REFinBlog

Editor: David Reiss
Brooklyn Law School

December 22, 2017

EggNoggin –> Light Bloggin

By David Reiss

Enjoy the holiday season!

December 22, 2017 | Permalink | No Comments

December 21, 2017

The Impact of Tax Reform on The Real Estate Sector

By David Reiss

photo by Sergiu Bacioiu

Congress passed the tax reform act on December 20, 2017 and President Trump is supposed to sign it by the end of the week. A lot of ink has been spilled on the impact of tax reform on homeowners, but less on real estate as an investment class. It will take lawyers and accountants a long time to understand all of the in ands outs of the law, but it is pretty clear that commercial real estate investors will benefit significantly. Most of the provisions of the act are effective at the start of the new year.

Homeowners and the businesses that operate in the residential real estate sector will be impacted in various ways (the net effect on any given taxpayer will vary significantly based on a whole lot of factors) by the increase in the standard deduction; the limits on the deductibility of state and local taxes; the shrinking of the mortgage interest deduction; and the restrictions on the capital gains exclusion for the sale of a primary residence. There are tons of articles out there on these subjects.

The impact on real estate investors has not been covered very much at all. The changes are very technical, but very beneficial to real estate investors. There are a couple of useful resources out there for those who want an overview of these changes. The BakerBotts law firm has posted Tax Reform Act – Impact on Real Estate Industry and the Seyfarth Shaw law firm has posted Tax Reform for REITs and Real Estate Businesses.

To understand the impacts on the real estate industry in particular, it is important to understand the big picture.  The new law lowered the highest marginal tax rates for individuals from 39.6% to 37% (some individuals will also need to pay unearned income Medicare tax as well). The highest marginal tax rate applicable to long-term capital gains stays at 20% for individuals. The other big change was a reduction in the corporate tax rate to 21%. Because qualified dividends are taxed at 20%, the effective tax rate on income from a C corp that is distributed to its shareholders will be 36.8% (plus Medicare tax, if applicable).

Benefits in the new law that particularly impact the real estate sector include:

  • REITs and other pass-through entities are eligible for as much as a 20% deduction for qualified business income;
  • favored treatment of interest expense deductions compared to other businesses;
  • Real estate owners can still engage in tax-favored 1031 exchanges while owners of other assets cannot; and
  • Some types of commercial real estate benefit from more favorable depreciation provisions.

While it is clear that real estate investors came out ahead with the new tax law, it is not yet clear the extent to which that is the case.

December 21, 2017 | Permalink | No Comments

December 20, 2017

Are The Stars Aligning For Fannie And Freddie Reform?

By David Reiss

Law360 published my op ed, Are The Stars Aligning For Fannie And Freddie Reform? It reads,

There has been a lot of talk of the closed-door discussions in the Senate about a reform plan for Fannie Mae and Freddie Mac, the two mammoth housing finance government-sponsored enterprises. There has long been a bipartisan push to get the two entities out of their conservatorships with some kind of permanent reform plan in place, but the stars never aligned properly. There was resistance on the right because of a concern about the increasing nationalization of the mortgage market and there was resistance on the left because of a concern that housing affordability would be unsupported in a new system. It looks like the leader of that right wing, House Financial Services Committee Chairman Jeb Hensarling, R-Texas, has indicated that he is willing to compromise in order to create a “sustainable housing finance system.” The question now is whether those on the left are also willing to compromise in order to put that system on a firm footing for the 21st century.

In a speech at the National Association of Realtors, Hensarling set forth a set of principles that he would be guided by:

  • Fannie Mae and Freddie Mac must be wound down and their charters repealed;
  • Securitizers need strong bank-like capital and community financial institutions must be able to compete on a level playing field;
  • Any new government affordable housing program needs to at least be on budget, be results-based and target actual homebuyers for the purpose of buying a home they can actually afford to keep;
  • The Federal Housing Administration must return to its traditional role of serving the first-time homebuyer and low- and moderate-income individuals.

I am not yet sure that all of the stars are now aligned for Congress to pass a GSE reform bill. But Hensarling’s change of heart is a welcome development for those of us who worry about some kind of slow-moving train wreck in our housing finance system. That system has been in limbo for nearly a decade since Fannie and Freddie were placed in conservatorship, with no end in sight for so long. Ten years is an awfully long time for employees, regulators and other stakeholders to play it by ear in a mortgage market measured in the trillions of dollars.

Even with a broad consensus on the need for (or even just the practical reality of) a federal role in housing finance, there are a lot of details that still need to be worked out. Should Fannie and Freddie be replaced with many mortgage-backed securities issuers whose securities are guaranteed by some arm of the federal government? Or should Fannie and Freddie become lender-owned mutual insurance entities with a government guarantee of the two companies? These are just two of the many options that have been proposed over the last 10 years.

Two housing finance reform leaders, Sens. Bob Corker, R-Tenn., and Mark Warner, D-Va., appear to favor some version of the former while Hensarling seems to favor the latter. And Hensarling stated his unequivocal opposition to some form of a “recap and release” plan, whereas Corker and Warner appear to be considering a plan that recapitalizes Fannie and Freddie and releases them back into private ownership, to the benefit of at least some of the companies’ shareholders. The bottom line is that there are still major differences among all of these important players, not to mention the competing concerns of Sen. Elizabeth Warren, D-Mass., and other progressives. Warren and her allies will seek to ensure that the federal housing system continues to support meaningful affordable housing initiatives for both homeowners and renters.

Hensarling made it clear that he does not favor a return to the status quo — he said that the hybrid GSE model “cannot be saved, it cannot be salvaged, it must not be resurrected, and needs to be scrapped.” But Hensarling also made it clear that he will negotiate and compromise. This represents a true opening for a bipartisan bill. For everyone on the left and the right who are hoping to create a sustainable housing finance system for the 21st century, let’s hope that his willingness to compromise is widely shared in 2018.

I am now cautiously optimistic that Congress can find some common ground. With Hensarling on board, there is now broad support for a government role in the housing sector. There is also broad support for a housing finance infrastructure that does not favor large financial institutions over small ones. Spreading the risk of default to private investors — as Fannie and Freddie have been doing for some time now under the direction of their regulator — is also a positive development, one with many supporters. Risk sharing reduces the likelihood of a taxpayer bailout in all but the most extreme scenarios.

There are still some big sticking points. What should happen with the private investors in Fannie and Freddie? Will they own part of the new housing finance infrastructure? While the investors have allies in Congress, there does not seem to be a groundswell of support for them on the right or the left.

How much of a commitment should there be to affordable housing? Hensarling acknowledges that the Federal Housing Administration should serve first-time homebuyers and low- and moderate-income individuals, but he is silent as to how big a commitment that should be. Democrats are invested in generating significant resources for affordable housing construction and preservation through the Affordable Housing Trust Fund. Hensarling appears to accept this in principle, while cautioning that any “new government affordable housing program needs to at least be on budget, results based, and target actual homebuyers for the purpose of buying a home they can actually afford to keep.” Democrats can work with Hensarling’s principles, although the extent of the ultimate federal funding commitment will certainly be hotly contested between the parties.

My cautious optimism feels a whole lot better than the fatalism I have felt for many years about the fate of our housing finance system. Let’s hope that soon departing Congressman Hensarling and Sen. Corker can help focus their colleagues on creating a housing finance system for the 21st century, one with broad enough support to survive the political winds that are buffeting so many other important policy areas today.

December 20, 2017 | Permalink | No Comments

December 19, 2017

What’s with 1031 Exchanges?

By David Reiss

photo by www.rentalrealities.com

US News & World Report quoted me in Why 1031 Exchange Investments Are Worth a Look. It opens,

With tax reform nearing final passage in Congress, one of the most underlooked, but potentially overpowering, tax-advantaged investment tools is the 1031 exchange, which was spared major changes in the proposed legislation.

The 1031 exchange, especially when related to real estate investments, is all about “timing and taxes” and the better you manage the two, the more money you can make.

What is a 1031 exchange? By and large, IRS Section 1031 covers “exchanges” or swaps of a specific investable asset (such as real estate) for another. The end game for the taxpayer/investor is to avoid having exchanges listed as taxable sales. But if they’re executed within the confines of a 1031 exchange, taxes are either significantly reduced or eliminated altogether.

The primary benefit of 1031 exchanges related to real estate investments is tax deferral, or avoidance of capital gains taxes on the sale of appreciated investment property, says Kevin O’Brian, a certified financial planner at Peak Financial Services, in Northborough, Massachusetts.
“If held inside owner’s estate at death, the asset would receive a step-up in cost basis to the market value, as of the date of death,” O’Brian says. “Therefore, heirs could avoid capital gains taxes, if sold after inheriting it as well.”
Others note that following IRS guidelines on Section 1031 are a must.
“1031 exchanges allow a real estate investor to sell one property that has appreciated in value and not pay capital gains tax so long as the investor buys another property,” says David Reiss, a professor at Brooklyn Law School. “This is a powerful tax deferral tool that many sophisticated real estate investors use. It is, however, somewhat complicated to pull off and involves some additional costs and planning so it is not for those looking for a quick and easy way to defer capital gains.”
What are the rules for a 1031 exchange? The rules governing 1031 exchanges have to be followed carefully and it makes sense to plan for it with an appropriate team of professional advisors and a reputable 1031 exchange company, Reiss says.
“Generally, the investor needs to sell the property that has appreciated in value; place the proceeds in escrow with an intermediary; and then use those proceeds to buy a replacement property within a certain period of time,” he says. “If the investor fails to follow the requirements for the exchange, he or she may be taxed on the full capital gain.”
Investors should also be sure to use a 1031 exchange company that meets specific criteria. “Not the least of which is that it’s properly insured to protect you in case your funds disappear from escrow,” Reiss says. “This has been known to happen.”

December 19, 2017 | Permalink | No Comments

December 15, 2017

People’s Credit Union v. Trump

By David Reiss

photo by Janine and Jim Eden

Twenty-one consumer finance regulation scholars (including yours truly) filed an amicus brief in Lower East Side People’s Federal Credit Union v. Trump, No. 1:17-cv-09536 (SDNY Dec. 14, 2017). The Summary of the Argument reads as follows:

The orderly succession of the leadership of regulatory agencies is a hallmark of American democracy. Regulated entities, such as Plaintiff Lower East Side People’s Federal Credit Union (LESPFCU) rely on there being absolute clarity regarding who is duly authorized to exercise regulatory authority over them. Without such clarity, regulated entities cannot be certain if agency actions, including the promulgation or repeal of rules and informal regulatory guidance, are actual agency policy or mere ultra vires actions.

This case involves a controversy over who lawfully serves as the Acting Director of the Consumer Financial Protection Bureau (CFPB or the Bureau) following the resignation of the Bureau’s first Senate-confirmed Director. The statute that created the CFPB, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), is clear: the Deputy Director of the CFPB “shall . . . serve as acting Director in the absence or unavailability of the Director.” 12 U.S.C. § 5491(b)(5)(B). Thus, upon the resignation of the Director, the CFPB’s Deputy Director, Leandra English, became Acting Director and may serve in that role until a new Director has either been confirmed by the Senate or been recess appointed.

Despite the Dodd-Frank Act’s clear statutory directive, Defendant Donald J. Trump declined to follow either of the routes constitutionally permitted to him for appointing a Director for the Bureau. Instead, Defendant Trump opted to illegally seize power at the CFPB by naming the current Director of Office of Management and Budget (OMB), Defendant John Michael Mulvaney, as Acting CFPB Director. Defendants claim this appointment is authorized by the Federal Vacancies Reform Act of 1998 (FVRA), 5 U.S.C. § 3345(a).

As scholars of financial regulation, we believe that Deputy Director English’s is the rightful Acting Director of the CPFB for a simple reason: the only applicable statute to the succession question is the Dodd-Frank Act. In the Dodd-Frank Act, Congress expressly provided for a mandatory line of succession for the position of CFPB Director, stating that the Deputy Director “shall” serve as the Acting Director in the event of a vacancy. Congress selected this provision after considering and rejecting the FVRA during the drafting of the Dodd-Frank Act, and Congress’s selection of this succession provision is an integral part of its design of the CFPB as an agency with unique independence and protection from policy control by the White House. The appointment of any White House official, but especially of the OMB Director as Acting CFPB Director is repugnant to the statutory design of the CFPB as an independent agency.

The FVRA has no application to the position of CFPB Director. By its own terms, the FVRA is inapplicable as it yields to subsequently enacted statutes with express mandatory provisions for filling vacancies at federal agencies. This is apparent from the text of the FVRA, from the FVRA’s legislative history, and from the need to comport with the basic constitutional principle that a law passed by an earlier Congress cannot bind a subsequent Congress. Moreover, the FVRA does not apply to “any member who is appointed by the President, by and with the advice and consent of the Senate to any” independent agencies with a multi-member board. 5 U.S.C. § 3349c(1). The CFPB Director is such a “member,” because the CFPB Director also serves as a member of a separate multi-member independent agency: the Board of Directors of the Federal Deposit Insurance Corporation (FDIC).

Plaintiff LESPFCU is seeking a preliminary injunction against acts by Defendants Mulvaney and Trump to illegally seize control of the CFPB, and it should be granted. As will be shown, LESPFCU has a high likelihood of success on the merits given the strength of its statutory arguments that the Dodd-Frank Act controls the CFPB Directorship succession. Unless the Court grants LESPFCU’s request for a preliminary injunction, LESPFCU will suffer irreparable harm because it will be subjected to regulation by a CFPB that would be under the direct political control by the White House that Congress took pains to forbid. Moreover, without a preliminary injunction, Defendant Mulvaney will continue to take actions that may place LESPFCU at a competitive disadvantage by creating an uneven regulatory playing field that favors certain types of institutions. See, e.g., Jessica Silver-Greenberg & Stacy Cowley, Consumer Bureau’s New Leader Steers a Sudden Reversal, N.Y.TIMES, Dec. 5, 2017. Nor will the President’s rights be in any way limited by such a preliminary injunction: the President remains able to seek Senate confirmation of a nominee for CFPB Director. All the President is being asked to do is fish or cut bait and proceed through normal constitutional order. The granting of a preliminary injunction is also very much in the public interest as it enables the controversy over the rightful claim to the CFPB Directorship to be resolved through an impartial court and not through a naked grab of power by the President.

December 15, 2017 | Permalink | No Comments

December 14, 2017

State of America’s Rental Housing

By David Reiss

The Joint Center for Housing Studies of Harvard University has released America’s Rental Housing 2017. I was a bit surprised that the report spent so little time addressing the types of restrictive zoning that depress the supply of new rental housing. Loosening those restrictions seems like a key component of any national affordability strategy for the rental sector. Some highlights of the report include the following selections from the Executive Summary:

After a decade of broad-based growth, renter households are increasingly likely to have higher incomes, be older, and have children. The market has responded to this shift in demand with an expanded supply of high-end apartments and single-family homes, but with little new housing affordable to low- and moderate-income renters. As a result, part of the new normal emerging in the rental market is that nearly half of renter households are cost burdened. Addressing this affordability challenge thus requires not only the expansion of subsidies for the nation’s lowest-income households, but also the fostering of private development of moderately priced housing.

Renter Household Growth in a Slowdown

Rental housing markets have seen an unprecedented run-up in demand over the last decade, with growth in renter housholds averaging just under one million annually since 2010. But the surge in demand now appears to be ending, with the three major government surveys reporting a sharp slowdown in renter household growth to the 136,000–625,000 range in 2016. Early indications for 2017 suggest a further deceleration, with one survey showing essentially no increase and another posting a substantial decline (Figure 1). While these estimates are notoriously volatile from year to year, the consistent trend across surveys provides some confidence that growth in renter households is indeed cooling.

*     *     *

Evolution of the Rental Supply

Soaring demand sparked a sharp expansion of the rental stock over the past decade. Initially, most of the additions to supply came from conversions of formerly owner-occupied units, particularly single-family homes, which provided housing for the increasing number of families with children in the rental market. Between 2006 and 2016, the number of single-family homes available for rent increased by nearly 4 million, lifting the total to 18.2 million. While single-family homes have always accounted for a large share of rental housing, they now make up 39 percent of the stock.

*     *     *

Rental Markets at a Turning Point

Rental construction led the housing recovery, rebounding nearly four-fold from the market trough in 2009 to 400,000 units in 2015— the highest annual level since the late 1980s. But after moving sideways in 2016, the pace of multifamily starts has fallen 9 percent through October 2017. The slowdown has occurred in markets across the country, but is most evident in metros where multifamily construction had been strongest.

*     *     *

Slight Easing of Affordability Pressures

With the economy continuing to improve and income growth accelerating, the share of renters with cost burdens (paying more than 30 percent of income for housing) fell in 2016 for the fourth time in five years, to 47 percent (Figure 5). The number of cost-burdened renters also fell for the second consecutive year, declining from 21.3 million in 2014 to 20.8 million in 2016, with the number of severely burdened households (paying more than 50 percent of income for housing) dipping from 11.4 million to 11.0 million. However, this progress comes only after a decade of steep increases. At the average rate of improvement from 2014 to 2016, it would take another 24 years for the number of cost-burdened renters to return to the 2001 level.

*     *     *

Shortfall in Rental Assistance

Need for housing assistance continues to grow. HUD’s Worst Case Housing Needs 2017 Report to Congress shows that the number of very low-income households receiving rental assistance increased by 600,000 from 2001 to 2015. Over the same period, the number of very low-income households (making less than 50 percent of area median) grew by 4.3 million, with extremely low-income households (making less than 30 percent of area median) accounting for more than half (2.6 million) of this increase. As a result, the share of renters potentially eligible for assistance and that were able to secure this support declined from 28 percent to 25 percent (Figure 6). Meanwhile, the share of very low-income renters facing worst case needs—that is, paying more than half their incomes for housing and/or living in severely inadequate units—increased from 34 percent to 43 percent.

*     *     *

Outlook

Slower growth in rental housing demand could be good news if it helps to check the rapid rise in rents. But even if the homeownership rate stabilizes near current levels, the number of renter households is likely to continue to increase at a healthy clip, driving up the need for additional supply. And given that a broader array of households has turned to renting, this also means a growing need for a range of rental housing options. (1-6)

December 14, 2017 | Permalink | No Comments