Southeast Real Estate Advisor : Atlanta Real Estate Lawyer & Attorney : Kevin Caiaccio Law Firm : Commercial Development, Retail Leasing : Buckhead, Sandy Springs, Georgia

The overhaul of Georgia's property tax system became law when signed by Governor Sonny Perdue last Friday, June 4.  As discussed previously on this blog, Senate Bill 346 is a taxpayer-friendly bill designed to create a more fair and transparent system of assessing property tax values.

As stated in the press release:

The overall reform includes more than 50 changes to current state law. Significant taxpayer friendly provisions include:

• Requirement that every property owner receive annual Notice of Assessment, which guarantees right to appeal;
• Every Notice of Assessment must contain estimated property tax
• Expansion of appeal time-period from 30 to 45 days
• Alternative streamlined appeal option for property valued in excess of $1,000,000
• Automatic taxpayer victory on appeals when government fails to respond within 45 days
• Requirement that all relevant sales, including distress sales, be included when determining Fair Market Value
• Requirement that only “current use of property” be used in determining Fair Market Value
• Taxpayer must be given access to all data used in determining Fair Market Value
• Sales price establishes Fair Market Value for next tax year

The full text of the new law, most of which goes into effect on January 1, 2011, can be viewed here. 

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Last week, the Senate Finance Committee reintroduced the long-discussed proposal to increase the tax rate applicable to carried interests.  As I discussed here a few months ago, this proposal is bad policy and bad for commercial real estate investment. 

The arguments against this proposal are well stated in an opinion piece in the Wall Street Journal today by economist John Rutledge:

"The tax hike on carried interest is partly being sold as a tax on wealthy hedge-fund managers, but that is not the case. Hedge funds hold assets for short periods and generate short-term capital gains; their managers already pay taxes at ordinary income rates. Instead the tax will fall on those who make the long-term investments that generate long-term capital gains.

"In 2007, real estate made up the largest category (48%) of partnerships, representing $4.4 trillion in investments by 6.8 million investors. Most of those are small, one-or-two property partnerships where one partner puts up the money to buy a dilapidated building and the other is the general partner who manages the work to improve the property. If you triple the tax rate on the general partner, many of the small deals simply will not happen and fewer buildings will be renovated."

The sponsors of the bill, Sen. Max Baucus (D-Mont.) and Sen. Sander Levin (D-Mich.), have mislabeled this proposal as the closing of an individual tax "loophole" (PDF).  In reality, the current tax treatment reflects the true character of the income as long-term equity at risk. 

Rather than closing a "loophole," this proposal will create a disincentive for risk taking in real-estate ventures and should be opposed.

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While commercial real estate continues to struggle through the current downturn, some initial signs of improvement are emerging in the multifamily sector. As vacancy rates gradually improve , rents are increasing and concessions are tightening (see chart below).  These emerging trends are causing a noticeable uptick in investor demand and a downward pressure on capitalization rates.

 According to the current data, it appears that the apartment sector will be the first to recover as the economy begins its turnaround .  There are a number of factors contributing to this budding recovery:

• Unlike other sectors, multifamily did not experience overbuilding in most markets.
• The lack of construction financing and dearth of new projects will result in few units coming online in the near future.
• Many people are electing to rent rather than own given the current state of the housing market.
• Fannie Mae and Freddie Mac continue to provide liquidity which is lacking in other sectors.

Investors should be cautioned that challenges remain and any sustained increase in demand will depend on a recovery in the employment market.  Even if unemployment does moderate as expected, rental increases for apartment owners will be gradual.  Nevertheless, many real estate professional believe that we may be seeing the bottom in multifamily asset prices and that the time is ripe to execute acquisitions.

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The Florida legislature is considering reforms to the state's foreclosure process.  According to a report in the Tampa Tribune yesterday, House Bill 1523 would allow non-judicial foreclosures in some cases, unlike the current system which requires the lender to file a foreclosure lawsuit.

Florida law has long been considered by many as too favorable to defaulting borrowers.  The judicial process can often take years, and this problem has been exacerbated recently with the steady rise in the number of foreclosures.

Georgia, on the other hand, is a non-judicial foreclosure state which allows a lender to foreclose without court action or approval.  This results in a system which is criticized for the opposite reason as Florida, as being too easy for lenders to take away a borrower's property.  As a result of this criticism, there are bills pending in the Georgia legislature which would make the process more borrower friendly as I discussed here recently.

In the Tampa Tribune article, the author quoted me about the need to strike a balance between the countervailing forces:  protecting the rights of the borrower vs. allowing lenders to repossess property within a reasonable time.  It makes little sense that two neighboring states have systems which are so diametrically different. 

I believe that the states should comprehensively study the various foreclosure systems utilized in the U.S. to determine which procedures best strike this balance.  Just as we have uniform laws for the commercial code and partnership law, we should consider more uniformity in the area of foreclosure law.

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Last Thursday, the Georgia Senate unanimously passed property tax reform which is designed to restore taxpayers' confidence in the fairness of the system of assessing property values.  The bill, which was introduced by Sen. Majority Leader Chip Rogers, will require that an assessment notice be sent to property owners every year.  The current system requires a notice only when the assessed value changes.

The version which passed the Senate was changed from the initial draft as previously summarized on this blog in the following respects:

• The taxpayer will have 45 days to appeal the proposed assessed value.  As I previously commented, the initial proposal of one year was unworkable.
• The requirement that an increase in value must be unanimously approved by the board of equalization was removed.
• The annual notice will include a pro forma estimate of the current year's taxes based on the prior year's millage rate.
• There is a more detailed definition of "arm's length, bona fide" sale which specifically includes distress sales, short sales, REO sales and foreclosures.
• The county's tax digest may be approved even if taxpayers' appeals are pending.

I believe that this is a good bill which will lead to a more transparent and accurate system for assessing property values.  Georgia property owners are currently paying taxes based on assessments which often do not reflect declining values.  Under the proposed new system, assessed values should fall more in line with market prices.  The downside is that  local governments will face the challenge of either raising millage rates or finding other sources of revenue to make up for lower tax receipts.

The bill now moves to the State House for further consideration. 

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Given the dramatic rise in foreclosures over the past several years, the Georgia legislature has tackled foreclosure reform on several occasions.  However, this reform has largely been cosmetic and has not helped property owners or lenders.

The most recent attempts at reform are currently pending in the legislature and,  like other recent efforts, are mostly lacking in substance.  House Bill 1228  would provide the borrower with a statutory "right of redemption" for 90 days after the foreclosure sale.  The right would very rarely be exercised because it involves the full payoff of the debt plus penalties within 90 days.  House Bill 972 introduced by Rep. Billy Mitchell would provide a 90-day right-to-cure period after default which the debtor could exercise once every 24 months. 

In 2008, the last time foreclosure reform passed, the measures centered on the content of the notice to the borrower.  While somewhat helpful, many of the reforms do not include a  remedy for violating the provisions.

In my opinion, none of these reforms addresses the major problem with the current system and that is the obstacles to potential buyers bidding at the foreclosure sale.  Although the current system requires notice of the sale by publication for 4 weeks, potential bidders face several challenges:

• Little or no opportunity to perform due diligence
• No set time for the sale to occur (other than a 6-hour window on the first Tuesday of the month)
• No prior notice of when a sale is canceled or postponed

These problems are particularly acute in commercial foreclosures, and the result is that there is rarely competitive bidding.  The lenders are then forced to repossess the property and deal with the headaches of REO property rather than having the chance to mitigate their losses.  I have clients who are often interested in acquiring property at foreclosure but do not have an adequate opportunity to bid.

Any foreclosure reform should focus on improving the bidding procedures so that the sale functions more like a normal auction. 

I'm interested in hearing others' opinions concerning how best to reform our system.  Reform shouldn't be just about helping debtors keep over leveraged properties but also about helping lenders mitigate losses and having properties trade at appropriate values.

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Last week, Senate Majority Leader Chip Rogers introduced a major overall of the property tax system in GA.  Senate Bill 346 (PDF) was drafted in response to the perceived unfairness which has resulted from falling home values.  Despite the significant drop in property values, assessments for tax purposes have remained artificially high.  This problem was well documented in a thorough report in the AJC late last year.

The comprehensive bill proposed by Sen. Rogers includes over 40 changes to the property tax system and will have a major impact on GA property owners.  Some of the highlights of the bill are as follows:

• Requires the county to send annual assessment notices on all properties along with information on how to file an appeal.  The current system only requires a notice if the assessed value is changing.
• Allows the property owner to file an appeal up to one year after receiving the assessment notice. This is probably one of the more controversial provisions of the bill.  Current law requires the owner to file an appeal within 30 days.
• Requires unanimous approval by the Board of Equalization to approve a value higher than that claimed by the property owner.
• Requires that the market value for tax purposes not exceed the sales price for the first year after an arms-length sale of the property.

 My initial thoughts on this bill are as follows:

Pros:   would create a more consistent, objective and fair system by shifting some power to the homeowners;  would simplify the tax appeals process.

Cons:  would increase administrative costs to counties; would likely result in reduced revenues unless the counties take the unpopular step of raising millage rates; could delay the approval of the tax digest and make budgeting more difficult;  could hurt schools which derive much of their revenue from property taxes.

Bottom Line:  I like the fundamental policy objectives of this bill, but some of the finer points will need tweaking. 

Sen. Rogers has indicated that the bill will not be fast tracked and that he is seeking wide input on the bill.  As result, the proposal will likely go through many iterations before reaching the Governor's desk. 

Because of the significance of these changes and the impact on GA property owners, I will continue to monitor this bill and provide updates as warranted.

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This morning I attended a breakfast seminar sponsored by the Atlanta Bar Association entitled "Leasing Issues in Today's Economy."  The panelists were three prominent Atlanta leasing attorneys:  Jonathan Neville of Arnall Golden Gregory, Robert Stanley of Stanley, Esrey & Buckley, and David Kitchens of Kitchens Kelly Gaynes.

The discussion centered on current issues in retail leasing.  The panelists did an excellent job of highlighting issues from both the landlord and tenant perspective. 

Here are some of the takeaway bullet points from this informative seminar:

• For a tenant seeking rent relief in this market, short-term relief is often a more viable option.  Longer term rent relief is less palatable to the LL due to the detrimental effect it has on the shopping center's value.
• A tenant seeking rent relief should be current on its rent when approaching the LL.  Many institutional LLs have a policy against negotiating with tenants who are behind on rent.
• Tenant improvement allowances are a hot topic in lease negotiations.  Because so many LLs are struggling, the tenant must protect itself from a LL who is unable make a TI payment.  The tenant should insist on either having the TI dollars escrowed with a third party and/or the right to offset unpaid TI from future rent payments.
• Co-tenancy clauses continue to be a point of contention in negotiations and are frequently being litigated.  (See my recent post on this topic.)
• Due to the increasing number of foreclosures, it is more important than ever for tenants (even smaller tenants) to insist on a subordination, non disturbance and attornment agreement (SNDA) with the LL's lender.  This will protect the tenant's rights under the lease in the event the lender becomes the owner through foreclosure.

The current economic climate continues to drive lease negotiations in many ways.  Not only is the leverage shifting in favor of creditworthy tenants, but certain issues have become increasingly important as both landlords and many tenants continue to struggle financially.

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There seems to be conflicting reports concerning whether the proposed tax increase on carried interests remains alive in Washington.  The proposal passed the House in December, and its fate is now in the hands of the Senate.  According to reports last week, the proposal appeared to be dead for this session.  However, the Administration's budget released just this morning includes this tax increase.

The issue is whether carried interests should continue to be taxed at the lower capital gains rate (as they are under current law), or taxed at the higher rate for ordinary income.  If passed, the bill could more than double the tax liability for real estate professionals who are compensated with a promoted interest in a partnership or LLC.  

The proposal originally gained popularity after reports of hedge fund managers who made enormous sums of money and were being taxed at a lower rate than ordinary working Americans.  While most of us are unsympathetic to wealthy hedge fund managers, the problem is the unintended effect that this tax increase would have on the real estate industry.  Many real estate ventures, both large and small, are structured such that the promoters receive a carried interest in exchange for know-how and sweat equity.  

As noted in this ICSC report , compensation of real estate managers is fundamentally different from hedge funds and private equity.  In the case of RE promoters, the income from a carried interest is not guaranteed, and there is often a longer hold time before any profits are realized.  Moreover, the promoters are often required to incur contingent liabilities in the form of loan guarantees. 

As a matter of public policy, the proposed tax increase comes at a terrible time.  Commercial real estate is already struggling, and this bill would create a disincentive for further risk taking and could lower property values even further.

If policymakers intend to help stem the decline in CRE markets and the resulting damage to the overall economy, this bill should be voted down or amended to limit its applicability to fund managers.

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