While the House of Representatives remains in Democratic hands, some Senate seats are currently too close to call. Both seats in Georgia could flip to blue after the January 5th runoff election. If that occurs, there would be a 50-50 tie in the Senate, with Democratic Vice President Harris casting the deciding vote.
In effect, the Democrats would then control both the House and the Senate. This could have a significant impact on policy, markets, the economy, and the commercial real estate industry.
In this article, we’ll take a closer look how President Biden and the Democratic Party could help or hurt commercial real estate.
Democrats and Commercial Real Estate
Let’s begin by asking – and answering – the $24,000 question: What affect would unified Democratic government really have on commercial real estate?
It’s a question that comes up like clockwork every election season, and one well worth considering in the event that the presidency and U.S. Congress turn completely blue.
In October, commercial real estate advisory firm Newmark Knight Frank (NKF) published The Impact of Elections on the U.S. Office and Multifamily Markets (White paper). Perhaps surprisingly, NKF found that one major political party having control does not have a significant impact on commercial real estate:
- Annualized returns over the past 40 years averaged 9.0% under Democratic presidents and 8.2% under Republican presidents
- Economic and geopolitical factors have more influence on the commercial real estate market than which political party controls the White House and Congress
It’s true that the most favorable policy changes affecting the office industry over the past 20 years occurred under a Republican-controlled Congress. But, that doesn’t necessarily mean Republican control caused the increase in demand for office space.
While politicians are keen to take credit for a strong economy when they’re in office, or blame their predecessor when the markets underperform, the fact is that the federal government tends to change at a glacial pace. For example, neither political party has proven to have a direct link to greater or weaker office fundamentals, according to NKF.
However there are two factors that will have a significant effect on commercial real estate investment today: Increases in consumer confidence with a stronger economy, and how quickly and safely the pandemic can be brought under control.
Bigger and Better Stimulus
Businesses and consumers prefer certainty. As a recent report from Bisnow noted, investors need a degree of public policy certainty to plan for the future.
President-elect Biden has promised to do all that he can to pass his $5.4 trillion economic plan once he takes office. The ultimate size and scope of his separate Covid-19 stimulus package remains to be seen, but has been estimated at around $3 trillion. But, over the next three months, there is still optimism that Congress will join forces to offer some immediate relief to the economy during the lame-duck session.
Biden’s transition team is starting talks over what priorities to pursue before January, and Senate Majority Leader Mitch McConnell is said to be taking the lead on stimulus talks to try and get a deal done.
In addition to bipartisan support of a bigger and better stimulus package, gaining control over Covid-19 is also essential to jump-starting the economy and accelerating the commercial real estate market. As Newmark Senior Managing Director of National Research told Bisnow, “In order to fully reboard offices downtown, we have to get a handle on the virus.”
Generally speaking, events outside the control of politicians tend to have a much greater impact on the macro performance of commercial real estate and specific asset classes.
As GlobeSt.com notes, there’s no greater externality to the commercial real estate industry than Covid-19 and the policies put in place to combat it. The economy and commercial real estate industry won’t begin to recover until there is a unified, nationwide solution to control the virus.
That’s why experts expect the Biden Administration to have a laser focus on controlling Covid-19, especially with cold winter weather arriving in much of the U.S., forcing people indoors where the virus can more easily spread. Efforts Biden and his new Administration may take include:
- An estimated $3 trillion plan that would include an extension of the small business support programs that have helped many tenants to make rent
- Persuade local governments in hot spots to temporarily close areas to contain the spread of the virus to avoid shutting down the entire national economy once again, which will create market-specific impacts on CRE
- Centers for Disease Control and Prevention (CDC) extending the moratorium on evictions set to expire in December 2020, potentially creating more financial stress of residential property owners and CMBS securities in the multifamily asset class
Many people believe that having a single party with majority control in Washington DC makes it easier to pass bills. To be fair, that isn’t always the case, particularly with the prospect of a 50-50 split Senate. The performance of the overall economy and commercial real estate market in our country is affected more by events that are taking place around the world than single-party control in the U.S.
CRE Tax Breaks
As the federal government attacks the virus and stimulates the economy, commercial real estate investors should also be prepared for the possibility of fewer tax breaks under the Biden Administration.
Changes to the cap on state and local tax breaks, 1031 exchanges, and opportunity zones could all come under renewed scrutiny, according to Commercial Observer and Bloomberg:
Under the Trump Administration, the deductibility of state and local tax (SALT) from federal income was capped at $10,000. While this hurt taxpayers in high-tax and expensive states such as New York and California, it was a boon to a state like Florida where there is no state income tax.
The SALT cap could be removed if Democrats regain control of the senate with Biden as president. However, many taxpayers may still be unable to fully benefit by deducting state and local income taxes from their federal returns, due to the alternative minimum tax. At the end of the day, low-tax states such as Florida will still remain a much more affordable places to live and invest.
Also known as a like-kind exchange, a 1031 exchange allows real estate investors to defer paying capital gains tax on the sale of an investment property by rolling the proceeds into another purchase. Bloomberg notes that the strategy is projected to save CRE investors $51 billion in capital gains taxes between 2019 and 2023.
During his presidential campaign, Biden promised to “tweak” the existing rules covering 1031 exchanges by limiting their use to people making less than $400,000 annually. The additional tax collected would be used to pay for his Administration’s $775 billion plan for child and senior care over the next 10 years.
Some tax experts claim that the benefits real estate investors receive from a 1031 exchange are difficult to defend. For example, the director of federal tax policy at the Institute on Taxation and Economic Policy (ITEP) recently said that “There are big real estate investors who are very comfortable with the idea that they don’t pay taxes . . . They think it’s shocking to think their industry would have to operate without a subsidy from the IRS.”
Of course, Section 1031 of the tax code has existed for decades, and many of the negative comments about tax deferred exchanges could simply be political posturing. The Tax Cuts and Jobs Act (TCJA) of 2017 signed by President Trump closed the loophole that allowed many industries to claim the benefit, while leaving it open for real estate investors.
On the one hand, reducing the benefits of 1031 exchanges would also disincentivize investment and remove liquidity from the commercial real estate market, and industry that is still reeling from the fallout of the pandemic in many parts of the country. On the other hand, cash may flow towards more productive real estate investments without the distorting affect of tax considerations.
Opportunity Zones (OZs) were created by the TCJA to encourage investment and economic development in blighted communities and underserved census tracts across the U.S. Real estate investors are allowed to defer taxes on capital gains that are invested in an OZ until the end of 2026, with any new gains from an investment held for at least 10 years becoming tax-free.
President-elect Biden has promised to reform the OZ program, although how is somewhat unclear. One reform could require Opportunity Zone investors to explain in detail how their investments are actually helping local residents.
There’s also the chance that the Biden Administration could end up expanding the Opportunity Zone program. By rolling it into a potentially massive 2021 stimulus program that creates public-private partnerships for infrastructure development and job creation using OZs as a platform, Biden could generate rare bipartisan support.
Infrastructure and Affordable Housing
Investors had high hopes that President Trump would be able to leverage his real estate development experience to boost infrastructure projects nationwide. As Commercial Observer reports, political infighting and controversies caused infrastructure projects to flounder.
While the Oval Office prepares for a new occupant, the pressing need for infrastructure improvement remains. Biden is open to discussing major projects such as retrofitting office buildings nationwide to make them more energy efficient, and partnering with private entities and state agencies on various infrastructure plans. The affordability of the latter proposal is unclear.
Biden also proposed a variety of affordable housing initiatives while campaigning for president. Among these is a proposal for a $100 billion affordable housing fund with $65 billion allocated for local housing authorities. Funding for Section 8 rent subsidies could also be boosted, helping to spur the development of affordable housing.
The federal government could also work to influence changes to local zoning laws that would allow for more housing development in general. Some affordable housing advocates have argued that issues related to zoning and new housing development need to be addressed at a national level, according to MarketWatch.
That’s because there is often little incentive for local municipalities to make changes. A loose alliance of NIMBYs (Not in My Backyard), preservationists, and incumbent homeowners wary of protecting their home values have successfully blocked upzoning proposals in cities like San Francisco, New York City, Seattle, and Los Angeles.
Biden Could be Good for Office Space
The Biden Administration is calling for $5.4 trillion in additional spending over the next 10 years. A recent U.S. MarketFlash report from CBRE shows Biden spending priorities focused on education, infrastructure and R&D, health care spending, and housing.
If enacted, all of these priorities could have a positive impact on the demand for office space:
- Expanded health insurance coverage will likely drive the demand for medical office space located closer to the consumer
- Spur the conversion of vacant retail space into office space
- Earmarked $1.6 trillion for infrastructure and R&D will further boost the demand for office and industrial real estate
Housing initiatives to increase residential development in suburban and secondary markets will create unique opportunities for residential real estate and office building owners, as people move to areas with a high quality of living and a strong job market
STEM jobs boost office space demand
One thing that all of the above drivers of demand for office space have in common is the growth of STEM jobs – science, technology, engineering, and mathematics.
At the end of last year, Tampa Bay ranked 4th in the U.S. for job growth and #1 in the State of Florida for the most employment growth. In fact, about one-third of the posted job openings in Tampa were for high-skill, high-wage STEM jobs, according to Tampa Bay Economic Development Council (Tampa Bay EDC) and Florida Politics.
Even without a multi-trillion-dollar stimulus package, the office market in Tampa Bay has been performing exceptionally well. As Florida Governor Ron DeSantis notes, Tampa Bay area leaders and various economic development boards are actively targeting STEM jobs with tax credit incentives and job training initiatives.
Private-sector industries have been relocating to and expanding in Tampa Bay due to Florida’s low taxes and reasonable regulations. Over the past year, the population of the Tampa Bay metropolitan area has grown by 1.66% while median household incomes have increased by 5.17%, far outpacing the national average (Data USA).
Stimulus Will Likely Boost Demand for CRE
The size and timing of future stimulus packages depends on which party ends up controlling the Senate.
If Republicans retain control, the Biden Administration’s ability to enact a stimulus program will likely be more constrained, even as Republicans are open to making a deal. On the other hand, a Congress controlled by the Democrats could generate a much higher level of stimulus, along with major changes to housing, health care, trade policy, and regulatory policy.
Regardless of what happens in January, much needed stimulus could have positive implications for commercial real estate demand.
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