
of the real estate so that the operation of the property is a value-added proposition. The carried interest of
general partner(s) has historically been taxed at capital gains rates, just as the limited partners’ gains are taxed
at capital gains rates. The current tax rate on capital gains is 15%.
Real estate investments are designed as long-term investments. The capital is "patient" because property
owners take major risks and hold the asset for long periods of time before seeing a gain, thus should be
taxed at capital gains rates. Unlike hedge fund managers, capital gains treatment for general partners
involved in real estate partnerships is an appropriate incentive for risk-taking. The direct risks include
environmental issues, loan guarantees, and lawsuits, to name a few. If carried interest rates increase, it may
drive investors to put their money elsewhere such as stocks with much more favorable tax treatment. It
creates a disincentive to invest in real estate since many would no longer earn a reasonable profit.
In 2008 and 2009, the House passed legislation that changed the rule so that carried interests in real estate
partnerships (and many other investment arrangements, as well), would be taxed as ordinary income. This
provision has been very controversial. To date, the Senate has been unwilling to pursue this particular
6
IREM and CCIM Institute 2012 Capitol Hill Visit Day Issues Briefing Paper
provision. The revenues generated from the House provision have been identified as a way to "pay for"
expired tax provisions.
These proposals to restructure carried interest tax rates are based off of invalid and flawed assumptions. It
is believed that the majority of those who pay the carried interest tax rate are largely Wall Street hedge funds
or private equity funds. This is not the case. Real estate accounts for almost 50% of the 2.5 million
partnerships in the United States. In reality, the 133% rate increase is an increase on a substantial amount of
real estate activity in an already volatile and recovering market.
POSITION: IREM and CCIM Institute oppose any proposal that would eliminate capital gains treatment
for any carried interest of a real estate partnership.
OPPOSING VIEWS: There are those who believe that carried interest should be treated more clearly as
compensation for services – like salary income, and taxed at ordinary income rates. There are some
professions that use carried interest like a salary – including hedge fund managers and some oil development
companies – so many argue it should be taxed like a salary.
STATUS: In light of Presidential candidate Romney’s tax disclosure, carried interest and other investment
income is receiving much attention in the media. It needs to be made clear to lawmakers and the public that
real estate transactions are different than hedge funds and oil development company profits. Congress may
feel the need to respond strongly to overcome the view that the rich benefit unfairly from the current tax
structure. In addition, with the upcoming expiration of the Bush tax cuts, Congress will need to restructure
government revenue. Carried interest will likely be a ripe target.
ACTION: IREM and CCIM Institute urge Congress to oppose an increase to the tax treatment of carried
interest for real estate partnerships. The real estate sector is facing an economic crisis. Making changes that
would further hinder the flow of capital into real estate markets will prolong the weakening of our economy.
More information about carried interest:
A Real Estate Developer’s Guide to Carried Interest Legislation
Internet Sales Tax Fairness
7
IREM and CCIM Institute 2012 Capitol Hill Visit Day Issues Briefing Paper
ISSUE: Under current law, purchases made online are subject to sales tax through what is known as a use
tax. Consumers who live in states with a sales tax are legally obligated to report and pay sales taxes on ALL
purchases made online, although the majority of them are unaware of this obligation, and very few pay this
sales tax. Conversely, brick-and-mortar retailers are required by law to collect the tax on behalf of the state.
This is putting some stores out of business because online retailers are not paying the same rate in taxes.
States that are currently experiencing massive budget deficits may increase other taxes and fees, like property
taxes and/or income taxes to make up the difference in lost sales tax revenue - in fact, it is already
happening in some states. The reality is that states have massive deficits and unfunded mandates they cannot
finance without finding additional revenue or cutting essential services. It only makes sense to collect a tax
that is already due before instituting new taxes on everyone.
States cannot require online retailers to collect the tax on their own. In the 1992, the U.S. Supreme Court
case Quill vs. North Dakota, the Court determined that states could not compel out-of-state sellers to collect
their sales taxes because the burden would be a violation of interstate commerce. Since Congress has the
power under the Commerce Clause to regulate interstate commerce, they can create a level playing field for
local merchants. In fact, the Supreme Court stated in the Quill decision that the problem "is not only one
that Congress may be better qualified to resolve, but also one that Congress has the ultimate power to
resolve." If legislation is passed and online retailers who do not have physical stores are required to collect
and pay sales taxes, a major advantage will be removed leaving the market more competitive.
POSITION: IREM and CCIM Institute support consistent state/local sales/use taxes for economically
equivalent transactions in the state or locality in which the goods are delivered. State/local sales/use tax
consequences should be consistent for economically equivalent transactions. IREM and CCIM Institute
support a level playing field for local in-store retailers and remote merchants (including Internet merchants).
IREM and CCIM Institute believe that local and state governments should enforce existing taxes, rather
than create new taxes. IREM and CCIM Institute firmly oppose any new programs that would impose taxes
on the cost of such services, such as fees and other costs associated with the purchase and ownership of real
estate.
OPPOSING VIEWS: Some argue that as different counties within a state may have different sales tax
rates, collecting the tax is too high a burden to place on online retailers. They argue that states can already
collect this sales tax directly from consumers. Individual consumers who purchase items online will likely
oppose an internet sales tax.
8
IREM and CCIM Institute 2012 Capitol Hill Visit Day Issues Briefing Paper
STATUS: 24 states have simplified their sales tax systems through the Streamlined Sales and Use Tax
Agreement (SSUTA) to provide one uniform system to administer and collect sales tax, eliminating the
burden of the country’s diverse sales tax systems on retailers. However, because this is a matter of interstate
commerce, Congressional authorization is still required to allow states to collect taxes from out-of-state
sellers and online retailers.
A number of bills have been introduced to fix the tax unfairness. The first two bills, called the “Main Street
Fairness Act” were introduced by Sen. Richard Durbin (D-IL) as S. 1452 and by Rep. John Conyers Jr. (DMI) as H.R. 2701. This bill provides tax collection authority in those states that comply with the SSUTA.
Two additional bills provide even greater flexibility and compliance. H.R. 3179, the Marketplace Equity Act,
was introduced by Reps. Steve Womack (R-AR) and Jackie Speier (D-CA). This bill would require states to
provide a minimum level of simplification, including but not limited to the SSUTA, in order to compel
remote sellers to collect sales taxes. Sens. Mike Enzi (R-WY), Dick Durbin (D-IL) and Lamar Alexander (RTN) introduced S. 1832, a companion bill.
ACTION: IREM and CCIM urge Congress to support H.R. 3179 and S. 1832 to modernize our nation’s
tax policy and provide equity between online and brick-and-mortar retailers.
More information about internet sales tax:
Main Street Stores Should Not Become Online Retailers’ Showrooms
Internet Sales Tax Returns to Congress; eBay Makes Their Case
9
IREM and CCIM Institute 2012 Capitol Hill Visit Day Issues Briefing Paper
Financial Accounting Standards Board Lease Accounting
ISSUE: The Financial Accounting Standards Board (FASB) and International Accounting Standards Board
(IASB) are organizations that establish accounting standards for either national (FASB) or international
(IASB) businesses and/or nongovernmental entities. In the 1970’s FASB began as an independent
organization, operating without government intervention.
The SEC was granted regulatory oversight of FASB with passage of section 108 of the Sarbanes-Oxley Act
of 2002. Since Sarbanes-Oxley, FASB maintains a minimum degree of independence from the political
process by not submitting proposed or final rules in the federal register, which provides public oversight of
the U.S. regulatory process.
The SEC approves FASB’s budget therefore the SEC can stronghold FASB when necessary. Any
accounting changes proposed by FASB or IASB must be closely monitored by the private sector. Proposed
accounting standard changes that have the potential to harm an economy must be effectively communicated
to the SEC, FASB and IASB.
In 2010 FASB and IASB proposed new lease accounting rule changes that, if implemented, could have
adverse economic consequences for American businesses and the commercial real estate industry. Under
the proposal, U.S. companies that lease office, industrial, and retail space would be required to capitalize the
costs of that lease – similar to as if they purchased the property – instead of recognizing the true costs of the
lease transaction.
For businesses leasing space, especially small businesses, this will change real estate leases into a major
liability. As a result, many businesses will shorten lease terms to minimize the impact. This will create
instability in future rental costs and uncertainty about availability of space, as frequent renewals will be
required. For commercial real estate property owners and investors the impact will be even greater. Among
other things, this proposal may jeopardize income property fundamentals, loan structures, property
valuations, financing covenants, and the underlying economics of commercial real estate – all during the
worst real estate crisis since the Great Depression.
Since 2010 IREM and CCIM Institute submitted several comment letters to FASB and IASB. Overall we
have asked FASB and IASB to delay any final decisions and collect more information about the substantial
problems the proposed lease accounting changes may have on the private sector. As a result of these letters,
FASB and IASB have delayed their initial implementation timeline. Furthermore, a coalition of non-profit
10
IREM and CCIM Institute 2012 Capitol Hill Visit Day Issues Briefing Paper
and commercial organizations (including NAR) funded a research project to determine the economic impact
of the proposed FASB and IASB changes to real estate operating leases.
The results of the study confirmed early estimates of having detrimental consequences for the American
economy. Of particular concern from the study is that the “proposed accounting standard would increase
the apparent liabilities of U.S. publicly traded companies by $1.5 trillion, the equivalent Gross State Product
of 20 states. Approximately $1.1 trillion of this would be attributable to balance sheet recognition of real
estate operating leases while the remainder would come from recognizing equipment and other leases as
liabilities.” Best case scenarios include a loss of “approximately 190,000 U.S. jobs and U.S. GDP would be
reduced by $27.5 billion annually.” Worst case scenarios include “a loss of 3.3 million U.S. jobs and the U.S.
GDP would be lowered by $478.6 billion.” The repercussions would not stop at U.S. businesses, individual
tax payers would also see a decrease in their household earnings.
POSITION: Despite these grave economic concerns raised by investors and businesses, FASB and IASB
have repeatedly failed to acknowledge the negative consequences could have on businesses, commercial
property, and the U.S. economy. Accordingly, accounting policy should reflect economic activity, not drive
it.
We oppose lease accounting changes that would treat the income producing real estate business as a
financing business on company balance sheets. Such a step would not accurately depict the unique
characteristics of the investment real estate sector and in turn discounts the usefulness of the industry’s
financial statements.
OPPOSING VIEWS: Some investors believe that capitalizing leases onto company balance sheets would
create more transparency in the marketplace.
STATUS: Responding to an outpouring of stakeholder concerns (from IREM, CCIM Institute, and others),
FASB and IASB this past fall agreed to exempt some commercial property owners from the new
requirements, stating that lessors would be allowed to measure their investment properties at fair value.
Unfortunately, commercial property tenants (lessees) would still be required to capitalize real estate leases
onto their balance sheets. FASB/IASB will likely “re-expose” or reintroduce their lease proposal by June
2012, with a 120 day comment period. While the potential exists for significant changes to the current lease
proposal, the two accounting boards remain split on alternative methods for lessee accounting for inclusion
in a new proposal. Both organizations are not expected to finalize the rules until mid-2013 and the likely
transition date could be pushed back to 2016.
11
IREM and CCIM Institute 2012 Capitol Hill Visit Day Issues Briefing Paper
ACTION: IREM and CCIM Institute urge Members of Congress to sign onto the lease accounting
coalition letter, which urges FASB to defer implementation until a comprehensive economic impact study
can be conducted to determine the economic costs the lease proposal. Also, ask your Congressmen to cosponsor H.R. 2308, the “SEC Regulatory Accountability Act,” introduced by Representative Garrett (R-NJ).
This bill would require the SEC to fully assess the economic impact of any intended regulation and adopt it
only on the determination that the benefits justify the costs.
More information about FASB lease accounting can be found here:
CoStar Group: Are Rule Makers Backing Off New Accounting Standards for Leases?
U.S. Chamber of Commerce: Proposed Lease Accounting Standards to Cost 190,000 Jobs and
Companies $10.2 Billion Annually
12