Bipartisan House Legislation Would Encourage Debt Workouts
Bipartisan legislation (H.R. 5580) introduced in the House this week would reduce the tax burden on a borrower that can arise when a troubled commercial real estate loan is modified as part of a debt workout. The legislation, introduced by Reps Claudia Tenney (R-NY) and Brian Higgins (D-NY), could help smooth the transition to a healthy and stable post-pandemic real estate market.
Restructuring CRE Loans
“From the tax law to banking regulation, housing policy, and other areas, public policy has always encouraged the restructuring of unsustainable loans to help businesses turnaround and help taxpayers get back on their feet,” said Real Estate Roundtable President and CEO Jeffrey DeBoer.
During the height of the pandemic, the federal government extended lifelines to businesses (PPP loans), suspended the repayment of federal debts, and imposed foreclosure moratoria on federally backed loans. Emergency legislation expressly excluded the forgiveness of federal loans from cancellation of debt (COD) income.
“In the case of commercial real estate, the full economic consequences of the pandemic are still unfolding. Remote work and other challenges facing cities have put stress on certain real estate assets, such as office buildings. Debt workouts between lenders and borrowers are a critical part of the solution. Workouts can ensure that these properties continue supporting jobs and economic activity,” said DeBoer.
The Tenney-Higgins bill would build on existing tax provisions by effectively deferring COD income. For over 30 years, a provision of the law (section 108(c)) has allowed noncorporate taxpayers to defer tax when a loan used to buy, construct, or improve real estate used in a trade or business is modified. To qualify for the provision, the taxpayer must have depreciable basis in the property. The taxpayer's basis is reduced by the amount of COD income, resulting in smaller depreciation deduction and larger capital gain when the property is eventually sold.
The Tenney-Higgins bill would expand on the current law COD income rules in the case of loans secured by nonresidential real property that were incurred before March 1, 2022 and are discharged in 2023-2026.
The Roundtable commends the leadership of Reps. Tenney and Higgins, both members of the tax-writing House Ways and Means Committee, above. The bipartisan bill was cosponsored by Reps. Mike Lawler (R-NY) and Pat Ryan (D-NY).
The Roundtable and its industry partners will continue working with House and Senate tax-writing committees to address gaps in the COD income rules and encourage loan restructurings that revitalize properties, save jobs and local tax bases, and strengthen the health and vitality of surrounding communities.
California Passes Corporate Climate Disclosure Package; Biden Administration Releases Net-Zero Emissions Principles for Financial Institutions
Recent government actions amplify the increasing focus by policymakers on climate laws and guidelines—and their heightened impact on CRE. The California legislature recently passed first-of-its-kind state laws that require companies to disclose their emissions, beating to the punch anticipated federal climate reporting rules from the U.S. Securities and Exchange Commission (SEC). (Politico, Sept. 17)
Meanwhile, the Biden administration issued voluntary principles this week for asset managers, banks, insurers, and venture capital companies with goals for “net zero” emissions investments, including real estate. (Treasury news release, Sept. 19)
California’s Climate Risk Disclosure Package
California’s legislature passed two bills (SB 253 and SB 261) last week requiring climate-related disclosures from certain companies doing business in the state. Most notably, the Climate Corporate Data Accountability Act (SB 253) would require entities with total annual global revenues greater than $1 billion to quantify and publicly report Scopes 1, 2, and 3 emissions.
SB 253 is estimated to regulate around 5,400 companies. Gov. Gavin Newsom (D) pledged to sign both bills, although he may request changes when the legislature reconvenes in January. The laws could be challenged in court before they take effect over the next several years. (Wall Street Journal, Sept. 20 and New York Times, Sept 17)
The California legislature “leapfrog[ged]” the U.S. SEC (Bloomberg, Sept. 12), which has yet to release highly anticipated federal rules that are expected to require registered companies to report to investors on material climate-related financial risks in 10-Ks and other filings. (See RER’s 2022 comments on SEC proposal | Roundtable Weekly, March 10 and June 10, 2022)
U.S. Treasury’s Net-Zero Emissions Investment PrinciplesThe Treasury Department’s Principles for Net-Zero Financing & Investment is focused on “financial institutions’ scope 3 financed and facilitated greenhouse gas (GHG) emissions.” It urges private sector financial institutions to align their GHG reduction efforts and net-zero goals with their “portfolio companies,” “portfolio of assets,” and “client base.”
The document notes that clients and portfolio companies should provide to their financial institutions their own net-zero plans, including “metrics and targets” for Scopes 1, 2 and 3 emissions. Buildings and real estate assets have long been considered part of a financial institution’s Scope 3 emissions “value chain.”
The set of nine principlesencourage greater adoption of emerging best practices for private sector financial institutions that have made net-zero commitments, while promoting consistent and credible implementation approaches.
Florida Proposes Positive Clarification to Law Impacting Foreign Investments in Real Estate
Yesterday, the Florida Department of Commerce proposed a positive clarification to a recently enacted law impacting foreign real estate investment, with implications for similar laws in several other states. The clarification responds to a Roundtable request on Sept. 5 urging the Florida Real Estate Commission to consider specific concerns before implementing the new state law, which could impair capital formation and hinder the important role that legitimate foreign investment plays in U.S. real estate, the broader economy and job growth. (Roundtable letter, Sept. 5 and Roundtable Weekly, Sept. 8)
The proposed rule published on Sept. 21 addresses the implementation of Florida Senate Bill 264 (SB 264), Section 203, signed into law on May 8. The new law aims to limit and regulate the sale and purchase of certain Florida real property by “foreign principals” from “foreign countries of concern.” The Florida Real Estate Commission will implement the new law. (SB 264 text).
Section 203 of the bill prohibits investment in real property near military installations and critical infrastructure. Importantly, the de minimis exemption has been re-drafted, which (1) fixes earlier drafting errors to the Registered Investment Advisor exemption, and (2) introduces a new category of de minimis interests that categorically exempts passive indirect investment. (See highlighted areas in the Notice of Proposed Rule)
The proposed rule clarification remains subject to change during a 21-day public comment period and may include a formal hearing.
Broader prohibitions in another area of SB 264—Section 204—generally preclude Chinese investors from acquiring “any interest” in any Florida real property anywhere in the state. Since the de minimis language and relevant statutory text are almost identical across Sections 203 and 204, The Roundtable is hopeful that similar language will be adopted during the rulemaking process for Section 204.
The Sept. 5 letter from Roundtable President and CEO Jeffrey DeBoer, above, notes that approximately $1.5 trillion of U.S. commercial real estate debt will come due in the next three years. Foreign equity investments in U.S. assets are often an important source of capital as commercial real estate owners seek to restructure, refinance or sell their properties.
DeBoer urged the Commission to “carefully consider the impact of your agency’s interpretation and implementation efforts of this new law so that it does not prohibit major investments in the state, which are safe from control by foreign countries of concern and promote growth without sacrificing the security or economic interests of Florida.” (Roundtable letter, Sept. 5)
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Capital and Credit
House Republicans Urge Federal Regulators to Withdraw Capital Rules Proposal for Large Banks
More than two dozen Republicans on the House Financial Services Committee, led by Chairman Patrick McHenry (NC), recently urged banking regulators to withdraw a sweeping set of proposed changes that would significantly increase capital requirements for large banks. The federal Agencies’ proposal—known as the “Basel III Endgame”—represents the final stages of the global regulatory response to the 2008-09 financial crisis. (Bloomberg Government, Sept. 14)
Proposed Agencies’ Rulemaking
In July, the Federal Reserve, Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC) jointly approved the 1,100-page proposed rulemaking, which would substantially revise the regulatory capital framework for banking organizations with total assets of $100 billion or more.
The Agencies’ proposal would have a long phase-in period and have not impact community banks. (CNBC, Fed news release, and Interagency Overview of the Notice of Proposed Rulemaking for Amendments to the Regulatory Capital Rule, July 27)
Fed Chairman Jerome Powell voted for the proposal, but noted a significant tone of caution. Powell stated, “Raising capital requirements also increases the cost of, and reduces access to, credit … threatening a decline in liquidity in critical markets and a movement of some of these activities into the shadow banking sector. I look forward to hearing from all stakeholders on how best to strike that balance,” (Federal Reserve Board Chair Powell statement, July 27)
The House Committee Republicans’ letter claims the scope and process of the banking regulators’ plan is flawed, while noting how the proposal was opposed by some members on the Federal Reserve and FDIC Boards. The letter concludes, “Given those fatal problems with your Basel III Endgame proposal, we urge that it be withdrawn. The proposal should be replaced with one based on sound, objective analysis supported by data.”
A subsequent hearing on Sept. 19 held by the House Financial Services Subcommittee on Financial Institutions and Monetary Policy—“A Holistic Review of Regulators: Regulatory Overreach and Economic Consequences”—explored the interaction and economic impact of recent federal regulatory proposals, including the Basel III Endgame, new and expanded long-term debt requirements, and changes to resolution plans.
Subcommittee Member William Timmons (R-SC), expressed concern during the hearing about how the Basel III capital requirements may exacerbate the strain on bank capital availability. He emphasized “… the fact that billions of dollars of commercial real estate projects must be refinanced the next 36 months, and not all those projects will be profitable when their mortgage payments more than double and banks are prevented from extending additional credit due to increases in capital requirements and an unfavorable interest rate environment.” Rep. Timmons added, “That is the looming crisis that we need to be preparing for, not further restricting capital availability.” (CQ, hearing transcript)
Impact on CRE
The proposed changes would increase capital requirements for the nation's largest banks by as much as 20%, with far broader indirect impacts on bank counterparties and customers and the broader financial markets. The Agencies’ rulemaking could significantly affect available liquidity for commercial real estate transactions, impact asset values, and hinder economic growth. (Roundtable Weekly, July 28)
Mortgage Bankers Association (MBA) President and CEO Robert Broeksmit testified during the Sept. 14 House Financial Services Committee hearing. “MBA strongly opposes certain provisions of the proposal that undermine the mortgage market and takes exception to the extremely scant economic analysis regarding how the changes will affect the economy, single-family housing market, and commercial real estate finance markets,” Broeksmit testified. (MBA Newslink, Sept. 19)
Real Estate Roundtable President and CEO Jeffrey DeBoer stated in a March 2023 comment letter to Fed Vice Chair Michael Barr and other key regulators, "At this critical time, it is important that the Agencies do not engage in pro-cyclical policies such as requiring financial institutions to increase capital and liquidity levels to reflect current mark to market models. These policies would have the unintended consequence of further diminishing liquidity and creating additional downward pressure on asset values. A deflationary spiral must be avoided at all costs. As recent events are only amplifying the contraction of credit, it is important for the Agencies to take measures to maintain sufficient liquidity levels and support positive economic activity."