Landmark Links April 20th – Surprise!


Lead Story… One of the biggest problems with rushing major federal bills through the legislative process is that it often results in lose ends and unintended consequences that were not properly thought through.  When the legislation in question deals with taxes, expect that enterprising tax attorneys and accountants will poke and prod it in every way possible to find weaknesses that can be exploited to the benefit of their clients.  That is happening now with the Tax Cut & Jobs Act and there could be a huge benefit for commercial real estate general partners.  Remember back during the election when then-candidate Trump famously said that he wanted the tax code simplified to the point that an individual could file on a post card?  Such a level of simplification may have been a worthy goal but shockingly, things didn’t exactly work out that way (end sarcasm here). Via Globe Street’s Erika Morphy (h/t Dave Kidder – emphasis mine):

One of the provisions of the Tax Cut & Jobs Act increased the holding period to qualify carried interest as a capital gain from 1 year to 3 years.

Or did it?

Stephen Sharkey, a partner at DLA Piper, has his doubts based on a technical reading of the new tax law. “When you look at the language of the bill, you will see there is a cross reference to a capital asset. Well, guess what — technically under the tax code real estate used in a trade or business is not a capital asset. It is what folks refer to as a 1231 asset and it has a special code provision under which you get capital gain treatment for commercial real estate even though it’s not a capital asset.”

In other words, he says, in one part the law specifically calls out commercial real estate. Then in another part, it uses a cross reference that doesn’t include it. The question is, which is accurate?

Sharkey thinks this was unintentional on the part of Congress, and will require Congress to fix it. In the meanwhile, he says there is a lot of hand-wringing in legal circles about how to handle carried interest. “The operative language that requires a taxpayer to have held an interest in a property for three years refers to capital assets — and that doesn’t pick up commercial real estate.”

In short, it is Sharkey’s opinion that the one-year hold period is still the law, not the three-year hold period.

First off, for the uninitiated, Investopedia defines Carried Interest as follows (emphasis mine):

Carried interest, or carry, is a share of any profits that the general partners of private equity and hedge funds receive as compensation, regardless of whether they contributed any initial funds. This method of compensation seeks to motivate the general partner (fund manager) to work toward improving the fund’s performance.

In English, carried interest is the difference between the percentage of the profit that the general partner receives and the percentage of the equity that the general partner invests.  Carried interest frequently finds itself in the political cross hairs with candidates frequently campaigning for it to be taxed as earned income and then quickly pivoting to a position allowing it to maintain capital gains treatment once elected.

As previously discussed here, the Tax Cuts and Jobs act was very favorable to commercial real estate developers and investors.  In fact, when the law passed, we noted that one of the few downsides for commercial real estate was the extension of the capital gains qualification on carried interest from one to three years since many smaller developers and value add investors were going to have to change their business model – which tends to run 18 – 24-months – or face a substantially higher tax bill.  I know of at least one Landmark client who had a sale linger into 2018 and thought that he would be on the hook for a much higher tax bill than had it sold in 2017 since he had been in said project for about 18 months.  If Stephen Sharkey is correct, he just got a massive boost in after-tax profit.  While this may be good news for real estate general partners in short term projects, it also introduces an element of uncertainty that makes it difficult to underwrite a project and formulate business plans.  Did Congress intend to exempt commercial real estate or was it an oversight in the rush to get something passed?  At this point no one can say for sure.  What I do know is that general partners will likely go with the most generous interpretation possible and wait for the IRS or Congress to push back or clarify.  If Congress does nothing to clarify and the IRS challenges the interpretation of tax attorneys like Sharkey, it would likely lead to a protracted legal dispute over the intent of the law.  At this point it’s probably better for general partners to hope for the best but prepare for the worst.  In other words, underwrite as if you will need three years for carried interest capital gains treatment yet hope for a more positive outcome.


Cash Cow: When Libor surged in 2008, it was a sign that the capital markets were frozen as banks needed to access capital in the Eurodollar market to fund their operations.  Today, banks aren’t dependent on short term capital markets like they were 10 years ago and are funding much of their operations through deposits – whose interest rates have barely budged.  As a result, surging Libor rates are going right to the banks’ bottom lines as revenue soars but borrowing costs remain largely unchanged. 

Bad Priorities: State and City politicians have long given out generous pension benefits in order to get votes.  However, bad demographics have led to deep funding deficits and cutbacks in services as costs spiral higher.

Getting Desperate: Facing historic labor shortages, companies have begun looking to teenagers to fill vacant positions.  However, teen employment still remains low by historical standards.

Inflated:  It’s difficult to read this and be at all positive about the direction of private equity in 2018:

The California gold rush of 1849 was led by individual speculators who dreamed of newfound wealth. The great private equity gold rush of the postcrisis era, like the subprime bubble before it, is led by managers and consultants, whose spreadsheets are well formatted and precisely wrong.

The California gold rush of 1849 was based on the discovery of actual gold in streams and mountains. The great private equity gold rush of the postcrisis era is based on airy ideas about operational improvements, low volatility, and historical outperformance. They may not be tangible, but they make for good bullets in a PowerPoint presentation.

The California gold rush of 1849 did not end well for the poor and desperate speculators who dreamed of a better future. And the great private equity gold rush of the postcrisis era may not end well for the confident experts who deploy other people’s capital with the goal of staying rich, not getting rich—and it may be even worse for everyone else.

How much has private equity contributed to the bizarre economic situation of recent years—in which asset prices soar while underlying GDP, along with productivity growth, remains historically weak? And is today’s private equity froth a warning sign of the next crisis?


Creative Destruction: There are some good reasons to be optimistic about the future of retail as leverage begins to fall and excess supply is re-positioned for other uses.  See Also: Don’t blame Amazon for retail woes, it’s only responding to market forces that would be in place whether it existed or not.


It’s Everywhere: Affordability issues may be worst in development-unfriendly California but its not so great everywhere else in the US either as labor scarcity and construction cost inflation take a toll.

Out of Reach: A new survey gives Los Angeles low marks for quality of life thanks to soaring housing costs.

That Was Quick: California lawmakers killed Senator Scott Weiner’s transit density bill earlier this week despite nearly all of them acknowledging that we are in an affordability crisis and need to build many more units to get out of it.  Yet another example of why we should watch what people do and not what they say.

Cutthroat: Low inventory, demographic shifts and rising prices have home buyers facing what may be the most competitive market in recorded history.


Piling In: A tidal wave of venture fund money, led by SoftBank’s massive Vision Fund has created bidding wars for startups that are causing concern about over-valuation.

Death Trap: If you ever fly Allegiant Air flight again after reading this story about it’s abysmal safety record, then you are far braver than I.

Hall Pass: The Trump Administration struck a deal with Republican Colorado Senator Cory Gardner to protect states that have legalized marijuana in exchange for Gardner ending his months-long Justice Department nominee blockade.

Great Divide: The Wall Street Journal finally weighs in on the great scourge of our time – pineapple pizza.

Chart of the Day

After a relatively short reprieve where long rates rose, the yield curve is back to it’s relentless flattening again.


Protected Speech: An Australian court dismissed a $1.8MM workplace bullying case that accused a boss of maliciously farting on one of his employees.  I interpret this to mean that farting is now considered protected speech in Australia.

This is Nuts: Students elected a squirrel to the ASUC Senate because Berkeley.

What A Headline: Scientists just recreated the horrendous substance found deep inside Uranus. (h/t Stacey Straw)

Chester Cheetah: A Louisiana resident returned home from work to discover a woman naked in her bathtub and eating her Cheetos.

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