Even the most bearish economist is predicting that commercial real estate prices will fall up to 40 percent from peak to trough. However, the data released yesterday from Moody’s Investor Service shows that in April commercial property prices plummeted a record 8.6 percent. According to Moody’s data, commercial property prices fell a total of 29.5 percent from their highs in 2007. This leaves another 10 percent drop in prices if the most bearish economists are correct. In my opinion, much of this drop was due to a speculative credit bubble that caused commercial property buyers to purchase properties that would never produce a positive cash flow, even assuming a strong economy and strong demand for commercial real estate.

I believe that most of the declines in commercial property prices that can be attributed to the credit bubble have mostly taken their toll on prices. But, I surmise that we could experience an even greater decline in commercial property prices due the fact that the economy is fundamentally unsound. If one closely examines the fundamentals of supply and demand for the commercial property sector, the prospects for continued price declines becomes readily apparent, especially in the retail and office building sectors of commercial real estate.

Background to a Crisis

During the speculative credit bubble, developers built many more office buildings and retail stores than could possibly be sustained. Now that unemployment is in the double digits and major economic sectors like the automotive industries are going bankrupt there is less demand for commercial property. There have been many large, well known, retail brands either going bankrupt or severely cutting back growth projections. In a small city, near where I live, there are at least fifteen Starbucks. How many Starbucks stores can one small city support? Circuit city is out of business, Brandsmart may be next. Car dealerships are closing their doors around the country. These are all commercial real estate tenants whose absence can’t easily be filled. The list goes on and on. If so many large retailers are going out of business or curtailing operations then there will be even less demand for all of the vacant commercial retail space.

Commercial Real Estate Breakdown & Predictions

As local, state and federal governments go deeper into debt they will be increasing taxes even further on businesses and property owners. This means higher taxes for the owners of commercial real estate. If the costs to hold a property increase, then its intrinsic value must decrease.

I would challenge the 40 percent figure and would argue that prices could drop even more due to the dismal state of the economy at large. I would go the record to say that the commercial property sector could see real price declines of up to 70 percent from peak to trough. The worst might still be ahead of us.

Source: Reuters
Photo Credit: strangelv

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Tags: Commercial, commercial property, commercial real estate buying, commercial real estate prices, commerical property investing, Retailing

The  mortgage interest deduction, which has long been an untouchable pillar of the tax code for homeowners, is on the chopping block in President Obama’s 2010 budget proposal. The President wants to reform our healthcare system here in America and is proposing the mortgage interest deduction be capped at 28%. This would affect homeowners making $208,850 over the 2009 married filing jointly tax bracket income calculations.  The mortgage interest deduction has been in place since we had an income tax code. All interest used to be deductible but over the years, congress has whittled down interest deductions for non-businesses to only the mortgage interest deduction. That was done with the Tax Reform Act of 1986.  Several groups are up in arms about this proposal as the mortgage deduction is seen as a help for lower income folks to buy a home. Many economists however disagree that the home mortgage interest is all it is cracked up to be. In a recent blog post in the New York Times Economix Blog,  Harvard University Economics Professor Edward Glazer makes some salient points about the flaws of the mortgage deduction. He outlines 5 problems with the “conventional wisdom” of the deduction as a savior of the working class hero:

Problem #1: Subsidizing interest payments encourages people to leverage themselves to the hilt to bet on housing markets. The size of the tax benefit is proportional to your debt. The deduction essentially encourages us to make leveraged bets on the swings of the housing market. That leverage means that housing price swings can easily wipe people out. We are currently experiencing the consequences of subsidizing gambles on housing.

Problem #2: The deduction pushes up prices in places where the supply of new homes is constrained, as it is in many coastal markets. Economics 101 teaches us that if we subsidize demand where supply is inelastic then the only effect is to make prices go up. Housing supply is pretty constrained in places like New York City because of land-use restrictions and lack of land. In these places, the deduction doesn’t make housing more affordable. It just transfers money from buyers to sellers, and that makes little sense.

Problem #3: The deduction is wildly regressive. The tax savings for households earning more than $250,000 is 10 times the tax savings for households earning between $40,000 and $75,000 a year, according to recent research by James Poterba and Todd Sinai.

If there ever was a case for small-government egalitarianism, then this is it. Eliminating the home mortgage deduction and replacing it with an across-the-board tax cut would equalize after-tax incomes without a single new government program.

Problem #4: The deduction encourages people to buy larger, single-family detached homes, and that increases carbon emissions and pushes people out of cities. The deduction encourages people to buy more expensive homes, which are generally bigger homes.

Bigger homes use more energy. The deduction is therefore implicitly urging Americans to run higher electricity bills and spend more on home heating. If global warming is a serious problem, then the government should be encouraging us to live in smaller, not bigger, dwellings.

Problem #5: The home mortgage interest deduction is poorly designed to encourage homeownership, which is, after all, the alleged desideratum. Much of the interest deduction’s benefits go to richer Americans who are likely to own homes in any case.

Poorer people who are on the margin of buying and renting often don’t even itemize. My own research in this area found that when the value of the interest deduction rose, during periods of high inflation, there was no observable increase in the homeownership rate.

If the goal of the deduction is just to increase homeownership, then it would make far more sense just to give a flat tax credit to people who buy homes. If the credit was independent of home value, then this would eliminate the incentive to buy bigger homes. If the credit was independent of borrowing, then this would decrease the incentive to over-borrow.

I would like to hear from the Bigger Pockets community about their feelings on the mortgage deduction.What do you think?  Is it truly something we can’t live without?

(Image Courtesy of: Arizona Mortgage News)

Okay, so despite Josh and my best efforts, we only had 6 people answer our poll through twitter . Therefore, this is by no means a large sampling fit to discern the efficacy of the tax credit, but I liked the headline–Catchy isn’t it? Of those who voted, 4 said it would incent them and 2 said it would not.  Hey, if you are clicking through to the poll–feel free to vote. Maybe I can do a follow up with more data down the road. For now however, I will go into the nuts and bolts of the new $8,000 tax credit. This is not to be confused with the $7500 “tax credit” from last year.

A tax credit of up to $8,000 or 10% of the purchase price (whichever is least) for 1st time home buyers is at the heart of the 2009 American Recovery and Reinvestment Act (ARRA). If you want to know more about the impact of   the ARRA on real estate and financing, I have posted a story on my blog at Arizona Mortgage News. According to lending guidelines, a 1st time homebuyer is someone who has never owned a home, or someone who has not owned or co-owned a house in the last three years proceeding the date that you close on your 2009 purchase.

The tax credit is an attempt by the Federal Government to spur a flurry of home buying in 2009. The question is  will it? According to Lawrence Yun, chief economist for the National Association of REALTORS®,  homebuyers will purchase an additional 300,000 homes in 2009 as a result of the tax credit. “The impact will likely not be felt for at least three or four months, because it generally takes buyers that long to qualify for a mortgage and search for a home,” says Yun.

Here are some of the rules for the 2009 ARRA first-time homebuyers’ tax credit:

• Does not have to be repaid, unless the home is sold within three years
• Applies only to first-time homebuyers, defined as those who have not owned a home within the previous three tax years.
• Available only for homes purchased between Jan. 1, 2009, and Dec. 1, 2009.
• Restricted by income; phases out for individuals with an adjusted gross income of $75,000 or above and for married couples with a combined adjusted gross income of$150,000 or above
• Tax credit is for up to 10 percent of the purchase price.
• The credit can be taken on 2008 taxes even when the purchase is made in 2009.

According to the 2009 ARRA, the home you buy must be used as your primary residence. Sorry investors and second home buyers. According to IRS rules, houseboats, house trailers, cooperative apartments and condominiums are acceptable.

If you bought a home in 2008 using the $7,500 tax credit, you will have to repay that credit, or loan as it were, over the next 15 years with no interest. However buyers in 2009 will reap the benefits of the 2009 ARRA first time homebuyer’s tax credit by not having to repay the $8,000. You will have to pass most of the eligibility requirements imposed under the 2008 program and those listed above.

(Image Courtesy of Arizona Mortgage News)

Tags: ARRA, mortgage, real estate, Taxes

Cost segregation is a tax saving method that apparently has caught on with the opportunity sales people. I know I get a spam or two a week telling me I can make jillions of dollars by marketing cost segregation to the local business community. Since I receive so many solicitations I’m beginning to believe this tax cutting method has become diluted and now borders on farce.

I say diluted and borders on farce because I’m willing to bet the purveyors of this opportunity have driven the cost through the roof for the business person. I’m also thinking that if I was a businessman holding commercial real estate I’d already be using a CPA who knew about cost segregation. After all, when I studied accounting in college in the 1970’s we had to know about the lives of assets and the different depreciation schedules and write off periods.

It seems nothing has really changed except maybe the liberalization of some of the rules the IRS/Congress create regarding depreciation and its attendant write off periods. I could be wrong but I don’t think so.

The Essence of Cost Segregation

Cost segregation carves out shorter lived assets, which qualify for five, seven and 15 year write off periods. These are normally embedded in a building’s construction or acquisition costs. These would normally be depreciated over 39 years except cost segregation reclassifies these assets and accelerates the depreciation. This brings about tax savings and easier write offs when assets become obsolete.

For the life of me, wouldn’t your CPA or accountant already know this? Yes, if they stay on top of the latest changes to the tax laws. If they don’t, would you really keep paying them?

Back To Opportunity Or Hype

Since this method seems to work best only on properties valued at $1 million or more, it would seem to me the opportunity offering genre are selling a program that is behind the times and not exactly a money maker to the person who buys into the hype. Let me state that that is my opinion but it is based on what I know about the tax laws and the practitioners in the tax preparing arena.

If anyone has more detailed information on this opportunity as to how it really works ( I don’t mean cost segregation, I mean how you sell it), I’d like to hear it. After all, if it is for real, I’d venture the opinion there are business people willing to listen to the presentation.

Just my 2¢ on an opportunity in this wonderful world of real estate.

Photo Credit: tanakawho

Tags: cost segregation, real estate, tax

    
Tax the rich, tax the rich! We can have everything if we just tax the rich. One question: how do we define rich? Would the top ten percent of income earners be considered the rich? The top ten percent already pay 71% of all Federal taxes despite only earning approximately 39% of all pre-tax income. The top one percent could certainly be considered rich, let’s get them to pay! The fact is that they already do, 40% of all Federal tax dollars come from the top one percent of income earners.

There was so much talk on the campaign trail about redistributing wealth. Some were saying that we should model ourselves after many of the European nations in regards to the way they handle the haves and have-nots. I recently came across a column by Jonah Goldberg that talked about that very thing. It seems that we already redistribute more wealth than European countries like France and Sweden do. The article states that the bottom 40% of income earners receive more from the Federal Government than they pay in taxes, isn’t that spreading the wealth?

New Tax Form:

1. What did you earn? 
2. Send it in.

Socialism is a philosophy of failure, the creed of ignorance, and the gospel of envy, its inherent virtue is the equal sharing of misery.
-Winston Churchill

Tags: tax reform, Taxes, wealth redistribution

Welcome to Real Estate Tax Season!
In an article in the Wall Street Journal, Real-Estate Professionals Say IRS Snares Them by Mistake, we learn that the IRS is watching . . .

Given all the real estate investors and speculators who appeared during the fast fading real estate bubble-boom, the IRS has decided to look closer at real estate professionals. full-time real-estate professionals, defined as someone who spends more than half of his working hours in real estate and more than 750 hours a year tending to real-estate activities, can fully deduct losses — including depreciation, interest expense on loans and property taxes.

But those who don’t fit into that category are typically considered to be “passive” real-estate investors with a limited ability to deduct their losses, says Alan Weiner, a CPA and tax partner at the firm of Holtz Rubenstein Reminick LLP in Melville, N.Y.

Are you a full-time real estate professional?

Its time to hunker back down and kick this blog off with a bang! In our absence over the past week, the world has continued to turn, and inportant information has continued to emerge. We’re back and ready to bring it all to you!

Real Estate Bubble News:
Former Boom Cities going Bust
The Washington Post is reporting that in the final 3 months of 2006, sales fell in 40 states and median home prices declined in close to half of the metro areas surveyed. The biggest percentage decline occurred in Nevada, a drop of 36.1 percent in the sales pace in the final three months of 2006 compared to the same period in 2005. In other former boom areas, Florida saw sales drop by 30.8 percent, in Arizona sales were down 26.9 percent and they fell 21.3 percent in California.

Regional Real Estate:
Wisconsin Residents Could Face 4% Increase in Property Taces
Governor Doyle proposed as much as a 4 percent increase in property taxes in his State Budget address earlier this week. This courageous move should anger many residents, but will likely result in an improved fiscal situation for the cheese state.

Real Estate Radio:
NPR story Is Housing Market Squeezing Out the Middle Class? is worth a listen. In a time when minority homeownership is on the rise, find out why the middle class is in the big squeeze.

Real Estate Junk Rag:
Real Estate Agent & Husband Accused of running $12 Million Drug Ring
Drug agents in Fayette county, Georgia say ReMax agent Blanca Botello helped close the sale on at least a dozen homes used in the operation. The drug ring supposedly used the basements of these vacant homes to grow and traffic marijuana.