CREJ

Page 10 — Office Properties Quarterly — September 2020 www.crej.com W hat a ride we have all been on this year. Every- one’s experience has dif- fered, and my heart goes out to those who have had to endure the worst of this. During my years deployed as an airborne infantryman, many years ago, we found out quickly that depending on what you signed up to do, indi- vidual experiences varied, but we were all in it together over there. I have spoken to the older genera- tion and the majority say this is just another blip on their radar, and not even a big one. They’ve seen it before: “Take heart young man, you still have your health, it’s just part of life and the economy.” My generation has been here before in 2008, and I hope many of us apply some of the lessons we learned then about tapping into hope and exercise some of the steely resolve our elders speak about. Despair, of course, is always one step behind me, but I keep my eyes up, search- ing for opportunity instead of sink- ing into nonaction. Courage is, of course, not the absence of fear; it is the action taken in spite of fear. It has been nerve-wracking and exhilarating to already have capital- ized on some of the opportunities this year has presented. Patience is a virtue, and continuous, relentless action always will result in massive results. Questions abound: When are people going to return to offices? Are they going to go back? With- out diving into any of the young and volatile data, tap into what your subconscious just answered for you: Yes. You miss getting out of the house, you miss interacting and you know col- laboration is much more effective in person. You love your kids and sig- nificant other, but … I know a few people in the younger genera- tion, who are just starting out and working hard, who live in a room under the stairs in a house with five roommates. While the wonderfully reimagined “new” Quayle building provides an amazing opportunity for many people, the 291-square- foot Deaton suite probably starts to really close in on you. The smaller your world, the smaller your imagi- nation, the smaller your drive, the smaller your productivity. While the concept of infinite remote work is freeing and excit- ing, so is the thought of getting in really good shape, quitting smoking or running a marathon. For those of us who have accomplished one of these goals, we probably had a sup- port system around us. Additionally, for every goal we accomplished, we have had 20 that never made it out of our minds. It boils down to the presence of daily, and even hourly, accountability and human interac- tion. While this can be artificially generated through Zoom and pro- ductivity monitoring systems, these can be easily worked around by increasingly savvy employees. The largest loss? The creativity sparking conversations that happen with in- person human interaction. At home, the main driver of creativity is just yourself. Over the next decade, owners of office product will be most suc- cessful when they realize that, while there are plenty of tenants to draw from, adjusting their product to what their tenants’ employees need and want will be key. All office employees have experienced a taste of working from home and, more than likely, will require a more flex- ible schedule moving forward. On the days when they do come into the office, it needs to be a place that they look forward to coming to – a place that is better than home. These adjustments may result in things such as more amenities in the buildings, smaller overall suite sizes or shared offices within the suites. Shared offices could accom- modate two employees per office, on a rotating schedule, instead of the traditional one employee per office. While slightly more labor intensive on the front end, smaller suite sizes will reduce the overall weight of a tenant leaving, since the percentage of income lost will not be as large. This should encourage more patience from landlords to sign synergetic tenants at market rates. Landlords can weather vacan- cies better, which will result in bet- ter stability, higher rents and higher value. Added amenities may result in the sacrifice of some square feet but can be recovered in a slightly increased common area. According to the Small Business Association, in 2018, 99.5% of Colorado business- es were classified as a small busi- ness. Targeting and capturing these as tenants with ready-to-lease, even expandable, offices, can result in a long-term relationship. Providing the place where these businesses can grow and thrive will be a great win for office owners. Doing some- thing always is better than doing nothing. Opportunity is waiting for us to grab its hand and start run- ning. s Consider a small-format office investment strategy Corey Sandberg Advisor, Pinnacle Real Estate Advisors On the days when they do come into the office, it needs to be a place that they look forward to coming to – a place that is better than home. Investment Market I t’s the time of year when politicians are outlining their vision for the future and plans to get there. One such plan recently introduced by a 2020 presidential candidate has caused some uncertainty around the future of capital gains tax breaks through 1031 exchanges. According to various reports, Joe Biden’s latest proposal calls for phasing out the 1031 exchange program for investors making over $400,000 annually, removing a pow- erful incentive for continued com- mercial real estate investment. The tax revenue created would contrib- ute to Biden’s $775 billion Caring Economy plan aimed to repair the fiscal damage caused by COVID-19 and help support child care, elder care and Medicare services. The 1031 exchange, also known as a like-kind exchange, dates back to 1921 and was defined more for- mally in Section 1031 of the tax code in 1954. It has come under scrutiny and has been threatened to be eliminated many times in the past, most recently by Republi- cans in 2017, but has survived time and time again mainly because of research proving its positive impact on the economy. While on a superficial level it would seem like doing away with the 1031 exchange would accomplish the goal of boosting tax revenue, in reality, it would have far-reaching detrimen- tal effects on the commercial real estate industry, economy and small businesses. The 1031 exchange allows an investor to defer capital gains tax on the sale of a property by rein- vesting in a new building. Currently, capital gains tax can be 15% or 20%, depending on income and tax fil- ing status. Short- term capital gains for properties held under one year are taxed at a tax- payer’s ordinary tax bracket, which is usually at a much higher percentage. Almost every property is subject to capital gains tax if sold for more than the original purchase price. In addition, the property may be subject to the state capital gains or income tax, which is 4.63% in Colorado, around the middle of the pack. So long as the property exchanged for, known as the replacement property or upleg, is like-kind, which can be interpreted liberally, and greater than the sale price, no capital gains are paid. There is a 45-day time frame to identify the replacement property after the sale of the relinquished, or downleg, property. Up to three candidates can be identified. The exchange period is the time frame between when the sale of the downleg property closes until the acquisition of the upleg property. It cannot exceed 180 days. There is no limit to how many times a 1031 exchange can be used by the same entity to roll gains into new properties. There are many more nuances to the process. Consulting with an accountant and qualified intermediary, who facilitates and holds funds for the 1031 exchange, are prudent first steps. Proponents of eliminating the 1031 exchange say that it artificial- ly inflates values due to the moti- vation created by a short exchange period while also providing an unfair mechanism and tax loop- hole for wealthy real estate inves- tors to avoid taxes. Some counter the tax argument by stating that real estate is constantly taxed dur- ing ownership through county and municipal property taxes. Repercussions of eliminating the 1031 exchange could have far- reaching effects on commercial real estate markets that already are suffering due to COVID-19. There could be a decrease in real estate investment, development and overall transaction volume as hold- ing periods of property increase. Commercial real estate could become even less liquid, and the market could become inefficient. The effects of this could be lower demand and plummeting prop- erty values, essentially decreasing property taxes and revenue for local government. The slowdown could affect commercial real estate brokers, architects, civil engineers, attorneys, building material provid- ers and contractors, to name a few sectors, while lenders, title compa- nies and related vendors may feel less impact as a result of an uptick in refinancing. The 1031 exchange is most fre- quently used by private investors and owner/users. It allows owners to better allocate resources and for the highest and best use of prop- erties. In the past several years, office buildings have traded at record pace with new owners put- ting into action a plan for capital improvements and tenant ameni- ties providing for improved build- ings throughout Denver and more opportunity for tenants to get what they demand. Beyond investors, owner/users use the 1031 exchange as a catalyst to make business sense of efficiently utilizing their real estate as their business evolves. For example, a business that has outgrown a 5,000-square- foot building that it owns and occupies can purchase and move into a larger, more expensive building without incurring a capi- tal gains tax at the time of the transaction. Not having the 1031 exchange available might negate their ability to do so or to use those funds in their business operation where they create the most benefit. That same user has more freedom to change geographic locations or diversify their holdings. In sum- mary, the more frequent trading of properties and real estate owner’s better use of resources on the right investments in turn creates a more efficient market. The outcome of the proposal to eliminate the 1031 exchange is unknown and could disappear quickly or continue to evolve. It is something that should be closely monitored. s 2020 election: 1031 exchange on the chopping block? Jeremy Reeves Vice president, Colliers International