Approaching the Edge

Fall 2012

By now, anyone watching the struggles of the political class in Washington, D.C. in dealing with our national government’s deteriorating financial condition has heard pundits warn of the “fiscal cliff” awaiting us at the end of 2012 and into early 2013. The term, used by Federal Reserve Chairman Ben Bernanke, refers to the economic impact of expiring tax cuts, mandatory, across-the-board budget reductions, and another stalemate over raising the national debt limit. Discussions regarding this fiscal cliff invariably include calls for congressional action, and speculation as to whether it can realistically be accomplished in a post-election “lame-duck” session.

The Fiscal Cliff and Consequences of Inaction

Unless Congress acts, current tax rates, resulting from Bush-era tax cuts, expire at the end of 2012, raising rates on capital gains and investment income, estates and gifts, and ordinary income. The payroll tax cut championed by the Obama Administration will expire, raising payroll taxes from 4.2 to 6.2 percent. Nearly 30 million more families will pay the Alternative Minimum Tax, and the marriage penalty will return. Tax provisions which enjoy widespread support among business, such as the research and development tax credit, will expire. Known as “tax extenders,” because they are temporary and must be periodically extended by Congress, they include provisions important to NAIOP’s members, such as 15-year qualified leasehold improvement depreciation, expensing of brownfields remediation costs and New Markets Tax Credits. Apart from these tax increases, mandatory spending reductions of $1.2 trillion over 10 years, across government programs (known as “sequestration”), go into effect January 2013. This is a result from the failure of last year’s congressional “supercommittee” to agree on a budget deal.

Combined, the tax increases and spending cuts will result in about a $600 billion hit to an already sluggish economy. The Congressional Budget Office estimated that allowing the sequester to go forward would result in a contraction of the economy of 1.3 percent over the first half of 2013, with growth, for all of 2013, in gross domestic product (GDP) of a mere 0.5 percent. Essentially, the combined impact of the tax increases and the sudden reduction in government spending would result in a new recession.

Lame-Duck Dynamics

While some hoped that Congress would act prior to November’s elections, the physics of our political universe make it almost impossible for substantive legislation to be enacted before that time. Moves by both the Senate and the House over the summer are political posturing, designed to sharpen each party’s message going into the fall campaign, to define the opposition negatively, and to position for negotiations after the elections, in the lame-duck session of Congress.

If President Obama loses to Mitt Romney, then Republicans would almost certainly remain the majority in the House of Representatives. They will want to wait until the new president is inaugurated, rather than negotiate with an outgoing President Obama. The question becomes whether President Obama holds to his threat to veto any extension of tax rates, unless they include an increase for upper income taxpayers, or whether he would negotiate a deal extending some of his own policies before he leaves office. The most likely outcome will be that some current provisions are temporarily extended to give the incoming Romney Administration time to undertake broader changes.

If re-elected, President Obama will have added negotiating leverage by threatening to allow all of the tax cuts to expire. Each side will accuse the other of holding the middle class “hostage” in order to advance their agenda. Republicans, particularly concerned about the impact of sequestration on defense programs, are more likely to come under pressure from their own constituency to seek an accommodation with the President on taxes in order to get some cooperation on defense cuts.

Addressing all of these tax increases and spending cuts cannot be separated from the larger issues of comprehensive tax reform and modification of our federal entitlement programs. Realistically, such large and complex issues simply cannot be dealt with in a lame-duck session of Congress. The last rewrite of the tax code in 1986 was the result of years of hearings, legislative debate and bipartisan negotiations. Moreover, efforts to address federal entitlement programs will require buy-in from both Democrats and Republicans, which will require a lot of negotiation.

Prominent leaders of both parties are working on proposals for the lame-duck that would amount to a “big fix” on these issues; but passage is unlikely. What is more likely is another congressional “punt” on taxes and entitlements, delaying effective dates of sequestration and tax increases. However, the lame-duck will have consequences important to our industry. The congressional tax leaders in both the House and Senate have said that “everything will be on the table” in a tax reform debate. Tax provisions not extended by the lame-duck may very well be those destined for the cutting room floor in tax reform. 

NAIOP Participates in Congressional Real Estate Caucus

The “State of the Real Estate Industry” briefing held in July on Capitol Hill, and hosted by the National Real Estate Organizations (NREO), brought together nearly 90 congressional staffers and representatives, as well as industry experts, to discuss the current commercial and residential real estate environments and what will continue to drive recovery.

In a presentation to attendees of the Congressional Real Estate Caucus, Margarita Foster, vice president of knowledge and research for NAIOP, provided a commercial real estate update. David Crowe, chief economist and senior vice president of the National Association of Home Builders, discussed current conditions in the residential sector. 

Foster presented lease and sales data on office, industrial and retail products, commenting “The commercial real estate recovery is just beginning. Minimal demand against a backdrop of limited new construction is causing vacancies to decline, ever so slowly.”

According to Foster, “The demand for industrial space is stronger than demand for office and retail. Increased international trade flow, logistics operations, and inventory rebuilding among wholesalers and retailers have driven demand for warehouse and manufacturing facilities. Flex space has been favored by technology companies, especially start-ups in social media, and demand for office and retail space has been positive, but minimal.” 

Foster concluded that, “jobs, jobs, jobs are the fuel that feeds the real estate industry. As net new jobs are added to the economy, this will generate demand for real estate products. At this point, the commercial real estate industry is in a holding pattern, waiting for those jobs to materialize.”

David Crowe, chief economist and senior vice president of the National Association of Home Builders, expressed that residential markets are improving slowly as the inventory of new homes declines. 
Construction of new single-family units has been minimal and will not take off until the job recovery is more significant. Single-family starts reached 516,000 units across the U.S. in May of 2012, a 46 percent increase above the market trough posted in March of 2009. 

Multi-family housing starts have done better due to demand for rental units among individuals who are either not interested or unable to purchase a home. In the first quarter of 2012, 225,000 multi-family units began construction. That is up 174 percent from the low posted in the 4th quarter of 2009.

Hindrances on the residential sector include real income levels declining for all but the elderly, appraisals coming in below expected levels, causing some sales to fall through, and credit standards that are still very tight.

The coalition of organizations that comprise the National Real Estate Organizations (NREO) works to advance responsible government policies and an economic climate that fosters the long-term health, vitality and job-producing ability of our nation’s real estate industry. Through education forums and symposiums, NREO works with lawmakers to identify, analyze and develop policy recommendations supporting these goals.

Associated General Contractors of America
American Hotel & Lodging Association
American Institute of Architects
American Land Title Association
Appraisal Institute
American Resort Development Association
Building Owners and Managers Association
CRE Finance Council
International Council of Shopping Centers
Manufactured Housing Institute
Mortgage Bankers Association
NAIOP, the Commercial Real Estate Development Association
National Apartment Association
National Association of Home Builders
National Multi Housing Council
National Association of Real Estate Investment Trusts
National Association of Real Estate Investment Managers
National Association of REALTORS®
The Real Estate Roundtable