The Politics of Commercial Real Estate: 3 Strategies You Can Take Right Now To Keep Politics From Souring Your Portfolio

It’s an election year, and everyone has politics on their mind. I do, too, but for very different reasons. Politics on the local, state and federal levels have an undeniable impact on our everyday lives. For the real estate investor, that impact can extend to their property portfolio more than what might be immediately apparent. The result can be a loss in property value, cash flow, and profit. However, there are steps commercial real estate investors can take now to keep their portfolio from taking a hit. 

Close to home

Most of us are acutely aware of how local politics and legislation can affect our day-to-day lives--from the schools our kids go to and how fast the potholes on our street get fixed, to which parks get better lighting and how often the trash gets collected. 

For commercial property owners, one decision at the local level can change the entire landscape with the stroke of a pen. 

For example, in New York, rent control is considered a state matter. However, two laws passed by the New York State Legislature, first in 1962 and then in 1974, gave and reinforced New York City’s ability to adopt, amend, and/or expand local residential rent control laws or ordinances consistent with the parameters set by the Legislature. 

More recently, The Housing Stability and Tenant Protection Act of 2019 (HSTPA) established rent stabilization as an option for localities statewide. In an attempt to alleviate New York City’s growing affordable housing problem, the City opted in. That decision by the local government dramatically changed the local multifamily landscape and potential profitability of the asset class in New York City. 

The passing of HSTPA means that rent increases are now capped at drastically reduced levels and the benefits of major capital improvements (MCIs) and individual apartment improvements (IAIs) have been significantly curtailed. The law eliminates vacancy and longevity increases, MCI and IAI increases are no longer permanent, and MCI rent increases were reduced from 6% to 2%. 

The result of the passing of this legislation was that within a few days, my phone started ringing from New York City-based investors. While some claimed they’d always wanted to look in the midwest but were only now finding the time to do so, others were clear that the new legislation was forcing them to look for opportunities in other markets.

The influx of investors and demand has been driving up prices, especially in the multifamily segment, lowering returns, and creating a seller’s market. 

Capital calling

While your properties may not be anywhere near the state capital, the effects of the decisions made within its hallowed walls can have far-reaching consequences. For example, in California, residential and commercial property owners have benefited from Proposition 13 since 1978. The law bases residential and commercial property taxes on the property’s purchase price with annual increases limited to the rate of inflation or 2 percent, whichever is lower. 

In November of this year, Californians will have a chance to vote on Proposition 15 which would create a split roll tax, in effect repealing the benefits of Prop 13 for commercial and industrial property owners. 

A “yes” vote on Proposition 15 would support a constitutional amendment requiring commercial and industrial properties, except those zoned as commercial agricultural, to be taxed on their market value rather than their purchase price. 

The implications of this state law could have a devastating impact on a property’s profitability, especially for longer-term owners or those who have seen considerable asset value growth. 

Another example of state politics and legislation impacting owners at the local level is the growing rent control trend. Not limited to implementation at the municipal level, more state governments are considering enacting rent control measures. 

In February of last year, Oregon became the first state to implement statewide rent-control measures. In California, the California Tenant Protection Act went into effect on January 1, 2020, and Washington state is considering similar regulations.  

Paying Uncle Sam 

As the election nears, concerns among the commercial property set have turned to the potential for 1031 Exchanges--which allow commercial property owners to defer capital gains taxes indefinitely--to be eliminated or limited in some way. A revision would have far-reaching implications including:

• Thousands of fewer transactions a month resulting in an extraordinary loss of profit, business, and commercial opportunity
• The evaporation of billions, if not trillions of dollars in equity 
• Lower property values and thus lower tax revenue to local communities and state coffers  

3 strategies all investors should take now 

Considering the far-reaching impact of politics on commercial real estate, what can owners do to protect their portfolios, income, and legacy? 

There are three essential strategies all commercial real estate investors can implement immediately.

1. Diversify geographically. Geographic diversification doesn’t mean you need to have holdings on opposite sides of the country. Owners can diversify with investments in multiple cities within state lines. 

1. Diversify within your asset class. While most investors tend to focus on one type of asset class, you can still diversify to protect your portfolio against economic cycles and political repercussions. For example, in the multifamily category, investors can choose from: 

1. Market-rate housing
2. Workforce housing
3. Affordable housing 
4. Mixed-use (apartments located above ground-floor retail establishments)
5. Senior (55+) housing 
6. Luxury rentals 
7. Student (“by the bed”) housing
8. Military housing

1. Think outside the box. I know that’s cliche, but in this case, it applies particularly well. When it’s time to sell, consult a commercial real estate broker, that specializes in your asset class to discuss disposition utilizing 1031 Exchanges to defer taxes, streamlining through DSTs and UPREITS, and cascading your time horizons, among other options.

Now is the time to speak with a trusted commercial real estate broker, such as myself, to evaluate your portfolio mix and take action to maximize your upside potential and minimize your downside risk. We can’t escape the reach of politics, but we can hedge against the impact to make sure you're protected regardless of which way the political and economic winds are blowing.