Donald Trump’s surprise win in the presidential election and Republican control of the federal government has left commercial real estate executives scrambling to digest the impact on the industry.
While it is too soon to say with any certainty what will happen with specific industry issues—in part because little was said during the campaign about policy matters of import to the industry, and what Trump said about many issues such as immigration was sometimes contradictory—clearly the end of eight years of divided government ushers in new direction for the economy and the regulatory environment.
For commercial real estate, that could mean a relaxation of regulations on financial institutions that have squeezed banks, an increase in infrastructure projects and lower taxes, all of which could lead to higher growth over the short term. Higher growth is largely positive for the real estate industry, but it could bring with it inflation and higher property yields and also erode the market discipline that has marked the recovery period. What’s more, Trump’s trade and immigration policies have the potential to undermine growth.
The commercial real estate industry has spent the last couple of years working out ways to operate under a stricter regulatory environment that was enacted in the wake of the global financial crisis via Dodd-Frank legislation and Basel III international banking accords. Now it’s unclear how much of that agenda will stand.
Because the regulations are extraordinarily complex and took many years to develop and implement, and banks have spent a lot of time adapting procedures to comply, market players largely expect that the relaxation of rules will be slow and measured.
“Wholesale repeal of Dodd-Frank or Basel III is procedurally challenging and does not seem to be the President-Elect’s first priority,” said Christina Zausner, vice president of policy and analysis at Washington D.C.-based trade group Commercial Real Estate Finance Council. Zausner said that the most likely outcome would be to delay or relax some of the changes that are scheduled to happen under Basel III.
However, predictions of incremental change may understate the degree to which Republicans have an ideological opposition to the regulatory burdens placed on the sector. House Financial Services Committee Chairman Jeb Hensarling, R-Texas, announced this week that he is talking to Trump’s team about repealing and replacing parts of Dodd-Frank. How much of Dodd-Frank and Basel III rules–which largely aim to put the U.S. banking system on more equal footing with regard to international bank standards–will be gutted is still to be determined.
The list of legislative issues impacting the industry is long, including the EB-5 program that grants green cards for foreigners that invest in U.S. real estate projects and national flood insurance that has to be reauthorized. On the tax front, carried interest, which allows partners in private investment vehicles a lower rate, and 1031 deferred tax exchanges, which allow real estate investors to defer taxes on capital gains if they purchase another property, could be on the chopping block. But the issue that might have the most direct impact on multifamily is the fate of the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. The GSEs guarantee covers almost all of the residential mortgages and nearly half of the multifamily mortgages originated.
Trump did not talk about housing finance leading up to the election. Republicans in general are less inclined to see the need for the GSEs to backstop the housing finance industry, but Republicans are not in agreement on a solution. In recent years, Idaho Senator Mike Crapo introduced a bill with Democrat Tim Johnson (former senator for South Dakota) that would involve a gradual wind-down of government involvement, while Hensarling has proposed legislation that would eliminate the GSE guarantee except as it relates to affordable housing. How easy it will be to eliminate the GSEs and what system will replace it is a big question, since virtually all home mortgages and a significant portion of multifamily mortgages originated today are backed by the GSEs.
Cindy Chetti, senior vice president of government affairs at the National Multifamily Housing Council, said the shape of GSE reform could depend on the identity of the new Treasury secretary. “We want to make sure that no matter how they go forward here, that they look at multifamily and understand its unique characteristics” relative to the single-family market, Chetti said.
One of the most disruptive elements to Basel III is the Fundamental Rule of the Trading Book, which requires banks to set aside more capital for securities that are held for trading, and set to be implemented in 2019. That has led banks to cut back on CMBS holdings, reducing liquidity, which has been blamed for being part of the reason CMBS prices dropped in 2016.
CMBS programs have been strategizing for the last year to figure out ways to comply with risk-retention rules legislated by Dodd-Frank that requires issuers of securitized bonds to retain 5 percent of the deal. Although the rule is set to take effect on December 24, a handful of CMBS deals have already been issued in which issuers retained 5 percent of the bonds, and investors have shown a willingness to pay higher prices for those transactions. “If they repeal and replace Dodd-Frank, clearly risk retention is part of the discussion,” Zausner said.
As important as individual issues are to commercial real estate, the performance of the economy is even more critical, since the market relies on growth and jobs to create demand for properties. In that regard, the market’s initial reaction is fairly sanguine. Economic growth has been consistent over the last seven years, with 15 million jobs created since the end of the last recession, but fairly subdued, with GDP averaging in the 2.0 percent range.
Trump’s policies seem poised to increase short-term growth. Plans to pass a $1 trillion infrastructure spending package, cut back on regulations that have moderated lending activity and reduce income and business taxes would inject a fair amount of fiscal stimulus into the economy. Certainly commercial real estate as an industry is likely to benefit from rebuilding the nation’s infrastructure.
Policies that might have a negative impact include trade and immigration. Trump has talked about increasing tariffs on foreign products, which would reduce trade and reduce demand for industrial real estate if it happened. To pass tariffs, Trump would need the support of GOP Congress, which historically has been in favor of free trade, so whatever happens in this regard would be an indicator of which wing of the party will control the legislative agenda.
Another potential negative is plans to deport illegal immigrants, not only because of the resources spent trying to identify and transport offenders, or build a wall on the southern border, but because immigrants increase the population and produce economic activity that factors into growth.
How investors react to Trump is critical to commercial real estate. Property values have grown steadily in recent years in large part because of low interest rates and the amount of capital that has flooded the market from investors seeking a safe haven. Tepid as it has been, U.S. growth has been higher than most developed economies in Europe and Asia and real estate has benefited from strong fundamentals with rising occupancy rates and rents and cautious development activity.
Again, it’s not clear how that will be affected by GOP rule. Trump’s choices for the Federal Reserve are likely to be more hawkish on raising rates, which is reflected in the fact that the 10-year U.S. Treasury yield rose about 50 basis points in the week after the election. That increases the cost of mortgage financing and could increase the yield (and reduce the price) of commercial properties, although historically the correlation between interest rate increases and property yields is weak. Spreads between property yields and Treasury rates have been near historical highs, so some of the increase in rates can be absorbed. And investors could bet that property incomes are set to rise, which would keep transaction yields low. Whatever the impact, it will likely differ depending on the property type and region.
The biggest factor in pricing, though, is investor confidence. Driven by strong performance, high dividends and relative value, commercial real estate has benefited in recent years from a huge amount of capital flow, particularly from outside the United States. Whatever uncertainty may come from the new regime, the United States still is likely to be considered more stable than the rest of the world by foreign investors.