Despite dire predictions of economic disaster for investors in real estate following the Tax Reform Act of 1986, investment real estate values have fared quite well under the new tax laws, according to real estate services firm Grubb & Ellis Co.
John B. Allen, senior vice president of the San Francisco-based firm with offices in Salt Lake City, said most investors took the position during the pre and post debate on the issue that tax reform would devastate investment real estate causing prices to fall while simultaneously forcing rents on office, commercial and industrial buildings to rise."Just how they reconciled rising rents and falling prices was never made clear," said Allen. "In any case, none of these things happened."
Ultimately, he said, taxes have virtually no effect on resale prices. "Investment sales activity slowed dramatically during the first year after tax reform, declining by approximately 331/3 percent because investors were slow in coming to an understanding of this complicated law."
The only ones to suffer from this, said Allen, were real estate brokers who lost commission revenue and the state and federal governments who lost tax revenue. "In 1988, however, investment sales activity rebounded with increases of 50 percent to 60 percent in most geographic areas as investors came to understand and accept the provisions of the 1986 act."
Allen said that over the long run, economic forces drive prices and taxes are only one of these forces. But in the short run, he said, "it's possible to see some price effects both up and down," he added.
Allen said that some tax provisions, like the Economic Recovery Tax Act (ERTA), can cause huge increases in the supply of office buildings and other real estate products. When such a tax provision is combined with other tax benefits, tremendous construction and resale activity often results.
"Eventually, the huge increase in supply causes rents to fall and, occasionally, resale prices soften or resale activity slows considerably. In recent history, this tax-induced glut seems to have stabilized resale prices or slowed their rise rather than precipitated a decline."
Where prices have dropped, he said, fundamental economic issues were the cause. In areas of the country with "strong economic diversity," he said there have been no significant resale price declines in investment property since 1986. "Today, in fact, prices are at an historic high for quality properties."
Why does quality real estate resist pressures that would seem, logically, to push prices down? "There are powerful demand elements at work that virtually guarantee a strong future price for quality U.S. real estate," Allen said. One of these is foreign investor demand.
U.S. real estate is moving toward a neutral tax environment and is underpriced relative to world price levels, according to Allen. As soon as the supply-demand situation moves toward balance, "significant" price increases will be the result.