Economic Overview by the St. Louis Fed
Bank Economist and Research Officer Kevin Kliesen with the Federal Reserve Bank of St. Louis, 8th District, gave an overview of the U.S. economy and what to expect by 2020. He began by sharing the astonishing fact that since the end of the recession in 2009 private employers in the U.S. have added $20 million jobs, or about 200,000 per month.
All those new jobs have brought us to the point in which a shortage of labor, particularly in construction, is one of the strains on our economy.
The U.S. added 2.7 million new jobs last year and brought unemployment down to a 50-year low. GDP was 3.1 percent for the year – the best year in the U.S. since 2005. Inflation remains low – below 2 percent, and Kliesen expects it to remain so. If inflation holds at its current level through 2019 it will be the 8th consecutive year in which inflation remained below the Federal Reserve’s forecast, he said.
Forecasters expect Germany to slip into recession sometime this year, joining Italy, which is already in recession. That’s because Germany’s economy has relied heavily the last eight or nine years on the Chinese economy importing so many goods, machinery and material from Germany. Kliesen said China still claims its GPD is running around 6 percent but he thinks it’s closer to 3 percent.
Unlike many economists, Kliesen thinks there is a very low chance for the U.S. to dip into recession any time soon, leveling the risk at 20 percent. Since the end of the recession the Fed has raised interest rates 225 basis points and while many forecasters expect the Fed to raise rates once, and maybe even twice by 2Q2020, he said his boss – the President of the Federal Reserve Bank of St. Louis, James Bullard, has said he sees no reason why the Fed should raise rates in the near future. Accordingly, 30-year fixed home mortgages have dipped to 4.75 percent recently and by 2Q2020 Kliesen said home mortgage rates should average around 5 percent. He added that many forecasters believe the U.S. gross domestic product will be cruising as low as 1.5 percent by the end of 2020 but Kliesen thinks it will be higher.
Tax Cuts & Jobs Act Overview and Impact on Commercial Real Estate Investing
Terri Johnson, CRE, Co-Founder and Managing Partner with Capstan Tax Strategies, presented a detailed overview of the Dec. 22, 2017 Tax Cuts & Jobs Act (TCJA) enacted by Congress a little over a year ago. She began by describing it as the biggest tax reform in this country since 1986.
The biggest impact on real estate is the Bonus depreciation deduction, which allows investors to take the complete deduction of personal property and land improvements in the first year for an acquisition, renovation or new construction project, rather than taking the deduction over a 39-year schedule. A cost segregation study provides the data required to support this accelerated depreciation, resulting in significant tax savings.
The Tax Cuts and Jobs Act (TCJA) increased the Bonus depreciation deduction to 100% for properties placed-in-service between 9.28.2017 and 12.31.2022 and rates will subsequently decline. Qualifying assets no longer have to be new – they must just be new to the acquirer.
In addition to encouraging investment and property acquisitions, the power of the TCJA is making certain projects more attractive candidates. Johnson noted that the new law is sparking a wave of new interest in previously declined investments. Taxpayers and developers are taking a second look at deals that they passed on due to marginal ROIs. With the first-year 100% Bonus deduction in place, some of those investments might be well worth reconsidering, stressed Johnson.
Johnson moved on to discuss Opportunity Zones, established by the TCJA. Qualified investors must first form an Opportunity Fund (OF), or reinvest capital gains into a previously established Opportunity Fund, to invest in specific zones that the governors of all 50 states have designated. There are over 8,700 Certified Zones in all 50 states plus Washington, D.C., Puerto Rico and the U.S. Virgin Islands, and all are low-income areas.
Qualifying OZ properties must have “original use” with the OF, or the OF must substantially improve the property – major redevelopment opportunities. Capital gains can be put into funds to buy, develop or re-develop property in Opportunity Zones (OZ). From a tax benefit perspective, investing in OZs is a front-end, temporary tax deferral and the capital gains tax would be paid when the property is sold, exchanged, or by 12.31.2026, whichever comes first. Johnson said that the OZ factor is not a huge tax benefit, but it does step up the basis on most acquisitions. For example, if the taxpayer holds the investment for 5+ years, the tax burden on the original capital gains investment will be reduced by 10% and if held for 7+ years, the tax burden on the original investment will be reduced by 15%. The major tax benefit comes at the end if the asset is held for at least 10 years. The taxpayer is exempt from paying capital gains tax on the subsequent gain accrued from investment in the Opportunity Fund.
Crucially, “The real estate deal has to still make sense -- without the Opportunity Zone status,” Johnson said. She noted that OZ projects being improved must be completed within 30 months, and that this stipulation does add an element of risk to OZ investments. This window is subject to change and may be extended by the IRS.