Legislative and Regulatory Outlook

Reviewing 1996, Previewing 1997

Now that President Clinton has been re-elected and the Republicans have managed to hold on to Congress, it is time to examine the legislative and regulatory landscape for commercial real estate in 1997. Precisely handicapping future legislative activity is a dicey prospect at best, because legislation moves along a current that is subject to perpetual change. For instance, the capital gains tax cut that the House and Senate approved in 1995 was never enacted because Clinton vetoed it over a rift with Republicans about spending priorities. However, the flurry of legislative activity during the closing days of the 104th Congress in September 1996 demonstrated that significant legislation can pass when partisan rancor is put aside.

Although legislation gets wide attention, regulatory activity can have an equal impact on commercial real estate. New legislation can authorize regulatory bodies to promulgate the regulations that implement the law. Regulations can have a significant impact on commercial real estate.

1996 Review
Before examining what 1997 holds for legislative and regulatory activity, it is important to look back to the immediate past-1996. This will provide the framework for identifying what's left to resolve in 1997. In 1996, we saw advancements for commercial real estate in tax, business, environmental, and commercial finance issues, as the following details.

Tax Issues
Depreciation-Tenant Improvement. H.R. 3448, the Small Business Job Protection Act, signed into law last August, allows property owners to deduct the nonamortized lease improvement costs when a tenant vacates. (See this issue's "Tax Watch" column, "Accounting for Tenant Improvements," page 6, for a more detailed discussion of the implications of H.R. 3448.)

Health Care Deduction for the Self-Employed. H.R. 3103, the Health Insurance Portability and Accountability Act of 1996, increases the insurance deduction for the self-employed, in stages, up from the 30 percent deduction that went into effect in 1995. The act allows deductions of up to 40 percent in 1997, 45 percent for 1998 through 2002, 50 percent in 2003, 60 percent in 2004, 70 percent in 2005, and up to 80 percent in 2006 and beyond. This will significantly lower health insurance costs for self-employed real estate practitioners.

Business Issues. The Small Business Job Protection Act also contains 11 provisions simplifying and adding flexibility to the Subchapter S corporate structure, notably increasing the number of shareholders allowed from 35 to 75, which will create greater flexibility for Subchapter S real estate organizations.

Multifamily Housing. Despite efforts in 1995 to terminate federally insured multifamily housing programs, Congress approved the fiscal 1996 Omnibus Appropriations Act (H.R. 3019), which provides appropriations for a demonstration mark-to-market, multifamily debt-restructuring program. Congress also approved H.R. 3666, the U.S. Department of Housing and Urban Development's fiscal 1997 budget, renewing the debt-restructuring demonstration program and extending expiring Section 8 rental contracts-on low- and middle-income properties with federal rent subsidies that many real estate practitioners own and manage-for another year.

Unfunded Mandates. Under the Federal Mandate Accountability and Reform Act of 1995, the Congressional Budget Office must issue analyses for bills that impose federal mandates on state and local governments of more than $50 million and for mandates that impose more than $100 million on the private sector annually.

The act provides greater stability to the commercial real estate market because the federal government's ability to impose costly mandates, such as environmental mandates, will require congressional approval.

Analysis must include a mandate description, its expected cost to state and local governments, and whether it is partially or entirely unfunded. Legislation creating a federal funding mandate without providing funding or specifying the funding source requires a separate majority vote in order to be allowed.

OCC Regulations. The Office of the Comptroller of the Currency (OCC) has proposed regulations that implement Section 347 of the Riegle Community Development and Regulatory Improvement Act of 1994 to extend the Secondary Mortgage Market Enhancement Act to banks and thrifts for the purchase of commercial mortgage-backed securities (CMBS). However, the provision was opposed by industry groups because the 5 percent diversification test would prevent banks from purchasing more than 50 percent of the CMBS that had been issued. Subsequently, the OCC indicated that these provisions would be dropped from the final regulations, which were expected in December 1996.

Superfund Clarification. Clarification of lender liability under the federal Superfund law was adopted as part of the 1996 Omnibus Spending Bill. Lenders are not liable under the federal Superfund law if they did not participate in polluting a property or did not manage the firm that caused the pollution. Just holding a financial interest or owning a property through foreclosure will not make the lender liable.

Bank Insurance Fund/Savings Association Insurance Fund. The savings insurance fund was capitalized, and interest on federal bonds used to finance the 1980s' thrift bailout was allocated between banks and thrifts as part of the 1996 Omnibus Spending Bill. At issue was the insurance premium disparity between banks and thrifts. Now Congress can address the issues associated with thrifts converting to banks and the future roles these lenders will play as providers of mortgage credit.

1997 Outlook
Clearly, commercial real estate experienced some significant victories in 1996. Nonetheless, major issues such as tax reform were left for 1997.

Tax Reform
Capital Gains. Reducing capital gains taxation would provide a dramatic boost to the commercial real estate market. In 1995, Clinton vetoed the 1995 Balanced Budget Reconciliation Act, which would have provided a 50 percent exclusion for capital gains income. In 1997, capital gains tax reform will be centered on residential real estate. Clinton pledged to exempt the first $500,000 capital gain on the sale of a primary residence for capital gains taxation. Because the Dole campaign supported a similar proposal, bipartisan support is expected in 1997.

However, reducing the overall capital gains tax rate in 1997 is a much bleaker prospect. To win the president's support, Republicans will be compelled to specify additional budget cuts to support revenue loss from reducing the capital gains tax rate. These cuts will have to be made in the context of a federal budget that is moving toward being balanced because of reductions in the rate of spending growth. Any revenue reduction attributable to the capital gains tax cut, in turn, would necessitate reduced federal spending equal to the cuts. While a dramatic across-the-board capital gains tax reduction is unlikely in 1997, more targeted efforts toward home ownership and small businesses have broader support.

Structural Tax Reform. As the leading proponents of structural tax reform, Republicans have not been able to establish a clear consensus about which strategy to employ. Competing strategies include the flat tax, national sales tax, and the value-added tax (VAT)-or a combination of flat and national sales taxes. A pure flat tax that did not allow for any itemized deductions-championed by Steve Forbes and Dick Armey-stalled in 1996 due to vigorous grass-roots and business-group opposition. Other flat tax proponents have offered plans permitting limited deductions for mortgage interest and charitable contributions. These proposals should remain in play during 1997. Further, proposals to replace the current income tax with a federal tax on the purchases of goods may be reintroduced into Congress in 1997. The VAT tax may also be reintroduced. However, the passage of any combination of these approaches is highly unlikely, because no faction within the Republican party has been able to gain control of the tax reform debate. However, because of the failure of the flat tax approach in 1996, the national sales tax will receive heightened interest in Republican circles in 1997.

Presidential Tax Reform. Aside from targeted tax relief for education and small-business tax cuts he advocated during the campaign, Clinton is unlikely to adopt a policy position favoring any of the proposed Republican plans or offer his own major tax reform proposals during 1997.

Superfund. Congress continues to grapple with the reauthorization of the Comprehensive Environmental Response, Compensation, and Liability Act, or Superfund Act. Reauthorization of the act offers the opportunity to restore and reform the secured party exclusion and other potential liability issues raised by adverse court decisions.

The Hazardous Substances Committee completed its markup of the legislation in November 1995. However, the full House Commerce Committee has not taken up the bill. Both sides have failed to reach agreement on a number of outstanding controversial issues, including retroactive liability repeal. The Senate Environment and Public Works committees' consideration of companion legislation, S. 1285, has stalled over the issue of tax credits for voluntary cleanups. Taxation authority for the Superfund program was scheduled to expire at the end of 1995. However, in separate legislation, Congress extended taxing authority for Superfund excise taxes until September 30, 1996, and the corporate environmental tax until December 31, 1996. A real estate industry Environmental Lender Liability Coalition is actively working to ensure that any final Superfund legislation is favorable to real estate interests. However, reauthorization of Superfund is uncertain in 1997 because special interests that supported lender liability provisions approved in 1996 could decide not to participate in 1997 lobbying efforts to reauthorize it.

Regulatory Reform
Appraisals-FIRREA Section 1110. The Capital Consortium-comprised of the National Association of Realtors, the Mortgage Bankers Association, and the National Realty Committee-detailed its concerns to the Federal Deposit Insurance Corporation that appraisal provisions in the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) could adversely affect the growth of the commercial secondary mortgage market. At issue is whether depository institutions must have federally approved appraisals of all properties in which they invest-including properties that collateralize CMBS. Previously, concerns about FIRREA-related appraisal requirements caused banks to re-appraise properties in mortgage pools where some underlying properties were underwritten by nonbanks without federally approved appraisals. This process was seen as a barrier to bank investment in certain mortgage pools. Legislative relief sought in 1996 was not obtained. The prospect for legislative relief in 1997 is guarded.

DOL ERISA Application. In March 1995, the Capital Consortium trade groups jointly submitted to the Department of Labor (DOL) a "class exemption" application from certain provisions in the Employee Retirement Income Security Act (ERISA). DOL had expressed concerns about aspects of the ERISA application dealing with "subordination interests." Previously, DOL has only granted exemptions for securities that were the senior most piece of an offering. The consortium clarified to DOL the reasons why "investment grade" securities, despite their possible subordinated status, should qualify for an ERISA exemption. A response to other DOL concerns, along with a drafted class exemption, went to DOL in March 1996. After a July teleconference between Capital Consortium and DOL staffs, a final package of information was submitted to the DOL on September 12, 1996. A decision on the issue is expected in early 1997, and analysts are said to be optimistic that the class exemption will be granted.

Telecommunications Act of 1996. The Federal Communication Commission (FCC) will be issuing regulations implementing the Telecommunications Act of 1996. Section 207 states that the regulation should "prohibit restrictions that impair a viewer's ability to receive video programming services through devices designed for over-the-air reception of television broadcast signals, multichannel multipoint distribution service, or direct broadcast satellite services." During 1996, real estate groups lobbied the FCC and Congress to ensure that real estate interests were represented in the decision-making process. The FCC issued rulemaking that implemented Section 207 on August 6, 1996. The ruling "preempts governmental regulations and restrictions, and nongovernmental restrictions on property within the exclusive use or control of the viewer in which the viewer has a direct or indirect ownership interest." Section 207 does not authorize the FCC to preempt leases, regulations, or restrictions dealing with commercial properties without common areas. Homeowner associations are treated just like governments, and the FCC can preempt any restrictions it enacts that may prohibit the reception of over-the-air transmissions. However, the treatment of rental properties and common areas of investment properties was left unresolved, and the FCC requested additional information and comments on whether Section 207 applies to such properties. Because this provision will be tightly contested among telecommunications and real estate interests, the FCC's final ruling cannot be accurately predicted.

What's Ahead for 1997?
In 1997, we could see action taken on issues that are of major importance to the commercial real estate market, including tax and regulatory reform. The Tax Reform Act of 1986 is a reminder that legislation can impact not only the health of national real estate markets, but also your livelihood.

George Green

George Green is a policy representative/senior economist for investment real estate at the National Association of Realtors in Washington, D.C.