How Policy Decisions Affect Property Markets

Government policy decisions such as zoning and land-use regulation carry important implications for real estate professionals evaluating potential acquisitions and developments, said Green Street Advisors LLC, Newport Beach, Calif.

“Property investors with awareness of government policy will have an underwriting edge over those who ignore its impact because policy shifts are often not priced into property markets,” said Green Street Managing Director of Strategic Research Dave Bragg in the report, Policy Decisions Impact Property Markets.

Bragg noted commercial real estate investors expend significant energy underwriting the projected performance of prospective investments. “Thoughtful demand and supply assumptions provide some comfort for outlooks of future rent and value levels,” he said, noting an awareness of potential policy changes leads to better underwriting.

Policy decisions affecting the outlook for real estate investments include land-use regulation, zoning and taxes, Bragg said. For example, many property investment strategies focus on high barrier-to-entry metros where land and cost are perceived as constraints on new supply. But focusing only on barriers to entry ignores the biggest impediment to supply growth: land-use regulation, the report noted.

Consider the incentives and influences of residents and cities to separate markets that are truly supply-constrained from those that are not, the report said. Residents’ “Not in My Backyard” desires have greater influence in markets with high population relative to commercial property inventory.

“In our framework, New York City does not merit the equivalent ‘high-barrier’ status as other gateway markets,” Bragg said. “The rezoning of wide swaths of the city under [former New York City] Mayor Michael Bloomberg is likely underappreciated and contributed to near-record levels of inventory growth across most property types in recent years. By contrast, West Los Angeles’s high barriers are daunting.”

Thorough underwriting also considers shifting tax burdens that can affect property, the report said. “The commercial real estate industry breathed a sigh of relief as threats such as the elimination of 1031 exchanges were avoided [during the federal tax reform process in 2017]”. But that December 2017 tax reform law did change state and local tax deductions, which could lead to companies and people moving. “Poor fiscal health might exacerbate this issue as high-tax states like Illinois, New York and Connecticut have suffered from outmigration as individual tax burdens have ballooned. The reduction of the SALT [state and local tax] deduction will likely induce further strain on high-income earners in those areas.”

As always, awareness is crucial, Bragg said. “Policy items ranging from land-use regulation to fiscal health to federal tax reform all carry important implications for commercial real estate investment professionals evaluating potential acquisitions and developments,” he said. “Investors with awareness of government policy will have an underwriting edge over those who ignore its impact.”