Now that vaccines are rolling out there is hope on the horizon. However, CRE could still face another rough year. Here are four issues which may impact CRE in 2021.
There are 8,700 Opportunity Zones throughout the United States with approximately 10% of the population living within the zones.(1) The Biden Administration has several proposals to amend the Opportunity Zone program. According to President Biden’s campaign site these proposals include greater transparency on projects through data gathering.
Previously some projects that have been developed in Opportunity Zones have faced criticism for increasing profits for investors while doing little for the community the project was supposed to support. The original legislation contained no requirements regarding job creation or even data about the project so it could be determined if the project was beneficial to a distressed community. Some of these projects, for instance, included luxury apartment complexes or projects that were adjacent to an already affluent neighborhood. By increasing the data required on Opportunity Zone projects it would ensure the project is beneficial for the residents of the zone.
Another proposal includes requirements for community and or nonprofit organizations partnering with investors to ensure that the community is positively impacted. None of the proposals so far include any changes to the tax benefits offered in the program. These potential changes to the program have bipartisan support, much like the original legislation. Most agree the program needs more oversight to be successful.
The CDC eviction moratorium was extended by Congress in the last stimulus package until the end of January. President Biden signed an Executive Order his first day in office extending the moratorium until March 31. The original order was issued by the previous administration last September. While no one wants to see people get evicted from their homes during a pandemic, this move has been divisive to landlords and property managers.
Landlords, who are still paying mortgages whether their tenants pay rent or not, would prefer a larger stimulus package to help tenants pay their rent. According to the National Multifamily Housing Council, as of February 6, 2021, 79.2% of rent payments in the United States had been paid, leaving approximately 20% unpaid and that number doesn’t include single family rentals.(2) The issue is a complicated one. Some states had allowed evictions to continue, despite the moratorium. According to a study by public health researchers at several universities including UCLA and John Hopkins, it’s estimated that evictions led to over 400,000 COVID-19 cases and 10,700 deaths.(3) In February, a federal judge in Texas ruled the CDC’s eviction moratorium is unconstitutional. The lawsuit was filed by a group of property managers and landlords. The ruling stated that Congress lacked the authority to grant the CDC power to halt evictions and that the order violated state law. The ruling will likely be appealed, so there’s no action yet.
The December stimulus package contained $25 billion in rental assistance and Biden has another $25 billion included in his $1.9 trillion relief package. Most economists agree that a larger stimulus is needed to get the economy back on track and provide relief for people affected by job losses or illness from the COVID-19 virus. Landlords largely support the stimulus to help their tenants get caught up on rent. Currently, the stimulus package has been approved by the House of Representatives, but still needs to make its way through the Senate. It likely has enough support to pass, although procedural changes in the Senate could still delay it’s passing.
The policy proposal getting the most attention in the commercial real estate industry regards the Biden-Harris plan to eliminate 1031 Exchanges, which would impact real estate investors. The proposal includes eliminating the exchanges for investors making more than $400,000 annually. The additional tax revenue would provide money for other programs, including child and elderly care. The impact for investors could be huge. Exchanges are estimated to account for 6% of all commercial real estate sales volume and is estimated to cost the government between $2-4 billion annually in lost tax revenue.(4)
The exchanges benefit investors by allowing them to the use proceeds from the sale of a property to purchase another one without having to pay a capital gains tax, so long as the next property purchased is similar to the one sold. Critics of the exchanges argue that the tax can be shuffled around indefinitely, thus the government is missing out on sizeable revenues. Critics of this component to the Biden tax plan fear it would reduce liquidity, with investors holding on to properties longer and fewer investors willing to purchase property. With increased taxes to pay, owners would likely raise rents to cover the additional cost, thus impacting tenants.
President Biden has also proposed raising the capital gains tax rate from 20% to the income tax rate of 39.6% for those making $1 million or more per year. While some fear these changes could harm the commercial real estate industry at a time when it’s still on shaky ground from the pandemic, others argue that there will be only a short-term drop in sales. It will be important to watch this proposal and monitor the impact it might have if it passes.
The office and retail sectors are still facing considerable challenges in 2021. Even though vaccines are finally available, questions remain. How many people will continue to work from home, how many furloughed workers will return to work, and will consumers return to pre-pandemic shopping and dining patterns? Work from home is likely to persist in some form even after the virus threat wanes, which begs the question, how much office do companies need?
Some larger firms have already stated they’re fine with some or all employees continuing to work from home, which as leases expire, could lead to large office vacancies. Some companies who do decide to return to the office may opt for smaller buildings in the suburbs, leaving large vacancies in downtown office towers.
Retail also faces hurdles, e-commerce growth accelerated in 2020 to a level that wasn’t expected to occur for another five years. Retailers have been closing stores and adjusting footprints while increasing their e-commerce side of business. These two trends could lead to sizeable vacancies and lower property values. This is already apparent in malls. According to a study by Bloomberg of reappraisals of retail real estate properties with commercial mortgage-backed securities debt, the pandemic lockdowns caused a 60% decline in mall values, and that 118 properties were worth $4 billion less to investors than they were in 2019.(5) Both sectors are also at risk of bankruptcies. As a slew of retail bankruptcies have occurred resulting in vacant store fronts, this may be accelerated by the debt loads many took on to weather the pandemic. These risks could escalate bringing more properties into distressed status, thus devaluing certain assets and distinct submarkets.