Contributed By Allen Matkins Leck Gamble Mallory & Natsis LLP
Real estate law is moving at a faster pace than ever. Clients demand highly skilled practitioners with keen knowledge of the markets in which they work, and a deep bench for large, complex deals. The US West Coast, taken as a whole, is the most dynamic real estate market in the country, thanks to the insatiable appetite for space from growing technology companies. Clients in these deals are accustomed to top business acumen and platinum-level service.
The growth of US technology companies has transformed the West Coast real estate market, particularly West Los Angeles, Northern California, which includes Silicon Valley, and the greater Seattle metropolitan area. Vacancy rates are down, rents are at record highs, and buildings built “on spec” are often fully rented before completion. Further growth is constrained only by the availability and affordability of housing and sufficient transit infrastructure.
Tenants like Google and Facebook have massive power and influence in deals, and can reshape markets. Amazon held a national “request for proposals” for a home for its second headquarters, a race that was covered on the front pages of national newspapers and resulted in generous, unprecedented tax-friendly bids from potential host cities.
“Co-working” spaces, in which a large tenant takes a lease and offers shorter-term subleases to smaller tenants and startups, have transformed the leasing market. At the time of writing, WeWork in San Francisco signed the largest lease of 2018, for 251,000 square feet. Los Angeles is the second-largest co-working market outside Manhattan.
In Los Angeles, the media and entertainment industries are market movers responsible for some of the largest deals and the redevelopment of communities, such as Inglewood.
Industrial space near cities is also at a premium, as online retailers look for “last-mile” distribution hubs. Some large Southern California industrial parcels have seen a 35% increase in price per acre.
Lastly, retail space is undergoing huge transitions as consumer shopping habits change. Shopping malls with high vacancies are being transformed into mixed-use spaces.
Significant Deals and Projects
In January 2018, Apple opened its USD5 billion campus in Silicon Valley, one of the costliest buildings in the country, which will eventually house 12,000 employees, and Salesforce began occupancy of the 61-story Salesforce Tower in San Francisco. As the tallest office building west of the Mississippi, it has remade the city’s skyline.
In March 2018, WeWork inked the largest lease deal of the year thus far, for 251,000 square feet in San Francisco. Facebook is expected to announce a large San Francisco project, and Google is looking at a very large transit-centric project that would remake downtown San Jose.
In the largest lease in the city’s history, Dropbox leased all 736,000 square feet of a speculative office project in San Francisco developed by Kilroy Realty.
In 2017, Blackstone Group purchased a majority stake in a 3.3 million square-foot office portfolio, valued at USD1.7 billion. Tenants include Warner Bros, Walt Disney, and Sony.
The 2017 “Tax Cuts and Jobs Act” is the most significant change to US tax law in 30 years, lowering the maximum federal corporate tax rate from 35% to 21%. According to the Winter/Spring 2018 Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey, the tax bill is expected to increase the rate of return on commercial real estate and make investment more attractive, as it reduces taxes for commercial real estate owners and developers.
1031 Exchanges Remain for Real Estate
While there was talk of eliminating this advantage, real estate capital gains remain tax-deferrable to the extent a qualified investment is timely made in like-kind replacement property.
Developers who organise their businesses as pass-through entities, such as partnerships and LLCs – as most do – can now take a deduction of up to 20% of their "qualified business income," subject to limitations. This does not include short- or long-term capital gains, but it does include certain REIT dividends.
Business Interest Deduction
Under the new law, the business interest deductions of a taxpayer with average annual gross receipts of more than $25 million are limited to the sum of business interest expense plus 30% of "adjusted taxable income" (roughly compared to EBITDA in years through 2021 and EBIT beginning after 2021). Disallowed deductions are carried forward. Real estate businesses can opt out of the limits by slightly extending the period over which they depreciate real property.
Extension of the “Carried Interest” Holding Period
Under the new law, the holder of a “carried interest” in a partnership or LLC is taxed at long-term capital gains rates on their allocable share of any gain recognized by the partnership on the sale of its investment property, but only if the property was held for more than three years (rather than one year under the prior law).
State property taxes are governed by California’s Proposition 13. Passed by voters in 1978, Prop. 13 caps annual property tax increases at 2%, meaning a property is only reassessed for tax purposes at the time of sale. While there is perennial debate about reforming Prop. 13 to eliminate its application to commercial real estate, which could allow for more equitable tax burdens while increasing the share borne by commercial real estate, there are no legal changes pending. Reformers say they hope to introduce a ballot measure changing the law in 2020.