By Russell Boniface

The ebb and flow of political power is as constant as the tides. The 2000 elections have again transformed the political land scape and the REIT industry is keeping a watchful eye on how President George W. Bush and the 107th Congress will address important real estate-related proposals.

REITs started the year off on an upbeat note when the instrumental REIT Modernization Act became effective January 1. The RMA allows REITs to own a taxable REIT subsidiary (TRS) for providing a variety of tenant services, thus enabling REITs to generate new income and stay competitive with non-REIT real estate owners. The RMA also changed the distribution requirement of a REIT's taxable income from 95 percent to 90 percent, allowing them to retain more cash for use in growing the business.

Now, NAREIT is hoping that policymakers will continue to advance the publicly traded real estate industry. They are monitoring several legislative issues including: forced access, the ten-year depreciation for tenant improvement costs and the TRS provisions to the RMA e-fairness.

Forced Access

The major goal of federal telecommunications deregulation in 1996 was to stimulate competition in the industry by removing government regulation. The result for publicly traded real estate companies has been a boom in communications choices for tenants. NAREIT and other major real estate organizations continue the work of the Real Access Alliance to demonstrate to the Federal Communications Commission (FCC) that the real estate industry is effectively providing tenants with competitive telecommunications options.

Key Committee Members for REIT Issues

Last October, the FCC issued a regulation that fell short of imposing mandates upon the real estate industry compelling totally unfettered access for telecom providers to multi-tenant environments (MTEs).

House Committee on Energy and Commerce chairman W.J. Tauzin (R-LA) stated last August as chairman of the Telecommunications Subcommittee that "this issue is extremely complex, involving several legal and constitutional questions," including a possible violation of the U.S. Constitution's Fifth Amendment property takings clause.

"Property owners are already arranging for multiple telecom service providers because that's what their tenants demand." explains Edwards. "There is no need for the government to intervene. The marketplace is working."

He points out that the telecom industry wanted an executive order granting increased access for federal contracting opportunities, but the White House never issued one. It was also seen as unnecessary by the General Services Administration, the largest commercial real estate organization, which is opposed to government-mandated telecom access. He predicts that the Competitive Local Exchange Carriers (CLECs) will continue to lobby the government for forced access but such regulatory power will be difficult to get. "President Bush is attuned to the benefits of an unregulated marketplace," he says.

Marty DePoy, NAREIT vice president of government relations, believes that the real issue for the telecom industry was to get more leverage on Wall Street, which may not have worked. "The perception now is that telecoms rolled out too aggressively... expanded far too quickly. In many cases they don't have the capital to wire an entire building network."

DePoy expects the telecoms to resort to other strategies. "Since they didn't get what they wanted, their plan of attack now will be to seek legislation that gives the FCC the authority to regulate telecom access. They will come at us with one hard, last gasp."

Katheryn Surface, general counsel at United Dominion Realty Trust, Inc. and a co-chair of NAREIT's Government Relations Committee, believes that for the telecom industry the next "battleground will be on the state level."

"The FCC is not going to pre-empt state law, so the telecom industry will attempt to implement forced access on that level." she says. "But are we going to have 50 states making their own rules?"

As DePoy sees it, telecoms shouldn't expect success on the state level. "There's no groundswell among states for forced access," he says.

The FCC is seeking additional comments from the industry as to how it might directly or indirectly regulate building owners, and whether the market requires additional regulation. Last December, the Real Access Alliance released a 48-page model license agreement covering terms and conditions for access by telecom providers. The Alliance solicited input from a wide range of companies and industry associations serving the real estate and telecom markets.

"Where comments included recommended changes, we addressed them in one of two ways," Real Access Alliance spokesman Roger Platt explains. "Either new language will be added to the draft, or existing language edited, to address specific issues or concerns."

The Alliance will be developing similar model agreements for residential and retail building access.

"The FCC has proposed another rulemaking and we will continue to engage in a dialogue with the them." Edwards says. "The FCC is still very much active in this issue."

Surface stresses the importance of the Alliance's efforts. "There needs to be a coordinated effort of the various real estate associations so that access will be handled in the marketplace rather than by government mandate."

Depreciation for Tenant Improvement Costs

As a function of doing business, REIT owners must modernize or reconfigure their rental space to suit the needs of new or existing tenants. However, for tax purposes the depreciable recovery period for costs incurred for constructing leasehold improvements is 39 years, causing a REIT to incur an artificially high tax cost on improvements. As a result, the commercial real estate industry is currently supporting legislation that would shorten the depreciation period to 10 years.

In the previous Congress, there were two 10-year leasehold improvement depreciation bills. Rep. Clay Shaw (R-FL) sponsored H.R. 844, an amendment to the Internal Revenue Code of 1986, and had the support of 144 cosponsors. An identical bill, S. 879, was introduced by Senators Don Nickles (R-OK) and Kent Conrad (D-ND) with 15 bipartisan cosponsors. The bills would allow building improvements to be depreciated using a 10-year depreciable life rather than the 39 years required by current law. If passed, real estate owners could more easily adapt their buildings to the specific needs of tenants. Companies would also be less pressured to develop "greenfields" in outlying areas.

"NAREIT supports this initiative," Edwards says. "Most commercial leases now average about seven years. To make the depreciation for tenant improvement 10 years is a little higher than matching the system to economic reality. But it would be much better than 39 years." Small businesses, he adds, would benefit because they turn over rental space more frequently than larger business and they can't afford to carry the cost of uneconomic tax depreciation.

As it stands now, property owners are discouraged from investing more resources for modern and efficient leasehold improvements. "The properties might need new light fixtures, plumbing and electrical systems, but property owners need to depreciate them for 39 years," says DePoy. "Things need to depreciate at a much faster pace."

Both Edwards and DePoy believe the future of 10-year depreciation legislation will depend on the cost-effect of the proposals, the positions of the new chairman of the Senate Finance Committee, Sen. Chuck Grassley (R-IA), Rep. Bill Thomas (R-CA), the new chairman of the House Ways and Means Committee, and President Bush's tax plan.

"President Bush has told business leaders he wants to better equate tax depreciation with economic reality to better promote efficiency," Edwards stated. "The House should give tax relief a warm welcome," he adds, "but since the Senate is divided the future of any tax legislation remains to be seen."

Taxable REIT Subsidiaries (TRS)

Prior to the RMA, REITs were prevented from deriving more than a nominal amount of income from "non-customary" tenant services. The RMA now gives REITs the power to own a TRS that provides non-customary tenant and building services so long as the services are subject to a corporate level tax. TRS examples include telecom providers, merchant building, and concierge, dry cleaning, delivery, renters insurance and travel services.

The TRS provision in the RMA allows a REIT to own up to 100 percent of TRS stock without disqualifying the rents it receives from its tenants. It also allows REITs to invest 20 percent of their assets into one or more TRS. Eighty percent of REITs will form a TRS, according to recent surveys.

"The new structure enables and encourages REITs to take the initiative in developing new and innovative services," said Mike Grupe, vice president and director of research at NAREIT. "REITs no longer must wait for others to introduce creative, value-added services and then follow their lead."

Grupe added that it's important to note that the TRS structure only provides the opportunity and does not guarantee results.

"Some strategies under the TRS structure will succeed and add appreciable value to the companies that effectively execute those strategies. Other strategies will be less successful and will either be modified or discontinued."

"REITs will have more flexibility," says Anthony Paolone, analyst at CIBC World Markets. Jay Leupp, managing director and senior real estate equity analyst at Bank America's Robertson Stephens Real Estate Group, believes the impact of the TRS structure can double the REITs industry's earnings growth rate to 14 percent to 18 percent annually.

But Surface cautions that REITs should avoid spreading themselves too thin. "They have to be careful and stay focused on their core business. They can't keep their eye off the ball."

Tax issues concerning TRS practices still need to be ironed out by the Internal Revenue Service, but it did clarify when a TRS election must be filed by granting REITs flexibility during the taxable year to file extensions.

"The devil will be in the details," says Surface. "Some procedures might be difficult to implement until industry practices are set."

Helping the REIT cause is Rep. Bill Thomas (R-CA), a primary sponsor of the RMA who was elected chairman of the Ways and Means Committee who will continue to bring the TRS issue to the table. "We are happy with his selection," says Edwards.

Adds Surface: "He's someone who doesn't need a learning curve."

E-Fairness: Sales and Use Taxes

E-fairness revolves around the collection of sales or use taxes on remote sales, including sales made on the Internet. The 1992 Quill v. North Dakota Supreme Court decision requires companies to collect sales and use tax only in states where they have a physical presence, and in 1998 the Internet Tax Freedom Act imposed a 3-year moratorium on e-commerce access taxes, ending in October of this year. The legislation did not, however, prevent states from collecting existing sales and use taxes on sales made over the Internet.

The legislation created The Advisory Commission on Electronic Commerce, which issued a report on Internet taxes to Congress in April 2000, but the Commission was not able to reach the two-thirds vote required by Congress to make any official recommendations. Last May, the House passed H.R. 3709, a 5-year extension of the moratorium included in the Internet Tax Freedom Act, however the Senate did not act, so the moratorium has not yet been extended. Congress has not yet addressed the separate issue of allowing states to require retailers to collect sales taxes on remote sales. President Bush has stated that he wants to extend the moratorium for five years, but he has not yet made any statements about the collection issue.

"We don't care if the Congress and the president extend the moratorium or make it permanent," says Tony Edwards, NAREIT senior vice president, general counsel and secretary. "However, we want the collection issue resolved at the same time. President Bush should be sensitized to the collection issue since Texas relies on sales tax. It is a contentious issue, but a perfect issue for the new president."

In June 2000, Peter Lowy, chief executive officer of Westfield America and founding chairman of the e-Fairness Coalition, went before the House Judiciary Committee to speak on the e-fairness legislation (H.R. 4462).

"We support a 'level playing field' so that all retailers have the same sales and use tax collection responsibilities," says Lowy. "Preferential tax policies and government subsidies for Internet retailers distort the market and give Internet retailers an unfair competitive advantage."

The issue was next considered by the Senate, as senator Byron Dorgan (D-SD) introduced the "Internet Tax Moratorium and Equity Act (S. 2775)," which encourages states to streamline and simplify their sales tax systems to allow retailers to collect sales and use taxes. "It would lessen the burden of collecting sales tax imposed on remote sellers," Edwards notes.

Edwards adds that this is also a "digital divide issue" because of the disparity between the use of the Internet among the rich and the poor. "Those with Internet access can avoid the sales tax, while those who don't have access must go to the store, where they can't avoid the tax." (For more information on sales and use tax and E-Fairness issues see "The Simple Life" on page 36 of this issue.)