Multifamily and Commercial Mortgage Market Liquidity



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.

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.

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.

More information about credit union lending can be found here:

Credit Unions: Member Business Lending

American Bankers Association: Credit Union Regulation

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 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 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

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.

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. (D-MI) 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 (R-TN) 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

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 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.

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 co-sponsor 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

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