Commercial real estate investment sales outlook: Alphabet soup or a double dip?

For those of us who thrive on high transaction volume, perhaps we'd best enjoy 2010 while we can. Commercial real estate may double dip, even if the general economy doesn't. We've all heard theories about where the economy is headed which revolve around letters of the alphabet. Will the recovery will be V, U, or W shaped? A "V"-shaped recovery is the most optimistic, with a strong, sustained recovery which, the argument runs, has already begun. Less ebullient "U" theorists predict a longer trough punctuated by short sporadic upticks, until a sustained recovery takes hold. Most anxiety-provoking of all the letter theories is W. The prospect of a 'W" shaped recession, in which 2010 represents a short-lived growth period followed by another period of negative GDP, before a sustained recovery, is a worrisome one. While we've enjoyed increased transaction volume this year, tax-clouds are gathering on the horizon. Commercial real estate, if not other sectors, may be headed for a relative decline next year. Even if GDP is able to show some growth, commercial real estate and investment sales may well experience the "W," or double-dip, all by itself. Will upcoming tax changes that now seem inevitable be a wet blanket for real estate? Here is not the place to argue merits (or otherwise) of these changes, but the affect may be dampening. At the beginning of 2011, federal, state and local tax rates are scheduled to rise sharply. There isn't space here to list all the tax increases planned at the federal level and further down the government food chain, but the triple-punch of federal income, capital gains and carried-interest tax changes are enough to make the point. Bush-era tax cuts are due to expire at the end of this year, at least for the top two income brackets, the expiry will very likely happen. The highest personal income tax rate will go to 39.6% from 35%, and the capital gains rate to 20% from 15%. In addition, as of the date of this writing, a provision to change the tax treatment of "carried-interest" income by investment partnerships sits on the Senate floor (HR-4213). If passed, it will result in tax hike that will discourage commercial real estate ventures. Carried-interest is the portion of a fund's investment gains taken by managers as compensation. It is proposed that this income, which is currently taxed at the capital gains rate of 15%, will be treated as a mix of ordinary income and capital gains (at the higher, 2011 rates). Increased carried-interest taxes may make new real estate ventures in 2011 less attractive. Have investors who have a choice shifted income and capital gains out of next year? I suspect that these impending hikes will have encouraged some investors to close transactions in 2010 that otherwise might eventuate in 2011. This may have given a boost to business in 2010, but it's one that may have to be paid for next year. Structures such as charitable trusts and charitable remainder trusts, structured sales and installment sale strategies to lessen the capital gains blow may see increased usage for sellers who do not want to buy more real estate (and take advantage of a 1031 exchange) in years to come. On the bright side, available product supply may be affected more than demand, in that there will possibly be even fewer properties available for sale because of transaction loading in 2010 to avoid higher taxation. Fewer available properties for sale will keep prices stable in the coming year. The possible slowing for individual investors will be short lived, as sale decisions are not made due to taxation changes, only the timing may be accelerated. The income and carried interest changes may re-orient real estate players back toward longer-term investments with focus on generating income, as opposed to the trading orgy recent yore. There is plenty of money to be made on fundamentals. Carol Ann Flint is a senior director at Besen & Associates, New York, N.Y.