Around the beginning of April, it became clear that an economic recovery would not be the V shape that many expected in the early days of the coronavirus. Instead, the outlook for the US commercial real estate sector, to say nothing of the overall economy, was utterly upended and research firms set about adjusting their initial expectations that the coronavirus would leave just a glancing blow on the industry.

A report from CBRE found that the US economy, which is now in a recession, will stabilize in the third quarter, start to recover in the fourth, and grow at more than 5% in 2021 due to pent-up demand and major government stimulus.

The US commercial real estate recovery will trail the economic rebound and span 12 to 30 months, depending on the sector, it said, with categories like industrial and logistics recovering within the year, and multifamily over 18 months. Retail, food and beverage and the hotel sector are facing a longer recovery of up to 30 months.

There will be no quick fix in the real estate industry, says Richard Barkham, global chief economist and head of Americas Research. "It will take several years for vacancy rates to fall back to their pre-crisis levels."

The experiences in China do provide some hope for the industry, Barkham adds. "We already are seeing signs of recovery in China's real estate market. Office-leasing inquiries in China are on the uptick, site-inspection volumes in Shanghai are back to 70% of pre-outbreak levels, and demand from tech companies for office space has been resilient."

The short-term, though, will not be pretty. CBRE foresees unemployment rising to above 11% by mid-year, registering a net loss of as many as 14 million jobs.          —Erika Morphy

CAPITAL MARKETS: Opportunistic Debt Funds to the Rescue

Amid the coronavirus many property owners are struggling and in need of a capital infusion. Gregory Freedman, a co-founder of real estate investment firm BH3, thinks opportunistic debt funds could provide an answer.

"There are certainly opportunities to get capital out there, which is always necessary in a recession," Freedman says. "That injection of capital is what gets people back to work and stabilizes the asset and the economy. If that hotel needs capital to hire back 400 people, a debt fund can provide that."

So, far opportunistic debt has flowed into places where securities trade publicly, such as CMBS. "You've already seen a bunch of that capital coming off the sidelines," Freedman says. "A lot of big-name firms have been buying up bonds. Those stock prices and bond prices had a substantial recovery after an initial dislocation."

With hard assets, capital has moved slower. "It's like turning a cruise ship," Freedman says. "This crisis has come on very quickly. If you're a landlord in any asset class, April 1st was your first month of collections during the crisis."

If tenants don't pay rent, Freedman predicts that in 60 and 180 days, opportunistic capital will move into hard assets. "The light switch just got turned off," he says. "There's zero cashflows. In fact, there's negative cashflow on assets like hotels and retail where your tenants aren't operating."

The situation was different in the Great Recession. In 2008, borrowers still had cash, but they were fighting to hold onto their assets. "They would fight you for two, three or four years in foreclosure and bankruptcy to try and hold onto that asset because it was their lifeline," Freedman says.

This time through, Freedman expects borrowers to try to work with lenders to get the latitude and the runway to hire people. "They need money for leasing commissions and improvement dollars for the next tenant, which is going to be at a lower rent," Freedman says.

The good news is today, unlike in 2008 and 2009, lenders are in better shape, according to Freedman. And there is money out there that can be deployed.

"In 2008, the financial markets were broken, and there wasn't liquidity," Freedman says. "Today, banks are generally healthy. The financial markets are operating and functioning. There's a lot of liquidity that can be redirected to opportunistic investing whether that's for debt or buying up properties. That, by and large, is a good thing."  —Les Shaver   

Exec WATCH

CBRE has expanded its corporate advisory team with the addition of Anya Ostry. Ostry joins the firm as first VP and as part of a 14-member team to focus on corporate occupiers.

REGULATORY WATCH: The Tax Provisions in the CARES Act Can Also Maximize Cash Flow

By Stephen Bertonaschi and Scott Drago

Although the economic stimulus provisions such as the small business loans and payroll tax deferrals of the Coronavirus Aid, Relief, and Economic Security Act have received much of the publicity, there are significant tax provisions that could have an almost immediate cash flow impact on commercial real estate entities. As is the case with any tax law that comes together in a matter of days (or even hours), there are often questions, and further guidance is needed. Despite the Internal Revenue Service's recent guidance , questions remain. Owners and investors, as well as REITs, are well advised to quickly take appropriate steps to obtain refunds, as many of the CARES Act provisions directly impact their businesses.

Interest Limitation and Bonus Depreciation
The 2017 Tax Cuts and Jobs Act created significant limitations on how much interest a business could deduct on money it borrows. For taxable years starting on January 1, 2018, and later, the limitation on deduction of interest expense for business entities is 30% of adjusted taxable income. ATI, a term defined in the Internal Revenue Code, is similar to EBITDA, which is used in financial reporting. One major exception to the interest limitation is provided for real property trades or businesses that were allowed to elect out of the limitation.

The one downside to electing out is that a RPTOB is required to depreciate real estate assets over a longer period under the alternative depreciation system. However, this "penalty" isn't so onerous because real estate assets would have to be depreciated over 40 years instead of the 39 years mandated under the general depreciation rules.

But there was a drafting glitch in the TCJA which caused nonresidential building improvements to be depreciated over 39 years instead of the 15 years under prior law. This also resulted in QIP no longer being eligible for bonus depreciation, which would normally result in a complete write-off of QIP acquired in a year. Note that QIP property is defined as any improvement made by the taxpayer to an interior portion of a building which is nonresidential real property. Such improvements do not include the enlargement of a building, any elevator or escalator work, or the internal structural framework of the building.

As a result, a RPTOB subject to the interest limitation had little downside to electing out of the rules. By opting out of the election, a RPTOB would be eligible to fully deduct interest on its borrowings, and the only cost would be to depreciate QIP over 40 years instead of 39 years.

For 2019 and 2020 tax years, the CARES Act increases the interest limitation to 50% of ATI for corporations and individuals. Although this change is not retroactive to 2018, if a taxpayer were no longer subject to the interest limitation when using 50% of ATI as the cap for 2019 and 2020, perhaps the taxpayer would not have made the RPTOB election in 2018.

In addition, the CARES Act redesignated QIP property to 15-year property, which makes it eligible for 100% bonus depreciation. This change is retroactive to January 1, 2018, and herein lies the rub: Property owners and investors that made the "irrevocable" RPTOB election in 2018 may have been better off not making the election, instead, taking 100% bonus depreciation on QIP and being limited on the interest expense deduction, because the additional bonus depreciation expense is greater than the limitation on the interest expense.

Last week the IRS issued Revenue Procedure 2020-22, which provides taxpayers leeway to revoke the RPTOB election by filing an amended 2018 tax return. In filing the amended return, the taxpayer could take advantage of 100% bonus depreciation on the QIP and revoke the election at the same time; the taxpayer thereby will be treated as never having made the election.

This still doesn't answer questions that came out when the TCJA was implemented. For example, would taxpayers be able to revoke the election for 2018 (to get the benefit of additional bonus depreciation) and then make the election in 2019, allowing all previous disallowed interest expense to be deductible? Or would the disallowed amount still need to go through the interest limitation calculation?

At the very least, taxpayers and their advisers will certainly have to put pen to paper to decide on the best course of action regarding the RPTOB election and QIP. And for partnerships, the change made by the CARES Act to the interest limitation complicates matters even more: For tax year 2019, the interest limitation percentage for partnerships is not increased.

Carrying Back NOLs
The CARES Act also provides corporations with the opportunity to carry back net operating losses from 2018, 2019 and 2020 for five years. One of the first ideas that comes to mind is that perhaps taxpayers could "supercharge" their 2018 NOLs (or create a 2018 NOL) by amending 2018 tax returns to take advantage of bonus depreciation on QIP. Alternatively, it may make sense for certain taxpayers to take advantage of bonus depreciation for the 2018 tax year by filing a change of accounting Form 3115, thereby taking the deduction in 2019. However, note that the corporate tax rate in 2019 is 21% versus the carryback years of 2013-2017 at 35%.

Thus, amending the 2018 tax return and carrying back the NOL will provide more bang for your buck.

In addition, the IRS issued Notice 2020-26, which allows corporations to use Form 1139 to carry back 2018 NOLs. Form 1139 provides for a "quick refund" with limited IRS review. The notice extends the due date for such forms to June 30, 2020. After that time, 2018 losses can still be carried back, but must be done so on an amended 1120X. The benefits of using Form 1139 include the ease of filing such forms and presumably getting money into the taxpayer's hands as quickly as possible. However, there may be delays in refunds, given the volume of anticipated claims.

Some intriguing questions also remain regarding

NOL carrybacks. Prior to 2018, there was still a corporate-level alternative minimum tax ("AMT"), but it was repealed with the enactment of the TCJA. It is difficult to conclude that there is no AMT NOL to carry back; surely that would not be the law's intent, as it would negate much of the benefit of the NOL carryback. However, even assuming there is an AMT NOL to carry back, under the rules provided for carryback years 2013-2017, the AMT NOLs would be limited to 90% of alternative minimum taxable income, resulting in an AMT due in those years.

This brings us to another change made by the CARES Act, which was to make minimum tax credits that are carried forward fully refundable in 2019. Additionally, taxpayers could, in fact, refund the entire credit on a 2018 amended return. Does this then require taxpayers to go through all the mechanics of filing different forms just to get the full refund?

The CARES Act made a second change to NOLs, which was to eliminate the limitation on NOL use for 2019 and 2020; under the TCJA, there was an 80% limitation on use of NOLs. Of course, this should be considered along with all the other changes mentioned above as taxpayers and their advisors work through their analysis.

Amended Partnership Returns
Finally, the IRS issued Revenue Procedure 2020-23, which allows an eligible partnership to file an amended Form 1065 and furnish a Schedule K-1 to each of its partners. The alternative to this would be for each partner to file their own administrative adjustment request. There are a couple of reasons to consider both options. First, if partners file their own AAR, such partners would take the adjustment in income during 2019 rather than 2018. Additionally, to the extent that a partnership is able to take advantage of bonus depreciation on QIP, for example, then it must consider that each of its partners will have to amend their Form 1065. A likely scenario may involve a corporate partner requesting that all partners invest to amend their 2018 K-1 so that the corporation can take advantage of the new carryback rules.

Stephen Bertonaschi is a senior managing director in the Business Tax Advisory group within the Real Estate Solutions practice at FTI Consulting. Contact Stephen at [email protected]. Scott Drago is a managing director in the group. Contact Scott at [email protected].