Market Pulse: Berdon LLP
The past 12 months have seen some significant shifts in the New York real estate market, from the influx of foreign buyers and the rise of the high-end condominium market to the institution of the Affordable Care Act and the tax implications that legislation has on real estate investors. As co-managing partners of accounting and advisory firm Berdon LLP, Mark Bosswick and Stuart Kotler are required to have their fingers on the pulse of the market, and whether its keeping an eye on real estate investment trusts or foreign capital, the accounting professionals need to know where the market stands and, more importantly, where it’s headed. Messrs. Bosswick and Kotler spoke to The Commercial Observer last week about accounting trends and tax challenges expected in the New Year.
We’ve seen an influx of foreign capital into the U.S. real estate market, particularly in New York. What do you attribute that to?
Stuart Kotler: In the 1980s, you had an influx of capital from Asia, and I think the U.S. market is still attractive. Interest rates are low, and that has brought prices up.
Mark Bosswick: People feel, in a politically uncertain time, the U.S. is a safe place to put their money. On certain standards, New York is still cheap compared to other cities, like London.
SK: I think the concern you still have is interest rates worldwide. I think the U.K. will continue to keep rates low, and indications are similar for the U.S. All that leads people to believe that interest rates will remain low. Is it a bubble? That’s the $64,000 question. The commercial market is driven by interest rates.
From a tax perspective, we hear a lot about FIRPTA. Can you detail how that influences the foreign buyer market?
SK: FIRPTA causes the foreign investor to pay tax on the sale of real estate. It’s why you’ve seen a lot of foreign investors come through REITs, because the sale of the stock is not taxable. I think you’ll see that structure more and more so they can get their money out without paying a tax.
Are there other tax issues you’ve encountered with foreign buyers?
MB: Depending on where the capital is coming from, there are changes in terms of how a deal is structured between debt and equity.
SK: Foreigners that are not coming in through these private REIT structures might be treaty countries. There is a lot of planning involved. Some investors have treaty protection so you have to look at where they are housed; they may not need a private REIT.
There is some reduced taxation for treaty countries. I have an investor from Italy investing in the United States, so their investment in the U.S. is structured a little differently.
How do you work with foreign buyers?
MB: The interesting thing in the accounting industry is when you see these foreign investors buying a $40 million condo, they don’t have an infrastructure in this country, so we’ve been retained to do their tax work, to even be a de facto CFO for them or a family office. We can make payments, collect rent.
There has also been a lot of activity in the multifamily market. What do you attribute that to?
MB: The low interest rate environment in general. There is still a perception that the population in the New York area is growing and there is demand for housing. Foreign investors coming in on the high-end condo market is also driving the growth.
SK: When you look at the foreign buyers, I don’t think it’s the best for the city, because they’re not spending time or creating jobs here. I wonder how many actually live here for any length of time. But everything that is priced today is priced to build condos.
MB: The price of land in Manhattan in the past year has gone from $350 to more than $700 per square foot.
SK: When you look at that market, you’re really only able to build condos as opposed to rentals.
MB: The question becomes: As the interest rate environment starts to rise, will that have an adverse effect on real estate?
Will it have an adverse effect?
MB: I believe it will drive cap rates up again. Even though cash flow could rise, I’ve looked at models of properties where the effect of cash flow rising is arithmetic, but a change in the cap rate is much more powerful on the value of the property.
Much more equity is required today than a few years ago, and it’s really bringing more institutional money to the table. That’s just the way things have historically worked out for capital-intensive industries.
How will the Affordable Care Act influence the real estate market from a tax standpoint?
MB: If one is deemed a real estate professional, they save 3.8 percent on their real estate investment. This is a federal tax. It’s unfortunate, because it’s an increase in the cost of doing business. Many family owners that have had land for generations are now going to be paying almost 4 percent more in taxes.
How is one defined as a real estate professional?
SK: There are a lot of different permutations, but you need to work at least 750 hours in real estate, and that has to be 50 percent of your time. It gets complicated to structure, but you have to show 750 hours. You really have to be working.
Will there be an impact on the market based on the tax?
MB: It’s hard to say, but I don’t think so. The interest rate environment and supply and demand is impacting the market. It puts a premium on accounting, and for tax purposes, we’ve looked at ways to qualify activities to avoid the tax. There are unanswered questions, because it’s so new.
What are you seeing in the REIT market?
MB: From a market point of view, REITs are required to continue to do acquisitions, so REITs will buy where a family might not make that investment choice.
SK: You have to look at the cost of capital, which is effectively what their dividend yield is. If its 3 or 3.5 percent, people look at that as a pretty good investment today. Their cost of capital is low, and that helps them.
What is your outlook for the market?
SK: I think the market will continue to stay strong, and I think interest rates are going to continue to stay low for a while, and you’ll still have plenty of buyers, both U.S. and foreign, that want to own quality real estate in New York.
MB: The other thing is inflation. When it does kick back in, one of the beneficiaries is going to be real property owners, because it drives up real assets. Interest rates will impact the market, but as they rise, so will inflation, which will bring up the value of properties.
SK: It’s a tough balance that I hope the Fed gets right.