Recent news about major tax changes and proposed new legislation could have a significant impact on commercial real estate investing. These recent tax changes may have important new benefits to both commercial real estate operators and investors. This has spurred industry interest in other pending legislative and regulatory changes on the horizon in 2018. This article will explore the recent federal capital markets reform recommendations and the impact of recently passed financial services legislation to online real estate investing and fundraising.
Tax Cuts and Jobs Act of 2017
One of the biggest impacts to CRE will be a forced reconsideration of commonly practiced organizational structures in private equity real estate. Changing tax rates for corporations and pass-through entities will alter the bottom line profits for operators and force a re-evaluation between filing as a corporation or a partnership. Further, partnership entities, funds, and Modeled after mutual funds, a REIT (real estate investment trust) is a company that owns, operates or finances income-producing real estate. They allow individual investors to buy shares in commercial real estate portfolios.... More investors will be eligible to claim a 20% reduction for business related-income. As operators work with their CPA’s to determine ideal corporate accounting structures, they will also need to be prepared for upcoming capital formation changes that will expand their access to online fundraising channels.
U.S. Treasury Department Capital Markets Report
In October of 2017, Treasury Secretary Mnuchin released a Capital Markets report in response to an executive order on the Core commercial real estate investments are the least risky offering. They are often fully leased to quality tenets, have stabilized returns and require little to no major renovations. These properties are often in highly desirable locations in major markets and have long term leases in place with high credit tenants. These buildings are well-kept and require little to no improvements... More principles for regulating the United States financial system. Included in that report to the President were three JOBS Act reform recommendations that would expand commercial real estate firms ability to raise capital online:
- Allow Additional Categories of Sophisticated Investors to Participate in Regulation D Offerings. Broaden the “accredited investor” definition to include any investor who is advised on the merits of the investment by a fiduciary, such as an SEC or state-registered investment advisor. This would enable unaccredited investors to diversify their portfolio with private real estate assets when managed in coordination with their wealth manager.
- Increase Flexibility for Regulation A Tier 2. Recommends expanding Regulation A eligibility to include Exchange Act reporting companies and increasing offering limit raise to $75m. Increasing the capital raise amount will justify the added reporting cost with such an offering. Further, allowing REIT’s to access this vehicle will enable them to raise capital at a lower cost than conventional markets.
- Review Rules for Private Funds Investing in Private Offerings. Review Securities Act and the Investment Company Act provisions that restrict unaccredited investors from investing in a private fund containing Rule 506 offerings. Investing in private placement offerings reduce risk and provide diversification for portfolios for clients of any size. Unaccredited investors may be given access to real estate assets if they are accessed through a diversified fund vehicle.
The theme of expanding access to unaccredited investors is prominent through the report. The U.S. House of Representatives passed corresponding legislation to this report in May 2017.
Financial CHOICE Act of 2017
H.R. 10 sponsored by Financial Services Committee Chairman Jeb Hensarling addresses #2 above by legislating an increase in the Tier 2 offering amount. However, expansion of the unaccredited investor definition or new fund access were not included as passed. Hearings have been held in the Senate Committee on Banking, Housing, and Urban Affairs with no activity since July 2017.
Expanding the definition of investor accreditation would provide a significant influx of private capital to middle-market commercial real estate operators with greater fundraising consistency. It is yet to be determined to what extent the Capital Markets report will serve as regulatory blueprint for the SEC and where the Senate falls on the matter of expanding private placement access to all investors. Given the significant returns CrowdStreet sponsors are providing to investors, it is only a matter of time before these private real estate opportunities are made available to unaccredited investors. Of course, regulatory authorities and legislators are responsible for protecting unaccredited investors from bad actors and unbearable losses. However, private real estate assets provide necessary portfolio diversification with lower volatility than publicly traded REIT’s. These offerings, which are currently unavailable in an offline world, can be made available at low cost in smaller investment amounts given the advancement of direct online investment management technology. Regulatory authorities and legislative decision-makers should model their policy framework based on the success of online real estate syndication. They should look to platforms who are diligent about screening issuers, providing complete offering transparency, ensuring compliance and reducing regulatory burden through technological efficiencies.