While at first blush immediate expensing appears to be a huge tax break, the honeymoon period would end with a crash when the write-off period ended.
The time may be right for comprehensive tax reform. However, certain proposals floating around Capitol Hill could do far more harm than good, drowning real estate investment and taking down markets across the country along with it. Congress should not attempt to fix what is not broken.
Particularly troubling are proposals to change the taxation of real estate investments by allowing investors to immediately expense the full value of improvements or buildings (land is not included). While at first blush immediate expensing appears to be a huge and unprecedented tax break—real estate investors would pay virtually no taxes in the first few years of the investment—the honeymoon period would end with a crash when the write-off period ended.
Nationwide, commercial real estate values have eclipsed their previous peak in 2007 by 23 percent. Real estate doesn’t need the stimulus that immediate expensing would create. Immediate expensing is akin to turning real estate into a speculative stock. Current depreciation levels are appropriate for this long-life asset class.
Under immediate expensing, the excess tax shelter resulting from the preliminary write-off could be used against other income and investments. This could cause a massive flow of capital into real estate, driving up real estate prices without changing the fundamentals. Bu the tax man would soon come calling, since immediate expensing’s rewards demand eliminating the depreciation deduction. The result? Taxable income that would exceed cash flow.
Immediate expensing would force well-financed investors into a pattern of flipping properties and trading up every few years to enjoy more tax shelter benefits. This cycle could not be sustained. Eventually, the real estate market, like Jack and Jill, would come tumbling down.
Real estate investment is no nursery rhyme or fairy tale. The health of the real estate industry affects every person across the nation who needs a place to live and work.
It is nearly certain that immediate expensing would create a bubble. We remember too well what happens when a bubble pops. All the wonder of this beautiful, fanciful creation dissipates in a heartbeat.
Bubbles burst when valuations get into realms that make no fundamental economic sense, or when investors run out of resources—usually when credit starts to tighten or when the rules change again. Aggressive tax incentives were put into place by Congress in 1980 to jumpstart the economy. With real estate in recession, depreciation schedules were cut in half. Real estate investors responded with alacrity, making investments on a gigantic scale. But it was too much of a good thing, creating a bubble of “see through” buildings that were built as tax shelters without regard to tenant demand, which was negligible. These buildings remained largely empty. Eventually, Congress lengthened the real estate depreciation schedule, correcting its mistake in 1986.
The party came to an abrupt end.
Congress’s actions triggered a major correction and decline in values. This was a contributing cause of the Savings & Loan crisis, in which thousands of financial institutions failed, requiring a government bailout of more than $125 billion, paid for by the taxpayers. In today’s dollars that would be $281 billion. Let’s not go there.
Stephen M. Breitstone is vice chairman of Meltzer, Lippe, Goldstein & Breitstone, based in Mineola, N.Y., and leads the firm’s private wealth and taxation group.
The intense vying for urgent care centers, surgery centers and other outpatient medical facilities is driving down cap rates in the sector.
When Physicians Realty Trust announced a purchase of 18 medical office facilities located in eight states for about $735 million last month, the Milwaukee-based REIT didn’t just sweep up prime properties. It won a round in the business of investing in medical office buildings (MOBs), which has become increasingly competitive.
The pending purchase includes the Baylor Cancer Center in Dallas, Texas. In a statement, executives with Physicians Realty described it as an on-campus medical office building consisting of about 458,396 net leasable sq. ft. At a purchase price of $290 million and after closing, the unlevered cash yield is expected to be 4.7 percent.
The intense vying for urgent care centers, surgery centers and other outpatient medical facilities is also driving down cap rates in the sector. Cap rates on MOBs tightened to 6.5 percent in the fourth quarter of 2016, after holding steady at 6.7 percent for the three previous quarters, according to the latest information from Revista, an Arnold, Md.-based property research firm that examines all out-patient medical properties. In its cap rate report, Revista examines a relatively small sampling of four transactions in four quartiles.
Its analysis found that tightening occurred for almost all segments of the market. Among the deals with the lowest reported cap rates in the fourth quarter of 2016, cap rates averaged 4.2 percent, down from 4.4 percent the quarter prior and 4.7 percent the year prior. On transactions in the 25th percentile, with the highest cap rates, cap rates averaged 7.0 percent, flat with the quarter prior. Median cap rates averaged 6.4 percent, down from 6.6 percent the quarter before.
The tightening is an indication of keen interest among domestic and international investors, all vying for purchase opportunities that seem too scarce.
“There has been a lot of demand,” says Hilda Martin, a principal at Revista. “A lot of new investment groups are entering the sector. There is more demand for less and less opportunity, and it’s just very competitive out there now.”
The private equity gaze
Private equity firms are a relatively new investor group that has been particularly eager to scoop up quality MOBs, according to Martin.
“They have historically been running at the $1 billion a year mark in acquisitions,” Martin says. “That has bumped up to $5 billion on an annual basis more recently. There is more interest—and they are not selling as much as they are buying.”
The recent upturn has been in place for about 12 to 18 months, Martin estimates. The interest among those companies is even prompting private equity firms to extend hold periods beyond the customary seven or eight years. The firms are drawn to the medical sector because it is a very stable segment. Medical practices tend to sign long-term leases and have stable occupancy and vacancy rates, too.
Private equity groups are not the only investor group circling the segment. Virtually all institutional investors, REITs, private capital investors and developers recently surveyed by real estate services CBRE indicated that MOBs meet their acquisition criteria, with 97 percent saying they preferred the property type.
The CBRE U.S. Healthcare Capital Markets 2017 Investor & Developer Survey was sent to investors and developers and received 91 total responses. Respondents indicated that:
- Their firms had allocated $14.9 billion in equity to healthcare real estate investment and development for 2017.
- The market cap rate for MOBs falls between 6.0 percent and 6.5 percent, according to 39 percent of respondents, making it the most aggressively priced property type.
- They are in the market to be net buyers, according to 78 percent of respondents.
- About 27 percent of investors and developers require a minimum ground lease of 60-29 years for an investment.
As for how cap rates are expected to move in the sector, the experts see more competition—and potential compression—ahead.
“A lot of companies are looking for sweet off-market deals that no one knows about,” Martin says. “That tends to be the sentiment when people are calling up, ‘Where can I find the opportunity?’”
Kilroy commented on the company’s recent leasing activity. He noted that Seattle and San Francisco are both in line for record leasing, “and that’s on top of five or six very strong years.”
CoreCivic, previously known as Corrections Corporation of America, provides corrections and detention facilities, government criminal justice real estate solutions, and residential re-entry centers.
New York-based Allianz Real Estate and Columbia Property Trust of Atlanta have formed a joint venture focused on acquiring and managing Class A office properties in select markets across the U.S. As part of the newly created initiative, the two firms have contributed three unencumbered properties with a combined gross asset value of $1.26 billion, located in San Francisco and Manhattan. The partnership plans to pursue additional prime office assets in top-tier locations.
Allianz contributed one of its Manhattan office properties to the joint venture. Valued at $220 million, 114 Fifth Ave. is a 352,000-square-foot office building that the company acquired back in 2015. Located in the bustling Flatiron District in Manhattan’s Midtown South, the 19-story property recently underwent a $45 million renovation effort and is fully leased to high-profile tenants such as MasterCard, First Look Media and Acxiom, according to Yardi Matrix data. The LEED Gold-certified tower includes 23,500 square feet of retail space and is managed by L&L Holding Co., which also holds a 1% stake in the property. As a result of the new venture, Allianz and Columbia each owns 49.5% of the Fifth Avenue property, with L&L Holding retaining its partnership stake. Allianz was advised by Cushman & Wakefield in the negotiations.
“In addition to an alignment of our investment strategies, the combination of our highly-experienced and knowledgeable teams of investment and asset management professionals will support growth in the portfolio of our joint investments over time,” Christoph Donner, CEO at Allianz Real Estate of America, said in a statement.
Columbia Property Trust contributed two prime Bay Area assets to the new joint venture: University Circle, a 451,000-square-foot Palo Alto office complex valued at $540 million, and 333 Market St., a 657,000-square-foot office tower in San Francisco’s Financial District, valued at $500 million. The Palo Alto property was acquired by Columbia in 2005, while 333 Market St. was purchased back in 2012. Columbia now retains a 77.5% stake in the two assets, with Allianz currently holding 22.5%. The New York City-based firm will increase its ownership stake to 45% within the next 12 months, while Columbia will continue to manage leasing and day-to-day operations for the two buildings.
“This partnership allows us to increase market presence without issuing stock or raising leverage, and we have found an ideal partner in Allianz, which shares our investment outlook and disciplined, long-term approach to investing,” said Nelson Mills, president & CEO of Columbia Property Trust.
The post Allianz, CXP Join Forces to Acquire Prime Office Assets Across the US appeared first on CommercialCafe.
Some argue that buildings with healthy features command up to a 20 percent rent premium over market rate, in addition to savings on operational costs.
Creating healthy workplaces is the next step in the evolution of office building sustainability. “Health is a key component to real estate for the long-term,” says Rachel McCleary, Urban Land Institute senior vice president, who heads the organization’s healthy buildings initiative. She points out that a healthy workplace requires a building to meet certain performance standards, and certification is based on testing.
The healthy workplace movement got a boost a few years ago when the U.S. Green Building Council (USGBC) partnered with the International Well Building Institute (IWBI) to streamline certification processes and minimize paperwork to achieve both Leadership in Energy and Environmental Design (LEED) and the WELL certifications simultaneously.
Launched in October 2014, WELL has registered or certified 450 projects, encompassing nearly 100 million sq. ft. of space in 27 countries, including 361 office projects.
“The rapid expansion of WELL worldwide underscores the fact that building and business developers, owners, and operators are taking notice of the need to harness the built environment as a tool to promote human health and wellness,” says IWBI President Kamyar Vaghar. He notes that IWBI is seeing increasing interest from core and shell building developers looking to achieve WELL certification, as well from tenants looking for buildings that facilitate a healthy fit-out.
WELL is an evidence-based system for designing, measuring, certifying and monitoring how buildings impact the health and well-being of occupants. It provides a 100 wellness features that impact 23 health pathways across seven concepts, including air, mind, water, nourishment, light, fitness, and comfort. Applicant spaces are evaluated for one year to ensure all necessary criteria are met before achieving certification and then are re-evaluated every three years for recertification.
In a 2014 Urban Land Institute study, which looked at the business case for developing healthy buildings, 13 developers reported that healthy buildings resulted in greater marketability and faster leasing and sales velocity, in addition to commanding higher rents than pro forma projections. They said the cost attributable to inclusion of wellness features represented a minimal percentage of the overall development budget.
An IWBI spokesperson told NREI that the cost to buildout the headquarters of Structure Tone, a New York City-based design firm, with WELL features came to less than $1 per sq. ft.
Dave Pogue, CBRE global director of corporate responsibility, who recently worked with a developer on a WELL-certified project in Vancouver, Canada, says that the cost to add WELL features to a building varies considerably, with ground-up projects usually costing less because healthy features can be incorporated into what the developer is already doing. For existing projects, the cost is determined by what types of features a building already has in place.
Developers Hines and Kilroy Realty are embracing the WELL standard for new buildings going forward.
Kilroy has started construction on its first WELL project, a $450-million, 680,000-sq.-ft. office campus at Mission Bay, a tech-centric master-planned community in San Francisco.
The Mission Bay project is a pilot for the company to demonstrate the value of WELL features, according to Maya Henderson, Kilroy sustainability manager. “This is a great place to start building this type of project into our portfolio going forward,” she says.
Hines’ first building to register for WELL is 609 Main in Houston, Texas, a one-million-sq.-ft., multi-tenant building, which is also pursuing LEED Platinum.
Designed architect Pickard Chilton, the exterior at 609 Main is composed of highly reflective glass curtain walls that change colors as the weather changes. But what sets 609 Main apart are details on the inside that pay attention to the health and happiness of occupants and enhance operational efficiencies for tenants, says Hines Senior Managing Director in Houston John Mooz, who oversaw the project’s development.
The building incorporates technology that provides continuous fresh air and natural light, in addition to managing energy efficiency and water conservation. Features include heat sensors that adjust room temperature according to the number of occupants in the room and an advanced under-floor air system.
The air system added $10 million to building cost, according to Mooz, but allows each employee to control the temperature around their own desk by delivering heating and cooling through individual portals in the floor around each workspace.
The building also has 3,000 sq. ft. of dynamic glass embedded with an electric current, in addition to floor-to-ceiling windows that provide natural light. The glass turns dark when the sun is high, shading building occupants.
“Our intent was to respond to the modern day workforce of Millennials with an amenity-rich, and tech-savvy environment,” Mooz notes. Additional amenities include a rooftop garden, an 8,500-sq.-ft. fitness center and a lobby concession stand that serves coffee in the mornings and drinks at quitting time.
High-quality buildings have higher resale values, according to Mooz, so the higher cost of adding WELL features is recouped over time. He notes that buildings with healthy features command up to a 20 percent rent premium over market rate, in addition to savings on operational costs.
He notes that 2017 was not the best timing to deliver one million sq. ft. of office space in Houston, as the market has been depressed due to the energy industry layoffs. Houston’s office vacancy reached a 22-year high in the first quarter, according to real estate services firm CBRE, at 16.8 percent, and is expected to rise to 17.5 percent by next year.
But despite unfavorable market conditions, 609 Main was 65 percent pre-leased before the building was completed in May.
“Demand for buildings that promote health and wellness has continued to increase among our tenants,” says Gary Holtzer, Hines senior managing director, global sustainability office. “The WELL Building Standard is one of the leading frameworks for measuring and certifying the impact of the built environment on humans and we want to help lead the charge.”
Hines has multiple office projects across the U.S. and globally that are being positioned for WELL certification, he adds.
“This is a new way the market is going,” says Evin Epstein, sustainability analyst at New York City-based NSL Green Realty. Her company, in partnership with Hines, is developing One Vanderbilt, a 1.7-million-sq.-ft. office tower under construction in Midtown Manhattan that is registered for both WELL and LEED Platinum certifications.
Epstein shares Hines view on the marketing advantages of healthy office space. She notes that LEED provides some elements that benefit health, but WELL has a much more direct impact on tenants, with better lighting and air quality and a host of other tangible features.
At One Vanderbilt, natural light will flood 80 percent of the building, maintenance will use only green cleaning products and a water filtration system is being installed.
Designed for the modern workforce, the building will also feature floor-to-ceiling windows, extra high ceilings and 360-degree views, in addition to best-in-class building systems.
CBRE’s Dave Pogue agrees that high-performance buildings have been shown to have benefits for both tenants and building owners. He notes, however, that the hope of developers is that WELL will give a project greater market advantage, but there are too few studies so far to know if this is true. “We do think the market is highly sensitive to this sort of thing,” he notes.
Anchored by international engineering, architectural and consulting firm Burns & McDonnell, the 272,941-square-foot office property is currently 81% occupied.
Lingerfelt will operate the building through its vertically integrated operating platform. Commonwealth Commercial Partners will handle property management and Avison Young will be in charge of marketing and leasing.
Jay Kraft, senior VP with Lingerfelt, stated: “Our company is excited to enter Houston at this time. We have been tracking the market and believe the basic fundamentals are strengthening. We look forward to exploring other opportunities and expanding our presence.”
Essex acquires, develops, redevelops and manages multifamily apartment communities on the West Coast.
Schall attributed Essex’s double-digit increase in funds from operations (FFO) in the first quarter to improved pricing power in the apartment REIT’s West Coast markets.
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