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January 3, 2018

U.S. lawmakers have passed a historic overhaul of the U.S. tax system, a move that is likely to have a ripple effect across the economy.

The cornerstone of the bill is a reduction of the corporate income tax rate from 35 percent to 20 percent.

“Corporations are literally going wild over this,” said President Donald Trump while signing the bill at the oval office.

Should real estate investors be going wild, too? The Investor looks at five things the commercial property industry needs to know about the Tax Cuts and Jobs Act.

#1: Overall, this is good for commercial real estate
The tax cuts could give the U.S. economy a boost, in turn benefiting property markets.

The legislation could increase economic growth by 50 basis points of upside in 2018, according to Ryan Severino, Chief Economist at JLL.

“Stronger economic growth, even if marginal, would benefit the entire commercial real estate industry,” Severino said.

#2: It’s a big deal for REITs
Real estate investment trusts are often set up as pass-through entities, one of the biggest winners of the tax cuts.

A chunky tax deduction for REIT investors and owners is likely to boost after-tax income and attract investment.

Here’s how it works: Pass-through entities do not pay direct corporate tax, but instead “pass through” their gains and losses to the members who control the entity. In the case of a limited liability corporation, those members are the owners. In a partnership agreement, the income is distributed to individual partners in proportions specified by their partnership agreement.

The new law gives a 20 percent deduction on taxable income to pass-through businesses owned by individuals or partners who make less than US$157,500 and joint filers making less than US$315,000.

In pass-through entities that have investors, the deduction also benefits them. This means that the income REIT investors receive through dividends will also receive the tax relief. This makes it more attractive to invest in a REIT than in another vehicle that will be taxed at a higher rate.

Dividends from REITs were historically treated as personal income, with shareholders paying the top income-tax rate of 39.6 percent. Under the new tax plan, that rate drops to 29.6 percent, according to Nareit, formerly the National Association of Real Estate Investment Trusts.

#3: Housing shakeup could benefit multifamily investors
House prices could fall, particularly in high-tax states like California and New York, because the new legislation limits mortgage and property tax reductions. These provisions were fought fiercely by residential real estate groups.

“The new law is taking away most of the tax benefits of owning a home,” the National Association of Realtors said in an analysis of the final bill.

The uncertainty could provide a short- to medium-term boost to owners of multifamily properties, as homeowners may remain renters while they wait for prices to adjust, Severino said.

But apartment owners should not expect long-term changes. There will not likely be a true shift away from home ownership “solely because of tax policy changes,” he said.

#4: Office demand increase not guaranteed
Office landlords could stand to benefit should corporate tenants with lower tax bills decide to ramp up hiring, which would increase demand for space, Severino said.

However, it’s hardly a given.

“There is little empirical evidence to support the notion that tax cuts lead to increased hiring,” he said.

Even if hiring did increase, “a lack of qualified people to fill jobs remains the largest problem in the labor market,” Severino said.

#5: Household income boost could filter into retail and hotels
Some households will receive an income boost from the new law. And that money could find its way into shopping and hospitality.

However, a significant percentage of the tax savings will go to high-income households, which are more inclined to store away tax savings, Severino said.

Lower income households are more likely to spend tax savings, but will receive much less of a boon from the new bill. That should somewhat limit the impact on retail and hotels.

Click to read more about real estate investment in the United States.

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Ryan Severino

Chief Economist, JLL

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