From ICSC Website

U.S. lawmakers introduced legislation yesterday that would increase taxes on the percent of the profits investors collect from the deals their firms complete. The proposals to increase taxes on so-called “carried interest” are part a of larger attempt to reform the U.S. financial sector, but could end up hurting the commercial real estate industry just as it is trying to emerge from the worst recession for decades.

Specifically, legislators want to reclassify “carried interest,” which is currently treated as capital gains and taxed at 15 percent. Instead, carried interest would be considered ordinary income, subjecting it to a top tax rate of 35 percent, plus the 2.9 percent Medicare tax. This is likely to rise to 39.6 percent next year. Furthermore, the 3.8 percent Medicare tax included as a last minute addition to the health care will be added on top in 2013. Limited partnerships and liability companies are so common in real estate that the impact would be wide, observers say.

Carried interest — sometimes referred to as “the carry” — refers to the share of profits general partners of such institutions receive as compensation. Typically, general partners also take management, construction or leasing fees, though that is already classified as ordinary income.

Congress initiated the carried tax increase back in 2007 as a way to target perceived excess and abuses within equity and hedge funds. Many in the real estate sector will be unintentionally swept up by the new legislation if it passes, opponents say. If carried interest is taxed as ordinary income, general partners will owe billions more in federal taxes annually. The equity at risk for higher taxation is a traditional part of compensation at real estate development and management companies (which are often partnerships) and also for individuals in private deals, observers say.

Critics point out that most limited partnership managers are not overseers of private equity and hedge funds with billion-dollar returns, but rather more-modest partnerships in which the general partners have a stake in the form of capital investment, sweat equity and reputation.

“Here’s what will happen if this bill becomes law,” said Betsy Laird, senior vice president at ICSC’s Washington office. “Real estate values will be depressed immediately, transaction volume will drop. Risk will get riskier and certain projects our members once may have undertaken will no longer make economic sense.”

Lee H. Wagman, vice chairman of Los Angeles–based CityView, also takes a dim view of the proposal. “The proposal to reclassify “carried interest” as ordinary income instead of capital gains is tantamount to a tax increase on limited partnerships which will be a significant disincentive to take the kind of entrepreneurial risks that have been the hallmark of our industry. By dampening the motivation of real estate developers to undertake new deals, we will put a drag on one of the few robust job-creating sectors in the economy,” he said. “The proposal also makes what I believe is a false comparison between real estate partnerships, where the general partner assumes significant risks in providing things like loan guarantees, upfront risk capital, and carve outs to non-recourse provisions, and the typical private equity structure where the carried interest is much less of a reward for taking on these risks and capital obligations, if at all.”

The House vote on the measure is planned for Tuesday, with the Senate vote due May 28.

The timing could not be worse, says Michael P. Kercheval, president and CEO of ICSC. “Imposing this tax burden would be devastating at a moment when the retail real estate industry, one of the U.S. economy’s biggest drivers, is recovering after the recession,” he said. “ICSC is doing all it can to make legislators aware of the unforeseen consequences of this provision.”

Compiled by the staff of Shopping Centers Today. © May 21, 2010 International Council of Shopping Centers.

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Just as commercial real estate is starting to recover… Congress plans to drive a stake through its heart and raise income taxes from 15% capital gains rate to 35% ordinary income rate. Tell your U.S. Senators about the unintended consequences associated with the carried interest proposal.  Please call 202-224-3121 and ask to be connected to your Senators’ offices.  Visit http://lac.icsc.org/icsc/dbq/officials/ to look up your Senators.

Key Points:

  • The tax increase on carried interest proposed in the tax extenders package will have serious unintended consequences to local communities.
  • This proposal would be the largest tax increase on real estate since the 1986 Tax Reform Act.
  • This tax increase is likely to hurt economic redevelopment and job creation in our most economically deprived communities because it captures real estate development.
  • While the original target was private equity and hedge fund managers, this proposal will disproportionately impact the real estate industry because it will increase the tax on the general partner’s share of profits in a real estate partnership.
  • Unlike hedge fund and private equity firms, carried interest in real estate deals is not simply compensation for services.  Rather, it is the return for taking on the tremendous risks and liabilities associated with real estate development projects, such as environmental concerns, lawsuits, operational shortfalls, construction delays and loan guaranties.
  • This potential tax increase does not recognize the entrepreneurial risk and personal guarantees that the managing partner offers on behalf of the real estate partnership.
  • Quite simply, if this legislation is enacted, the managing partner’s incentive to take-on the risk is greatly diminished.  Projects with brownfield, mixed-use, or low income components will be most impacted by the carried interest proposal because they are the most risky.
  • This tax increase will also hit small to medium size developers the hardest.  These developers are already struggling with the current credit crisis, and this proposal will further limit available capital in the real estate market.
  • With the commercial real estate industry under serious strain due to current economic conditions, raising this carried interest tax on real estate will not only threaten economic development projects, but it will also jeopardize the related jobs that those projects create.

The Apartment Finance Today conference was a great opportunity to share ideas with the best and brightest in the multi-family investment, development and finance industry. The final session of the conference was a panel with three economists focused on answering the key question on everyone’s mind:

  • What are the best & worst nationwide markets for apartment investment?

If you would like to view these PowerPoint presentations they are available from the box.net widget on the right hand side of this blog or follow this link to the folder: http://www.box.net/shared/zmttpnc3hh

NOTE: These are not my work product, they were prepared by:

  • Sam Chandan, Global Chief Economist and Executive Vice President, Real Capital Analytics
  • Ryan Severino, Economist, REIS
  • Greg Willett, Vice President, Research & Analysis, MPF Research

I am back from moderating an all-star panel discussion at the Apartment Finance Today Conference in Fort Lauderdale, FL.

Our topic: “Small but Mighty: Finding the Best Small-Balance Apartment Loan” was well received by a full house of real estate investors and developers.  As sources of capital are becoming harder to find our panel of industry veterans provided input and guidance on why this is the greatest opportunity to acquire multi-family properties in a generation. Our panel focused on discussing the financing options for real estate investors that need up to $5 million to buy, build or renovate rental apartment properties.

We tackled the problems facing the industry head-on and shared ideas on how investors can find the best small loans at the most generous rates and terms. Underwriting criteria for portfolio lenders such as banks, insurance companies and private lenders was contrasted with Agency lenders such as Fannie, Freddie and FHA. Contrary to the myths perpetuated by the mass media there is still abundant capital available to owners, developers and investors focused on multi-family housing. This session hammered home the fact that long term, fixed rate loans with interest rates starting in the 4-5% range can still be achieved.

Panel included:

Jerry Anderson
Senior Vice President, Alliant Capital

Rick Wolf
Senior Managing Director, Greystone Servicing Corp

Charles Ostroff
Chief Underwriter, Arbor Commercial Mortgage

Michael McCleary
Associate Director, Marcus & Millichap Capital Corporation

Our presentation notes can be downloaded from the box.net widget on the right hand side of this screen or will be automatically e-mailed to you by sending a note to SmallButMighty5mm@gmail.com

And you learn that Hometown Democracy shifts many of the planning and zoning decisions from professionals that have spent a career working through the critical issues to all the voters. America was not founded as a Democracy with majority rule but as a Republic in which elected officials are selected by the people to study the issues and do what is best for their constituents.

The City of St. Pete Beach is the first city in Florida to select Hometown Democracy. It has been a nightmare. When individual voters are presented with potentially hundreds of referendums in each election cycle… nothing happens. The practice of “voting on everything” creates information overload. The result is exactly what the “Hometown Democracy” folks want to happen: no growth, no economic development & no new jobs. They have their own piece of paradise and they don’t want anything to happen in their backyard. They use the word democracy as a marketing buzzword and ask, “how dare someone not like Democracy? That’s like turning your back on motherhood and apple pie“.

Don’t let them distort the issues… please visit http://www.florida2010.org to learn more on this critical topic.

D.C.-area developer Jeff Neal gives the Huffington Post Investigative Fund a tour of empty commercial properties just blocks from the Capitol. He says we were, “drunk on a binge of easy credit and the bartender (the market) took away the bottle (credit).”

BLOGGER COMMENT: Private equity groups are looking to double down. They are building massive cash war chests to acquire properties from banks and distressed sellers for a fraction of replacement cost. Should the government create a false bottom or allow the market to find the true bottom where transactions can take place to eliminate the “Zombie overhang” on the market?

By David Repka

I’ve written in previous posts about the recent changes to the growth management laws that have eliminated traffic concurrency from every real estate developer’s worst nightmares (we think!).

Today I received a newsletter from a local land brokerage shop with a great overview on the new law.

Look to the right hand column labeled “box.net” and download or view the file labeled “Nye Newsletter”.