By Jessica Fiur, News Editor
New York—As previously reported by MHN, in mid-September, President Obama proposed the American Jobs Act 2011, which aims to create more jobs nationally and stimulate the economy. The $467 billion bill includes a proposed carried interest tax.
“There should be nothing controversial about this piece of legislation,” President Obama said in a speech to Congress earlier this month. Of course, this almost never proves to be true when it comes to new bills, especially those that propose raising taxes.
Carried interest—a share of any profits that partners receive as a bonus, which works as an incentive to make sure the deal performs well, despite not contributing initial or personal funds to the initial deal—is often the backbone of real estate deals. Therefore, the proposed tax, if it is enacted, has the possibility of severely hindering new multifamily developments.
How could the tax affect the real estate industry? Developers might have to start weighing the risk of putting money into particular apartment communities.
According to Matthew Berger, vice president of tax, National Multi Housing Council, a tax increase on carried interest would “reduce rates of return applicable to real estate investment and impose the most sweeping and most disruptive new tax on real estate since the Tax Reform Act of 1986.” This could mean: “fewer deals will be done.”
And first on that chopping block might be affordable housing.
“Real estate valuations are integrally related to the high degree of and variety of risk types associated with real estate transactions,” Robert Seldin, CEO, NOVUS Residences, LLC, a Cafritz Interests Company, tells MHN. “Any additional tax burden placed upon real estate ownership and investment will require investors to reassess the risk/reward metrics associated with any transaction and to evaluate if the potential rewards still justify the palate of risks.”
And as developers find themselves backed up against the wall, they could fight back—at the expense of the industry.
“If there are no funds for [developing], then guess what, no deals will get built, especially in the high barrier to entry markets,” Clyde Holland, CEO, Holland Partner Group, says. “That means an under supply of housing and jobs that could have been created are not being created.”
Additionally, renters might end up bearing the brunt of a carried interest tax.
“As new taxes are simply additional operating costs, the property owners would likely try to pass the increased taxes through to the residents in the form of higher rents,” Seldin says.
“Pension funds, investment funds and institutional investors are putting capital into commercial real estate with the intent of gaining the returns they need to pay their retirement and dividend obligations,” Jack Kern, managing director, Kern Investment Research, LLC., says. “That is perhaps the most forgotten part of this. A great deal of the proceeds ends up being part of the total returns paid back to the core professional investment group. That level of investment gives both beneficiaries and retirees, as well as the risk-taking owners, a sufficient return to warrant the efforts necessary to build these performing property portfolios.”
Some feel it’s not just the real estate industry that could be affected by a carried interest tax. “The negative impact of the proposed legislation would affect venture capital, development of new medical products, capitalization of start-up companies, funding for IT development and the investment banking industry dramatically,” David Snyder, chairman and CEO, Continental Realty Advisors Ltd., says. “This is not just a partnership issue that relates to individuals. The scope of proposed regulation reaches out to both direct and indirect investment interests whether held by an individual, trust, partnership, estate, company, or corporation.”
However, not everyone is against the proposed carried interest tax—and its proponents are sometimes surprising sources. In an op-ed piece titled “Stop Coddling the Super-Rich” in The New York Times, Warren Buffett, CEO of Berkshire Hathaway, wrote “It’s time for our government to get serious about shared sacrifice.”
Still, those in the real estate industry remain leery of a carried interest tax.
“Changing the tax structure, to effectively transfer wealth back to the government is the worst kind of tax increase, since it not only is a legislated mandate, but fuels government spending,” Kern says. “We can’t solve the federal budget deficits by taking gains away from one of the most important sectors of the economy.”