The conundrum with taxation and real estate is that the demand for much of US commercial property is inversely proportional to the reduction of tax rates.

As such, Fair Tax advocates such as Ron Paul would not do our industry many favors over the mid term. Over 50% of all income producing properties purchased in the US are wrapped in an IRS 1031 Deferred Exchange agreement, wherein the purchaser elects to defer the payment of capital gain income taxes until the property, or its successor, is sold.

One may argue that the buyers of such property would have more after-tax capital in the event of a substitution of a national consumption tax for the current income tax, and thus more liquidity to purchase income producing properties. There is no argument there, however if there were not tax advantages for many income producing properties, and especially smaller properties like our strip malls, one could arguably postulate that those investors would demand a higher return rate (Cap Rate) than the 7% or so we are seeing today.

The worst possible scenario would be raising taxes and eliminating capital gains. Currently a 1031 exchange is predicated on a holding period equal to the capital gain qualification period. With higher taxes and virtually no tax incentives, cap rates could easily become double digit once again as we experienced in the late 70s and early 80s. With a chasm-like positive leverage gap created between the cap rate and the current mortgage loan constants, one of the two would have to normalize over time. I’d bet on the mortgage bankers, and you really don’t want to be on the wrong side of that bet.

The most significant Congressional act of my career was Tax Reform Act 1986. Prior to that reform, there were so many loopholes and incentives for purchasing investor real estate that there were actually promoters guaranteeing negative cash flow to unsophisticated investors. TRA 1986 jettisoned most of these tax advantages and shortly thereafter real estate was once again valued on…..cash flow! And that is as it should be.

Ron Paul is not a contender, but we’re still on the sidelines as buyers until we get a little clarity of what the new administration and the Congress might bring us in 2009.

NEWS FLASH - MORTGAGE RATES ARE DROPPING!

Hope you had a wonderful New Year celebration!

Just wanted to give you some great news and a hot tip to start off the year with.

Mortgage interest rates have dropped significantly in the past couple of weeks, especially for so called “conforming” loans ($417,000 and under for single family homes, $533,850 and less for duplexes, $645,300 and less for triplexes, $801,950 and less for fourplexes).

The only time rates have been lower than this in the past 40 years was during a short time in 2003 and 2004.

Why is this happening now? A combination of 1) concerns that a recession is ahead, and 2) the political unease resulting from the assassination of Benazir Bhutto. The assassination and its repercussions have weighed particularly heavily on the bond and mortgage backed securities markets.

If you’d like us to take a look to see if you can save some money, give me a call at (415) 406-2330 or send an email to ed@smithcraine.com.

Here’s hoping we can save you a boatload of money to start the New Year off right!

Ed Craine is a principal in Smith-Craine Mortgage, and is a good friend and business associate. Ed is the promoter of The Strip Mall Conference, for which I have been a speaker on several occasions. He specializes in small commercial deals andis extremely customer-friendly and knowledgeable.