Pass the SALT?

I am a big infrastructure guy. Everywhere I go, I tell local investors that their city’s growth potential is limited unless it has good transportation infrastructure (roads, airports and mass transit). Based on my experience, “old-school” cities like New York, Washington D.C., Chicago and Boston score very high for transportation infrastructure. While Chicago’s subway system may look old, it would cost about $500 billion to replace. That’s a lot of valuable infrastructure that gives Chicago a long-term competitive advantage!

This is not so for “new-school” hip, young, up-and-coming cities like Nashville, Austin and Raleigh-Durham. But despite their inferior transportation infrastructure, these cities are growing like gangbusters with no end in sight. Seattle has grown so quickly that it is the only market I’ve seen in my career move up from secondary to primary status. These cities have grown despite their relatively weak infrastructure because they have deep pools of home-grown talent from top-tier local universities and live-work-play attributes that make them hotbeds for in-migration of highly skilled young professionals. Based on these observations, it’s easy to conclude that a lack of adequate transportation infrastructure does not prevent a city from attracting top talent.

The same can be said for taxes. The biggest issue in U.S. commercial real estate right now is the Republican tax plan, versions of which, at the time of this writing, have passed the House and Senate and are now in the reconciliation process. Both versions preserve many of the tax advantages for the commercial real estate industry, such as the 1031 like-kind exchange and the deductibility of commercial mortgage interest.

Perhaps the biggest concern for commercial real estate investors and occupiers is the proposed reduction or elimination of the state and local tax (SALT) deduction for taxpayers on their federal tax returns. These taxes can range from 7% to 13% of individual income in high-tax states like New York, California and Illinois, to as little as zero in low-tax states like Florida, Texas and Tennessee. The tax plans also have certain provisions that mitigate some of the impact of the loss of SALT, such as higher income thresholds to reach the top tax bracket, significant higher standard deduction (which means fewer people need to take advantage of itemized deductions like SALT) and a potential end to the Alternate Minimum Tax (in the House bill).  However, the fear is that, if the SALT deduction is eliminated, high-income folks in high-tax states may see a big tax increase, which could in turn make these markets less attractive to workers and the companies that employ them.

Nevertheless, I am not as concerned as many in the industry about elimination of the SALT deduction for the same reason I have stated about infrastructure. Markets that create and draw highly educated workers will continue to do so even if the marginal cost of doing business increases. Much like a market’s concentration of talent trumps its infrastructure quality for investors, that talent also trumps any higher cost of doing business. The markets that will be impacted most by an elimination of the SALT deduction already have a high cost of business and are some of the most dynamic markets in the country. High-cost markets like New York, San Francisco, Los Angeles and Chicago will always be magnets for talent.

As legendary New York Yankees catcher Yogi Berra famously said, “It ain’t over ‘til it’s over,” and that’s where we are with the tax bill. But even if Congress eliminates the SALT deduction, the high-tax markets with large concentrations of highly skilled workers should remain attractive to investors.

By Spencer Levy, Americas Head of @CBREResearch | Senior Economic Advisor.