Possible Changes to the 1031 Exchange Rules

Congress is again discussing implementing significant changes to or eliminating the 1031 exchange rule in efforts to reform the tax code.

The 1031 section of the IRS tax code (also known as a Starker Exchange) allows for the exchange of certain types of property deferring the recognition of capital gains or losses due upon sale, thus deferring any capital gains taxes otherwise due.

Washington’s attempt to simplify this portion of the tax code is shortsighted. Congress enacted the like-exchange statue in 1921 for three reasons: first to encourage active reinvestment, second to avoid unfair taxation of ongoing investments in property and finally for administrative convenience. The last ceased to be relevant to the underlying policy within several years after its passage.

Like exchanges have become not just important but an essential component in today’s commercial real estate markets often providing the needed liquidity to complete the transaction. Any changes to the code would have a devastating effect on the real estate market resulting in the substantial reduction of transactions and lack of desirability by investors to “actively reinvest” – a factor more relevant than ever in today’s global economy. Without active reinvestment and the incentives offered by the 1031 code – property and community development along with the resultant job growth as well as the overall benefit to the economy would come to an immediate halt.

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Hotel Development Market Overview – West Los Angeles

A review of studies conducted by PKF Hospitality Research and HVS Consulting has stated that Los Angeles County is one of the largest lodging submarkets in the United States. Due to the redevelopment of the downtown area of the City of Los Angeles, maintaining one of the nation’s largest international airports, a diverse local economy, as well as a significant entertainment presence has contributed to a strong lodging demand rebound following the recent economic recession.

The County lodging market experienced several challenges beginning in the 1990’s with the fluctuation of hotel supply, the rise and fall of demand generators and the increased competition in meeting and convention business from other regional metropolitan markets. HVS Consulting’s study determined that three Los Angeles submarkets have recovered very well from the recent economic recession and could be considered attractive markets for hotel development. These three submarkets are Downtown Los Angeles, Los Angeles International Airport Area and Westside Los Angeles.

The Westside submarket of Los Angeles County is one of the most affluent lodging submarkets consisting of luxury and high-end properties in the areas of Beverly Hills, Bel Air, Century City, Santa Monica and West Los Angeles. Hotels in these areas include a variety of nationally and international recognized brands and independent ones. These properties achieve the highest average rates of any hotels in the country. These hotels include the Beverly Hills Hotel, the Hotel Bel-Air, the Peninsula Beverly Hills and the Chateau Marmont. West Hollywood and Beverly Hills are considered the world headquarters for the entertainment industry generating a significant amount of lodging demand to the area. Additionally, demand in the market is also generated by various companies within the financial, legal, healthcare, technology industries, as well as an assortment of tourist and leisure attractions.

Due to the limited amount of developable space, hotel development in recent years within the Beverly Hills/Sunset Strip area has consisted of renovations or conversions of existing hotel properties instead of new ones. The more notable and recently completed conversions include the Tower Beverly Hills Hotel converting to the Mr. C at Beverly Hills in April 2011 and the renovation of the Hotel Bel-Air in October 2011. Three new hotels entered into the submarket – the Montage Beverly Hills in November 2008, the W Hollywood in January 2010 and the Shore Hotel in Santa Monica in October 2011. The one exception in new construction is the development of Sunset La Cienega, formerly known as Sunset Millenium that broke ground in 2014. This project by CIM Group, on the corner of Sunset and La Cienega Boulevards will have two 10 story towers with 296 hotel rooms and 15,000 square feet of retail space. There will also be two 8 story towers with 190 residential units with 55,000 square feet of retail. This site is on La Cienega and Alta Loma. Both properties will feature large pubic plazas and viewing terraces.

There are also several proposed luxury hotels projects: a mixed-use hotel development located at Sunset Boulevard and Doheny Drive, a proposed Waldorf Astoria, a proposed full service hotel in a mixed-use development along Wilshire Boulevard in Santa Monica, a proposed Hard Rock Hotel Los Angeles.

The strengthening economic conditions and the large number of demand orginators have resulted in a sharp rebound in lodging demand beginning in late 2010 through 2011. The Westside submarket continues to be one of the most desirable lodging locations not just Los Angeles County but the United States. Given the diverse demand base and the desirability of the area this submarket is anticipated to remain a strong area for hotel investors/developers.

Federal Reserve decides against rate increase

The Federal Reserve voted 9 to 1 on Thursday, September 17th not to raise interest rates. What does that mean for the US economy?

With the Fed not raising rates it is a clear signal that the economy is not in good shape. The Fed recognizes this and that was the determining factor for not increasing the rate. We have been at zero for over six years. With the inability to get decent returns on CD’s or money market accounts investors are forced to seek riskier products to generate higher rates of return. While the current Administration touts an unemployment rate of 5.1% it does not address the lack of labor participation, which is at its lowest rate since the 1970’s.

How does this affect the real estate market? The Fed is scheduled to meet two more times this year, October and December. In our opinion, it is unlikely that there will be a rate hike between now and the end of the year. We have been advising our clients since the beginning of the year to take advantage of the low interest rates and, if they haven’t already, refinance their properties immediately.

A more pressing issue is property assessments and taxes. With the low interest rates, driven by the liquidity provided by the Federal Reserve, property values are increasing. As such, state, county and local governments are seeking higher taxes to offset the deficits on their budgets, particularly due to their unfunded pension liabilities. Appeals need to be filed on a timely basis to contest the higher assessments.