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Policy Issues Facing Commercial Real Estate

01/26/2012 | By Carisa Chappell

Major policy issues facing commercial real estate in 2012 range from reforming foreign investment regulations to taxation of Internet commerce, according to industry analysts.

In an interview with REIT.com, John Rayis, partner with Skadden, Arps, Slate, Meagher & Flom LLP, said proposed changes to the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) will most likely dominate the radar screen of real estate corporations.

FIRPTA taxes non-U.S. residents on sales of commercial real estate property in the United States. Under FIRPTA, the buyer is required to withhold 10 percent of the gross sales prices if the seller is from another country. As a result, the FIRPTA rules are discouraging non-U.S.investors from buying property in the country, according to Rayis. He noted that non-U.S. residents can sell stock in any other asset class besides real estate and not be subject to tax in the U.S.

"FIRPTA reform is going to be an enormous story," Rayis said. "I think it's critically important for the country to pass the reform. There are hundreds of billions (of dollars) in pent-up demand to invest in United States" commercial real estate.

Rayis added that FIRPTA was created in 1980 and was designed to discourage investment in U.S. commercial property from outside the country. "It has worked better than anyone can imagine to discourage investment in the U.S.," he quipped.

Tony Edwards, executive vice president and general counsel at NAREIT, said that while tax reform could become a significant issue potentially impacting all businesses following the 2012 elections, he agrees that FIRPTA will be a big story in the coming year.

"FIRPTA affects the entire commercial real estate industry," Edwards said. "What FIRPTA reform would accomplish would be to treat the sale of stock in real estate companies on the same basis as the sale of stock of companies in other industries."

REIT tax regulatory guidance will be another big issue this year, according to Rayis.

He noted that as the REIT industry matures, he anticipates that more non-traditional real estate assets types will enter the REIT space, as has been the case with timber, data-center and cell-tower companies.

"We expect to see REITs pursuing new types of investments and potential income streams in the coming year, with ongoing dialogue with the IRS as to the qualification of various mortgage-type investments under the REIT rules," Rayis said.

Both Rayis and Edwards also plan to keep an eye on developments in the mortgage REIT arena. While mortgage REITs are generally excluded from regulation as "investment companies" by the Investment Act of 1940, the Securities and Exchange Commission (SEC) has recently asked whether its long-standing interpretation of the 1940 Act's exclusion of real estate mortgages and interests in real estate should be changed or, at least, codified in public guidance.

Analysts have said that restricting the exemption would have serious implications for mortgage REITs in terms of leverage, legal liability and their ability to raise capital. Legislators and other stakeholders have cautioned the SEC against taking any action that would restrict the ability of mortgage REITs to continue to raise capital that will be essential for GSE reform and other purposes.

Even so, Rayis said he expects the sector to grow in 2012.

"With interest rates so low, I think that area is just tremendously promising," he said.

Edwards pointed out that other policy issues facing REITs and other real estate businesses include the collection of sales taxes. Currently, Internet and catalogue sellers that don't have a physical location in a state don't have to collect sales tax, though state law assesses a sale and use tax on the sale. Legislation known as the Marketplace Fairness Act would change that policy.

According to proponents of the bill such as NAREIT, online sellers have an advantage over brick-and-mortar retail shop owners that must collect state and local sales taxes on their sales.

In terms of regulatory issues, Edwards said the Dodd-Frank Wall Street Reform and Consumer Protection Act has a host of implications for NAREIT's member companies. Among them, NAREIT is urging regulators to ensure that end users of derivatives such as REITs do not have to clear their trades over clearinghouses or otherwise post additional collateral, driving up their cost of capital for business transactions.

In addition, NAREIT is hoping that proposed rules would be changed when finalized so that REITs would not be excluded from using a test intended to make it easier to securitize mortgages that meet strict underwriting standards.

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