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EisnerAmper Blog

Building Success: An EisnerAmper Real Estate Blog

IRS Targets Tax Avoidance on REIT Conversions

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June 23, 2016

By Charles Anastasia

The IRS initiated final and temporary regulations on June 7, 2016 impacting REIT conversions and spin-offs.  The issuance of these regulations follows a recent trend of activity in the IRS in this specific area.     

The Internal Revenue Code (“Code”) requires corporations to recognize gain or loss on the distribution of property in connection with complete liquidations other than certain subsidiary liquidations.  However, if satisfied, § 355 generally permits a corporation to distribute interests of one or more controlled corporations to its shareholders and security holders in tax-free transaction.  Sections 311(a) and (b) of the Protecting Americans Against Tax Hikes Act of 2015 (the “PATH Act”) amended §§ 355(h) and 856(c)(8) of the Code, respectively.  As amended, § 355(h)(1) of the Code provides that § 355 shall not apply to a distribution if either the distributing corporation or the controlled corporation is a REIT.  Section 355(h)(2) provides exceptions permitting a REIT to distribute the stock of another REIT or of a taxable REIT subsidiary under certain conditions.

This section seems to block the previously allowed benefit afforded to REITs under § 1374 whereby appreciated property would be not taxed at a gain if the REIT held the property if certain requirements were met.   The temporary regulations provide that a C corporation engaging in a conversion transaction involving a REIT within the 10-year period following a related § 355 distribution is treated as making an election to recognize gain and loss as if it had sold all of the converted property to an unrelated party at fair market value on the deemed sale date.  Section 1374 treatment is accordingly not available in these cases as an alternative to recognizing any gain with respect to the converted property on the deemed sale date.

The proposed regulations discussed above also have increased the “recognition period” to 10 years and thereby decoupling from the 5-year period instituted by the PATH Act.  The provisions of § 1.337(d)-7 will no longer be affected by § 127 of the PATH Act and the recognition period is no longer determined by reference to § 1374(d)(7).  Instead, the recognition period is determined by reference to the first day of the RIC or the REIT's first taxable year (in the case of a conversion transaction that is a qualification of a C corporation as a RIC or a REIT) or on the date the property is acquired by the RIC or the REIT.

These new regulations will certainly add another layer of due diligence to be performed for all REIT conversions going forward.

 

Want Real Estate Success? Creativity’s a Must, Say Four Young Leaders

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New York City real estate is heading into a slowdown due to stricter banking regulations and changes on the municipal and state levels, warned Heritage Equity Partners founder and CEO Toby Moskovits during a panel discussion at the annual Real Estate Young Leaders’ Forum recently. But that doesn’t mean a dearth of opportunity.

It’s a great moment for someone who isn’t established in a career to get involved and find opportunity, in a market where typical deal structures or sources of financing are not necessarily going to work, she told an audience. “Sometimes being a little inexperienced in an industry helps you.”

Moskovits joined L&L Holding Co. senior vice president Joshua Carson, Megalith Capital Management principal Philip Watkins, and Cushman & Wakefield senior director Chris Moyer for the panel, which focused on where those opportunities can be found in the office, residential, and hospitality markets.

EisnerAmper tax partner Lisa Knee, who moderated, pointed out that L&L Holding Company’s repositioning projects at 390 Madison Avenue and 425 Park Avenue are 2 prime examples of how you can bring a “wow factor” to old office product.

“The basic concept is that the average age of an office building is Midtown is about 70 years old,” Carson replied. “When you think about what’s changed in those 70 years, it’s just about everything—from technology to architecture to design to how tenants use and lease space.”

In response, L&L is transforming these buildings into modern, first-class assets in a variety of ways—including going down to the guts of new infrastructure, replacing low ceiling heights with double- or triple-height spaces, adding terraces and rooftop spaces, and creating amenities.

“The real focus is de-commoditizing what was previously commoditized product,” he continued. “Through a package of these different concepts, we’re creating at 390 Madison and 425 Park what we think is unique product and what tenants will pay for.”

It’s a strategy working for 425 Park, the first block-facing building being developed on Park Avenue in 50 years. Earlier this year, hedge fund Citadel inked a 200,000-square-foot deal at the building in which it will be paying a reported $300 per square foot for the penthouse space—an unheard of amount in Manhattan. In fact, Carson pointed out, L&L is not marketing the building—any leasing has been solely through word of mouth and planting seeds with select office brokers.

“We capitalized the deal so we didn’t have to do pre-leasing,” he explained, noting that tenants would be able to see the “dramatic difference” between 425 Park and aging competitive space once the tower started coming out of the ground.

But in order to continue to build the new office product Midtown East desperately needs, he said the City’s rezoning plan—which would make way for larger, more modern towers—needs to pass, and unfortunately, L&L did not have the luxury to wait. “We see it as an important element for the future of New York City,” he said. “Something will go through, but we wish we could have participated in it.”

Moskovits recently visited a company on Park Avenue, and while on the elevator passed offices for beer brand Stella Artois. The décor, she recalled, recreated a Brooklyn warehouse in the middle of Manhattan. It’s indicative of a larger trend in which the office market in both Manhattan and the outer boroughs will change rapidly over next 24 to 36 months as buildings turn over, she pointed out.

“I think the office market is transforming and we’re only in the first or second inning,” she said. “People are simply working differently, including their expectations for how their workspace looks and feels and how close it is to their home.”

Knee noted that when people think of Williamsburg, Brooklyn, they think of Heritage Equity Partners and Moskovits. “Most people want to know, how did you know?” she asked.

Moskovits’ venture capital background helps, as it’s an industry where things transform very quickly and it requires the ability to think 2, 5, and 10 years ahead. “It’s a little easier in real estate, because you have what’s called the ‘Gordian Knot’ of the industry—everything is comp-based,” she replied. But if she goes into a new area that she knows is on the cusp of transformation and doesn’t have that comp data or established use, she can’t use typical bank financing to buy office or hotel, forcing her get creative. As a result, she’s essentially making the market.

“On our heels, prices are escalating and others are pointing at the comps of the leases that I have signed to go ahead and get typical financing,” she said. “That is both a challenge and the opportunity …. To me the future is innovation and how building are financed. That flexibility allows creative, innovative approaches.”

Knee then pointed out the 5 hotels that are coming to Williamsburg and asked if there was demand for all those rooms.

“Fifty million people come to New York each year, and there are perhaps 50,000 hotel rooms,” Moskovits replied. “In our pocket, it will be under 400 hotel rooms [that are] high-end, boutique hotels in which the demographic is primarily between 25 and 45 who have been to New York hundreds of times …. They’re coming for the experience.” For instance, Heritage’s Wythe Hotel in Williamsburg has experienced a consistent 95% occupancy and rates have tripled. “I’ve had to send people to Manhattan because there have been no rooms in Williamsburg.”

Watkins also pointed out that Brooklyn is an international brand and destination within itself, benefiting from the City’s push to get tourists out of Manhattan proper and into areas like Williamsburg, Harlem, and Queens. One area where you can see that transformation is Dumbo, where Megalith is currently building boutique condo and ground-up rental buildings in 2 properties that once belonged to the Jehovah's Witnesses.

On the office side, he continued, “There used to not be quality product in Brooklyn—all conversions were on an ad-hoc basis. Now it’s being done in an institutional way and you’re seeing the leasing velocity happen.” One of the biggest examples is at Dumbo Heights, which has hundreds of thousands square feet of leasing velocity, attracting ancillary retail. “You suddenly have a critical mass … People wanted to be there for a while, but there was just an extreme dearth of product.”

Moyer said he had to tap into creative financing for a 14-story condo development Cushman & Wakefield is involved with at 62nd Street and Fifth Avenue, which is being underwritten for $7,000 per square foot and don’t have the needed comps. “But time and again, we’ve seen that when developers bring what buyers are looking for, they get the price,” he said.

In this case, the 3-bedroom duplexes will total 3,000 square feet each and overlook the park. Lenders, however, will only go for $3,000 per square foot. While there’s been pushback from the private side, he reported that closed-end fund, family offices, and high net worth investors are happy to own product at that price.

Given that banks are cheap, he also noted that borrowers are stepping away from them and are willing to pay rates of 8% or 9% for a more flexible loan. “If you miss that $7,000 per square foot sellout because of the loan and the market dips to $5,000 per square foot, you lose way more in the sellout than you would have in financing costs.”

He’s also involved in a $1 billion, 1 million-square-foot expansion project in Seattle that required creative financing for a $600 million construction loan, which would typically need 15 to 30 banks and take 6 to 12 months to close. The owner wanted one lender and a 15-year loan, and Cushman & Wakefield went on global road shows with sovereign wealth funds and insurance companies. Eventually, it was able to close the deal with one lender at 55% LTC for 15 years, separated into 4 separate loans in case the lender decided to sell off any pieces in the future.

EA Young Leaders

 

 

 

Can You Really Have It All? Women Real Estate Finance Leaders Weigh In

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When EisnerAmper tax partner Lisa Knee moderates panel discussions, she often tells the speakers about a situation that happened between her and a colleague in the early part of her career.

“He told me that I can’t have it all,” she told panelists during the private equity session at Real Estate Weekly and EisnerAmper’s Women’s Forum, held at the New York City Bar Association on May 11. “I’ve spent my entire career trying to prove him wrong.”

So is it possible?

TPG Real Estate Finance Trust CEO Greta Guggenheim shaped the discussion by recalling a situation that has happened in different iterations to many professional women. She was watching a video from her son’s pre-school class, and it showed her son following his teacher, pulling on her skirt, and repeating, “My mommy’s picking me up today!”

“He said it about 100 times,” she said. “I do it so rarely that I felt guilty and lost some sleep over it. It’s tough.” 

Brookfield Property Partners senior vice president of asset management Sara Queen also recalled one of her children’s school projects, which insinuated that all Mommy does is “work, work, work.” (Her guilt was assuaged by another child’s project, which claimed that all his stay-at-home mother does is “yell, yell, yell.”)

“You can have it all, but not all at once,” said Kathleen McCarthy, global COO for Blackstone’s real estate group. “I feel like I get a lot done in a day and live a very full life as a result. But there’s a lot of people who don’t start practicing early enough in their careers trying to manage a full personal life and career. I don’t think you wake up one day and figure it out.”

Carnegie Corporation director of investments Alisa Mall once read an article by Facebook’s Randi Zuckerberg which talked about career, family, fitness, friends, and sleep—and how you can only pick 3 of those. “I think that’s 100% correct, but for me, it’s 3 on any given day,” Mall said. “That’s how I like to think of it, and I make sure they’re in constant rotation.”

One of her colleagues once told her to sneak out for 45 minutes each day, and that no one would notice. “I thought I’d get in trouble,” Mall recalled. “But I started practicing it, and in 15 years, no one has really noticed. Everyone’s important, but you’re not that important—try to really embrace that. When I try to compare myself, it makes me feel terrible.… You can’t win at everything.”

A strategy that Queen employs: “Outsource all the crap you don’t want to do,” she said to audience laughter. “There are all sorts of great ways to outsource in this city, so embrace those. Just because your kids know your FreshDirect or Seamless password does not make you a bad mother.”

Queen also lets her children know that the opportunities they have happen because she works. “So everyone understands that there are times when you can’t be there and there are times when you can. So you have to pick the ones that are really important and be there.”

The industry is really beginning to understand how important it is to have diverse ideas in a room, McCarthy added. “We have different experiences and exposure to things, and that’s valuable. Be memorable and be vocal—it’s important that you add something to the conversation.”

Even though the real estate and finance industries have made strides in attracting more women over the past 20 years, “we need to be genderless,” Knee said.

Guggenheim, who grew up in a family of all girls, said she’s never felt different than men, despite it being more difficult to break through into the c-suite. Throughout her career, she said she has joined trade organizations—not women’s organizations—because she wanted to interact with everyone in her industry.

“I never felt or acted different, which has served me well,” she said. “I feel like I’m a real estate professional, not a female real estate professional.”

 
EisnerAmper is an independent member of Allinial Global.
EisnerAmper is an independent member of EisnerAmper Global.