Tax-Cut Winners: Landlords! [Updated]

Last week much attention was focused on winners and losers. Republicans in the House of Representatives narrowly passed a budget resolution (‘blueprint’ it was called) as a step toward tax cuts. While sold as a middle-class cut, analysts say that the middle-class will pick up the $1.5 trillion tab for the breaks afforded to corporations and the wealthy. There will be the inevitable horse-trading over the coming weeks but we can be sure of one thing: corporations will win BIG and landlords as a class will benefit too.

Note: This was posted November 1st long before the House and Senate came to an agreement on a tax bill – and more importantly before Trump signed into law a significant tax break for corporations and pass-through entities (like property owners).

First off, the tax cuts envisioned by the budget blueprint would reduce the corporate tax rate from 35% to as low as 20%. Some corporations already are able to reduce their effective tax rate to that level already, so presumably the lower corporate rate will produce much lower effective rates in practice. A lower corporate tax rate means more profit distributed to owners and shareholders. Moreover, those with a stake in those corporations will take home more of their income should individual tax rates drop from the top marginal tax of 39.6% to 35% (or even less) as envisioned. If today’s personal deductions hold then their effective tax rate will be that much lower.

And should the tax cuts stoke the economy as projected (a big if), then big landlords reap higher rents too. That’s why they are called the the rentier class: unlike those who derive income from wage labor, landlords accrue wealth by exploiting the value of land. And nothing affects land values more than public policy. Constraining the supply of housing only puts an additional premium on the available housing. Between the higher rents and tax savings, the rentier class floats higher – indeed higher than most.

For big corporate property investors there are yet other advantages. Capital gains on shares, for example: federal tax policy rewards capital over labor, and shareholders in top brackets now pay about half the tax rate on gains than they pay on wage income. Then there is the cheap money: Federal Reserve has kept interest rates near zero for a decade. And there is more money available though the federal EB-5 program that sells foreigners visas (starting at $500k) allowing developers to aggregate ‘investors’ funds to capitalize projects.

In the Los Angeles area, corporate residential landlords own upwards of 5,000 units each. Donald Sterling is one such corporate operator in Beverly Hills.

Second, the proposed tax cuts will give a huge break to non-corporate landlords who do business as limited partnerships or limited liability corporations. They will realize a big tax cut because these entities pass net income directly to partners. The proposed cuts under the budget blueprint would create a new tax category for that passed-through income – and with a lower tax rate (proposed at 25%). The more successful the investment then the bigger the break the partner(s) would get at tax-time.

For example, an apartment leasing business is organized as an LLC so it passes net income to owners at individual tax rates. Today marginal rates range from 28% to 39.6% in the top four federal tax brackets. After the proposed change, those owners would be taxed at just 25%. So the more successful is the partner, the tax cut would be proportionally larger.

Beneficiaries of pass-through entities are already at the top of the heap. Federal figures show that 70% of all pass-through income goes to the top 1% of taxpayers today. The tax change may find many landlords rushing to join them as limited-liability partners. And Beverly Hills landlords love limited-liability companies.

A substantial number of residential rental businesses in Beverly Hills are already organized as limited liability companies (or limited partnerships) even though the rental stock in the city skews toward smaller properties. According to city business tax records accessed today, 60 of 199 licensed apartment leasing businesses are of the limited-liability variety and thus pass net income to investors. We now this because such entities are required by the state to indicate they are limited-liability right in the name.*

11TH STREET INVESTMENTS LLC 716 ROXBURY DRIVE LLC JSSPEZESHK LLC
1317 BUNDY LLC 9709 WEST OLYMPIC BLVD LLC L CAP III, LLC
137 S BEDFORD, LLC 9750 – 9774 OLYMPIC BLVD LLC MC PARNELL PROPERTIES, LLC
145 N CLARK DR., LLC 9940 ROBBINS DRIVE LLC MGPMJ INVESTMENTS, LLC
145 SOUTH CAMDEN DRIVE LLC AK PROPERTIES-UPLAND LLC MIGDAL BH PROPERTIES LLC
153 S CAMDEN LLC AK PROPERTIES-UPLAND LLC MK REEVES APARTMENTS, LLC
158 S. ELM LLC ARBOR PLACE, LLC. N CLARK DRIVE LLC
200 SWALL INVESTMENTS, LLC BAHAR REALTY LLC NHVA1-XXXIX LLC
213 SOUTH HAMILTON DRIVE LLC BENEDICT LLC NORTH OAKHURST DRIVE LLC
220 DOHENY LLC BILRICH REXFORD LLC NPB ENTERPRISE LLC
273 LLC BURTON WAY REALTY, LLC OAKHURST RESIDENCES LLC
328 MAPLE LIMITED PARTNERSHIP CANON MOORPARK PROPERTIES LLC OAKHURST ROSE, LLC
337 DOHENY DR. LLC CLYDESDALE INVESTMENTS LLC PR BLU LTD.
341 SOUTH DOHENY BEVERLY HILLS 90211 LLC DIAMOND SHIELD INVESTMENTS LLC/ NASCOR LLC REEVES BH, LLC
443 S DOHENY DRIVE, LLC. DOHENY ARMS LLC RICHCOR HESS PROPERTIES, LLC
445 DOHENY DRIVE LLC DRESKIN, GELBER & SILVERMAN LLC ROBERTSON254, LLC
448-50 SOUTH DOHENY DRIVE LLC ELM DRIVE. LLC RODEO LLC DBA CASA RODEO
454 NORTH OAKHURST PROPERTIES LLC FOUR BJD, LLC S & A REAL ESTATE I LLC
454 ROXBURY PROPERTIES LLC GALE ONE PROPERTIES ,LLC S & A REAL ESTATE I LLC
474 ROXBURY DRIVE LLC JAFFA PROPERTIES, LLC VERTE & CO. L.L.C.

(Even though many apartment leasing businesses are named as LLCs in city records, some checking against state business entities suggests that there are more, even though they may not say ‘LLC.’ I have seen several city-licensed businesses that appear to match state-listed LLCs but don’t use ‘LLC’ in the city business name.)

I expect that we will see many more landlords convert their apartment leasing businesses to a limited-liability structure should the new tax law effectively lower the top rate to 25% just because it passes through a limited-liability company. That is simply a scandal!

Let’s Put It In Perspective

The rationale for these business-friendly tax cuts is to give employers more cash to distribute to employees. Though the prospect of big tax cuts probably have landlords already ready to bank their added ‘unearned increment,’ most of us tenants will not see the windfall reaped by landlords large and small because we won’t see rent decreases. And labor wages generally lag behind economic stimuli (such as a tax cut) because labor markets are relatively slow to respond (when they respond at all).

City Council adopted an urgency ordinance earlier this year to cap rent hikes at 3% precisely because rents in Beverly Hills seem to rise much more quickly than does a typical tenants’ ability to pay.

Even though landlords are likely to see a big bonus at tax time, let’s remember then they howled when City Council capped the annual rent increase. Indeed some were apoplectic at the prospect of an allowed 3% rise even though 1) landlords claimed in public meetings never to raise rents more than 3%; and 2) the allowed 3% rent increase is significantly higher than the annual rise in consumer costs. That capped allowed rent increase applies only to existing tenancies – lease renewals and month-to-month tenancies. Every new tenancy resets to market rent through ‘vacancy decontrol.’

So it’s difficult to feel much sympathy for landlords especially when a big tax cut comes their way. What is a few points shaved off the allowed annual rent increase when the landlord can reap a 10% or more reduction from top individual rates with a reduced rate for his apartment leasing business LLC? Yet we will still hear landlords gripe about the 3% rent cap. (We heard plenty of griping about the city’s business tax too, and that was just over a penny on the dollar, and as many as one-in-ten landlords weren’t even paying it.)

* California law requires all such entities to include the designation right in the name. The proposed name must include: LLC, L.L.C., Limited Liability Company, Limited Liability Co., Ltd. Liability Company, or Ltd. Liability Co.” (Section 17701.08).