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Excerpt from recent S&P press release:

It’s become clear during the past few months–and especially in the past few weeks–that the problems facing the global financial markets and the U.S. economy have left the commercial mortgage-backed securities (CMBS) sector in a fundamentally weaker credit position. As a result, Standard & Poor’s Ratings Services is expecting an increase in the number and severity of CMBS downgrades in 2009 …

"Now that the U.S. is officially in a recession, and since commercial real estate performance typically tends to lag U.S. economic developments, we’re expecting property values to continue to drop and loans with marginal cash flow to default with increasing frequency," said credit analyst James Manzi. "We believe that borrowers with negative equity have little incentive to come ‘out of pocket’ to bring their payments current," he said.

Evidence of this malaise appears to be mounting: The delinquency rate has been increasing significantly, and Standard & Poor’s internal reporting measures show an acceleration in the volume of troubled loans, especially large loans. "Any current change in property prices is hard to measure accurately because of the marked reduction in transaction volume during 2008, but estimates we’ve seen indicate a decline of roughly 10%-15% from the peaks of early 2007. And the gap between offered prices and asking prices, in our view, signals that valuations must decline further to restart any meaningful trading activity," said credit analyst Barbara Duka.

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What is Capital Gains Tax? When a taxpayer sells assets that have been held for more than a year and one day (366 days) the taxpayer is subject to capital gains taxes.

The rates are currently as follows:

Long Term Capital Gain – Since 2003, the rate for Long Term Capital Gain has been 15% (lowered from 20%) for taxpayers in the 25% income tax bracket or higher. For taxpayers in the lower income tax brackets (10% and 15%), the rate has been lowered to 5% from 10%.

In 2008, the 15% rate has remained the same; however, the 5% rate has been reduced to zero! In order to qualify for this rate, a married couple may make no more than $65,100 annually or $32,550 annually for single filers.

These rates are scheduled to remain through the end of 2010 as outlined in the Tax Increase Prevention and Reconciliation Act of 2006. In 2011, the capital gain rates are scheduled to return to the previous rates of 20% and 10%. Although these rates are scheduled to increase to 20% in 2011, many experts believe the future tax rates will be changed more significantly due to the outcome of the recent Presidential Election. President-Elect Obama has stated that he is in favor of increasing capital gains tax to 25%.

State Rate – In addition to the Federal capital gains tax, each state has individual capital gains rates. In some states, there are no capital gains taxes (tax rate is determined by the state in which the real estate is sold). It is advisable to check with one’s own tax advisor to determine the appropriate rate.

Depreciation Recapture – There is also a 25% tax rate also known as Depreciation Recapture. This rate applies to the portion of real estate that has been depreciated.

In the interim, we will have to standby until Congress addresses the issues surrounding capital gains. Whatever the proposed tax changes may be, one of the best ways to successfully navigate around capital gains tax is simply to utilize a §1031 Tax-Deferred Exchange.

Compliments of:
Whitney Brennan
www.ncs1031.com

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1. Solutions Create Opportunity

   Solving problems for distressed investors will create prime investment opportunities.  Look for ways to provide workouts for distressed investments.  As loan terms mature, many properties will be unable to cover the debt service associated with new loans. Financing criteria has changed dramatically and will surprise many investors as they look to re-finance.  Large “vulture” funds are being formed for the sole purpose of raising capital to profit from distressed institutional grade investments.  On a smaller scale, attentive investors can capitalize on opportunities by providing solutions in their local market.

2. Cash is King

   Investors who have been disciplined and kept a healthy amount of liquid assets are now in a favorable position.Kelly Hugh, a well respected real estate economist says “There is such a volume of capital out there. I have three pictures I use in my talks, one is of Niagara Falls, one is the Sahara Desert and the third is the Hoover Dam. The argument is that for a long time we had a Niagara of capital, now people think we have a Sahara but we don’t. It’s a Hoover Dam. It’s all sitting back there. The question is; when does it get released?”

   Those investors who can move quickly and provide interim resolutions will come out ahead

3. Change Strategy from Growth Investing to Value Investing

   In recent years past, investors had a buffer that alleviated bad investment decisions.  Rent growth and appreciation seemed to remedy any ill-advised acquisitions.Now with rent growth and appreciation absent, property owners are forced to find new ways to produce the yield desired.  Strong asset management combined with tenant retention will help drive yield in existing properties.  New acquisition investments can take advantage of the upward trend in CAP rates.

4. Avoid Lowering Rents

   Commercial real estate values are tied to the income the property produces.  As retailers are struggling we will see more and more vacancies in the market.  Existing property owners should strive to minimize down time and re-tenant quickly.  Up-front incentives such as free rent and tenant allowances will help entice new tenants while maintaining your property value for the long-term.

5. “Buy into Fear, Sell into Greed”

   There is no arguing we are in a slowing market, however investors that seize the opportunity can turn this into a wealth-creation market. While the masses are standing on the sidelines there are unbelievable opportunities for a knowledgeable investor.

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A popular loophole to avoid paying capital gains taxes on sale of residential investment properties is coming to a close at the end of this year.  Previously an owner has been able to convert an investment property into a primary residence and later sell it to take advantage of the Homeowner’s Exemption under Section 121 of the US Tax Code.   The owner could exclude up to $250,000 ($500,000 for married couples filing jointly) of gain realized on the sale of a primary residence if the taxpayer had owned and occupied the property for two years out of the five year period preceding the date of sale.

New Rule

The rental use is now considered a ‘non-qualified use’ for exclusion from gain. The owners (sellers) will only get a prorated amount of the gain to qualify for exclusion. Gain is allocated to non-qualified use by dividing aggregate years of non-qualified use by total years the taxpayer owns the property.

Example: Assume a couple has a $600,000 gain on a house they have owned for 5 years. For the first 3 years the couple rented out the house and then moved into it using it as a primary residence for 2 years to meet the 5-year ownership requirement. They would have no exclusion for 3/5 or $360,000 of the gain on the sale. They can only take $240,000 of the §121 residential exclusion. This change prevents taxpayers from moving into their vacation home or rental property for only 2 years and then obtaining the entire exclusion upon sale.

Exception

This prorated formula applies only to non-primary (“non-qualified”) residential use that occurs before the property was last occupied as the principal residence of the taxpayer. This is a significant distinction.  Conversion of a primary residence to a rental does not preclude use of the full §121 exclusion.

Example: A taxpayer buys and lives in a home for 2 years. They move out and rent the home for 1 year.  The taxpayer is entitled to claim the entire §121 deduction. It also appears that the former provision allowing the taxpayer to utilize §1031 to defer any gain over and above the §121 exclusion remains intact.

Effective Date

Nonqualified use periods preceding January 1, 2009, are ignored. A taxpayer who placed a property into rental service in 1997 and converted it into a primary residence on 1/1/09 would be entitled to the full exclusion if they used it as their primary residence for 2 years prior to selling it.

As always, please consult our tax specialist and legal counsel for full details on how this could affect your specific tax situation.  Special thanks to Starker Exchange services for details on this change.

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Coldwell Banker Commercial has just released a national overview of the commercial real estate market for Fall 2008.  This report gives a good summary of the major indicators and trends that are affecting our local market.  Click here to download the report as a PDF file.

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The Spokesman Review is reporting on a planned expansion for Kootenai Medical Center in Coeur d’Alene.  The expansion is currently projected to cost $30 million and is slated to add 52,000 square feet.

Here’s The Dirt: Kootenai Medical Center to expand

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The International Council of Shopping Centers estimates nationwide retail store closures will total 144,000 in 2007, a 7 percent increase from 2006.  Although this a large number, in 2006 123,000 new stores opened and 139,000 closed.  New store opening have helped soften the effects of nationwide store closures.

There is no arguing that retail is presently a troubled sector with consumer confidence dropping and consumer disposable spending in negative double digits for 50 straight weeks.  The confidence confidence index serves as an important bellwether of consumer spending, which accounts for two-thirds of the U.S. economy and an essential economic driver for the retail sector.

Nationwide retail properties reported a vacancy rate of 7.8 percent in the Reis Inc. second quarter 2008 survey.  Locally we have seen a number of store closures, but nothing close to other troubled markets around the United States.  Starbucks recently posted the final list of approximately 600 company-operated stores in 45 states scheduled to close beginning this month through next March.  Our MSA has only one store scheduled for closure, the Starbucks located off Market and Garland in Spokane.

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A recent article in National Real Estate Investor gives insight on Standard & Poor’s March GRA Commercial Real Estate Indices.  Overall, national commercial property prices have risen over 5% from March 2007 to March 2008.  The strongest performing region in the month-over-month indice was the Pacific West region.  For more details, click on the link below.

Commercial Property Prices Still Gaining

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Deer Park looks to awaken - Spokane Business Journal

City approval of office tower is appealed - Spokane Business Journal

Big project planned in Rathdrum - Spokane Business Journal

Bankcda consolidating offices - CDA Press

Lounge aims to fill swanky void - Spokesman Review

Judge OKs county track purchase - Spokesman Review

Big projects eyed near raceway - Spokane Business Journal

Parker Toyota reconsiders expansion - Spokane Business Journal

Crown West plans project at SBIP, but sees slower growth - Spokane Business Journal

PARD will not take appeal to state supreme court - Daily Evergreen

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