Restructured excise tax could harm business, development

Restructured excise tax could harm business, development
The new state real estate excise tax (REET) structure set to take effect next year could raise rental rates and discourage further business investment and development in Washington. Photo: freepik.com

In a move that has stakeholders raising red flags about business investment in Washington and housing affordability, the state legislature earlier this year approved a bill that swaps the flat-rate real estate excise tax (REET) with a graduated rate – a change that is scheduled to take effect next year.

Members of the real estate, housing and development industries have articulated a clear warning that rather than generate new revenue for the state as some suggest, the change may instead prove detrimental on multiple fronts, including discouraging future business investment in Washington, reducing property sales and driving up rental rates – notably for senior housing.

During public testimony on SB 5998, McKenzie Darr with multifamily and senior housing developer The Wolff Company told state lawmakers that “should the bill pass, the only way to offset the negative consequences of the diminished value is to increase revenue by raising rents,” estimating increases of $250 for regular apartments and $400 for senior housing.

Notably, at a time when some legislators on the one hand say they are looking to address housing affordability issues, the new tax may well prove to undermine that objective, adding hundreds of dollars to annual residential apartment rent in Seattle according to industry members and the Up for Growth National Coalition (UFNGC), which has developed an online calculator showing how changes to public policy – in this case the new REET – lead to increased housing costs.

Currently 36 states impose a REET. Under Washington’s prior tax structure, all real estate transactions in Washington involved a 1.28 percent excise tax on the sale amount – the fifth highest rate in the country. Starting in 2020, under SB 5998 that flat rate will be replaced by a graduated rate determined by property sales prices, as follows:

  • 1 percent for property sold at or under $500,000;
  • 1.28 percent for properties sold between $500,000 and $1.5 million, as well as certain types of properties such as timberland, regardless of sales price;
  • 2.75 percent for properties between $1.5 million and $3 million; and
  • 3 percent on properties worth more than $3 million.

While the bill and other similar proposals were under consideration by the legislature, economic consulting firm ECONorthwest studied the potential impacts of the proposed REET. It concluded that “the burden of the tax changes fall disproportionally on multifamily residential, commercial, industrial, agricultural, and natural resource uses.”

The tax will also fall disproportionately on the central Puget Sound region, where King, Pierce and Snohomish counties made up almost 70 percent of all REET revenue in 2015.

In King County alone, 100 property sales compose 23 percent of all REET revenue, according to Greg Hanon with NAIOP Washington State, the Commercial Real Estate Development Association.

While the tax shift will affect Puget Sound to the greatest extent, ECONorthwest’s report noted that Washington’s border states of Oregon and Idaho have no REETs. The nearest states who do impose the tax are California and Nevada, with rates of .11 percent and .55 percent, respectively.

“The impact of these taxes will be felt strongest in neighboring metropolitan counties of Clark and Spokane,” the report states.

According to UFGNC’s calculator, the increased REET from 1.28 to 3 percent will add $264 to the annual rent for a mid-rise apartment and $348 to annual rent for a high-rise apartment.

That cost is even greater for industrial building renters. Travis Hale is a real estate developer with Panattoni Development Company and serves as its Seattle Partner. He told Lens that because of the new REET structure, the company has had to increase by more than $50,000 the annual rental cost for one of its warehouses.

“These returns are what Wall Street demands, and Wall Street’s not going to allow a lower return in Washington,” he said. “This increased excise tax is actually going to harm business and/or development.”

To avoid the looming tax implications, his company is planning multiple property sales by the end of the year. “Everything that’s stabilized and ready to sell, we’re going to sell it.”

Other high-value property owners may also choose to cash out before next year. The Economic and Revenue Forecast Council’s September report found that large commercial sales – greater than $10 million – spiked in July to $2 billion before falling to $600 million in August. However, the report added that those sales “could spike again to beat REET rate increase.”

Whatever happens in December, Hale anticipates a fewer sales once the law takes effect. “I think it’s going to cause a slowdown or hiccup – a temporary stall in the market for a little bit as we try to figure out how we’re going to absorb it.”

A loss in REET revenue could also cause budgetary problems for state lawmakers; the expected revenue for the restructured tax is $1.2 billion through 2025. Under SB 5998, the revenue is distributed as follows:

  • 4 percent to the general fund;
  • 7 percent to the Public Works Assistance Account; and
  • 4 percent to the City-County Assistance Account, with the remaining amount going to the Education Legacy Trust Account.

Another likely impact will be fewer housing units built, Darr said.

“The impact of excise taxes is considered by investors prior to initial capital commitment,” Darr said during her testimony. “The problem is not one of diminished returns but of an inability to obtain project financing; financing that is necessary for a project to advance.”

Also, the REET could cause property owners to hold off on a potential sale. In 2008, the city of Toronto enacted a 1.1 percent land transfer tax. A 2012 study concluded that it reduced the number of sales by 15 percent and prompted a decline in property values. “Relative to an equivalent property tax, the associated welfare loss is substantial, about $1 for every $8 in tax revenue.”

Hale envisions fewer developments occurring in Washington. “We’re going to have challenges. Some things are not going to pencil out. Things won’t underwrite.”

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