WASHINGTON, DC-Carried interest, it appears, has been placed on the table in the ongoing negotiations between Congressional Democrats and Republicans and the White House over the budget deficit and the debt ceiling. The negotiations are expected to come to a head on August 2nd. Some Democrats and the White House, according to news accounts, want to change the tax characterization of carried interest, which currently allows hedge fund and private equity managers to pay a 15% capital-gains rate on their earnings. Republicans, not surprisingly, are against the move.
Carried interest also played a similar role in the negotiations over last year’s $848 billion tax cut package, but the proposal to change its characterization was eventually tabled. At least those negotiations were somewhat transparent--the budget deficit talks are being held behind closed doors, with the occasional partisan sound bite released to the media, leaving the commercial real estate industry to dark ruminations about what might emerge. Still, it is to be expected that carried interest would be on the table, Jeff DeBoer, the Real Estate Roundtable’s CEO and president, tells GlobeSt.com. Indeed in May, the Roundtable and Deloitte released a joint report on the tax issues most important to commercial real estate that were likely to become part of the negotiations. Besides carried interest, FIRPTA reform and the many elements that make up the tax extender package passed each session were identified.
“The likely place that everyone looks to are the issues that have been debated over the last few years and that includes carried interest,” DeBoer says. The fear of many observers now is with a looming Aug. 2nd deadline, the fine points of what this change could mean to the real estate industry might be overlooked in the rush.
Changing the tax characterization of carried interest “needs to be discussed in the context of an overall review of tax law and an conversation about capital gains, partnerships, economic growth and job creation,” says DeBoer. “It should not be dealt with in a narrow conversation.”
Which side will fold on carried interest--or even if someone has already caved--will not likely be clear for several days or weeks. What is clear, though, are the ramifications for the real estate industry if a deal is not reached, with carried interest as part of the package or not.
Rating agencies have warned that the US credit rating would be downgraded if a debt ceiling-related default were to happen. Standard & Poor’s said it would drop the US to the lowest rung on its scale--D--while Moody’s Investor Service said it would likely drop the US by three steps.
The impact will be far reaching starting with GSE credits and indirectly affecting the ratings of certain US corporates, banks and local and regional governments.
Also, short-term interest rates are sure to spike if there is a default, Carl Schwartz, chair of the commercial real estate practice at Herrick, Feinstein, tells GlobeSt.com. “That, in turn, would lessen demand for US assets among domestic and foreign investors, damaging the sales-investment market.” Leasing would also be affected as a by-product of less economic growth, he adds.
Of course it’s anyone’s guess whether the government will default, he says. “History tells us that in general, modest cutbacks in government spending are enough to trigger increases in the debt ceiling. But the country’s mood and the results of the mid-year elections may mean that this time--bi-partisan political theater notwithstanding--a default is in the offing.”
The good news, he said, is that so far, the pricing of US Treasuries seems to indicate that there will be an agreement to raise the debt ceiling. Also, if a default does occur there will certainly be unfavorable short-term ramifications for the commercial real estate market but the long-term effect will be less. “Unlike Greece and other countries that may simply not be able to pay debt service on their obligations, we have the means to meet our obligations,” Schwartz says. “Investors will probably get over a default more quickly if it was caused by a political stalemate rather than insolvency or illiquidity.”
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Erika Morphy
Erika Morphy has been writing about commercial real estate at GlobeSt.com for more than ten years, covering the capital markets, the Mid-Atlantic region and national topics. She's a nerd so favorite examples of the former include accounting standards, Basel III and what Congress is brewing.
